Risk drivers and outlook

The lasting political stalemate will remain until the 2014 general elections, affecting India’s economic outlook.

Communal violence, Maoist insurgency and unresolved conflict with Pakistan over Kashmir constitute India’s main security risks.

India’s weakened economic momentum partly results from cyclical factors and external shocks, namely the global slowdown, high inflation – particularly oil prices – and the eurozone crisis. But a deteriorated business environment and lack of structural reform further penalize the economy and threaten growth potential.

Poor public finances compel the general government to fiscal consolidation, depriving it from a major policy tool.

Facts & figures


  • Huge growth potential (favourable demographic profile, high savings and investment rates)
  • Broad-based economy
  • Performing services and industrial sectors
  • Sustainable external debt, comfortable liquidity position


  • Internal instability due to communal and socio- economic tensions
  • Difficult political ruling
  • Heavy imported fuel bill
  • Poor public finances

Main export products

  • Software services (12.3% of current account receipts), gems/jewellery (9%), chemicals (6.4%),agricultural (5.5%), textile (5.2%), tourism (3.4%)

Income group

  • Lower middle income

Per capita Income (USD)

  • 1,330


  • 1,205 m

Description of electoral system

  • presidential: 5-year term; next election: mid-2012;
  • legislative: 5 -year term; next election: 2014

Prime Minister

  • Manmohan Singh

Head of State

  • Pratibha Patil

Country risk assessment

Concerning political impasse

The federal political landscape has been paralyzed since a number of bribery scandals involving government officials and pointing to collusion with the business community were revealed late 2010. PM Singh’s Congress Party has had to face regular obstruction from the opposition within the Parliament and periodic disagreements with smaller allies within the ruling UPA (“United Progressive Alliance”) coalition, which have resulted in a lower number of bills being passed. Mr Singh’s government remains under pressure from the opposition and civil society, specifically over the disputed “Lokpal” anti-corruption bill that would give an ombudsman the power to investigate the political class and officials. Moreover, India’s federalism and democracy imply that the Congress Party is vulnerable to state election ballots. Its poor performance in several recent state elections, particularly in India’s largest state Uttar Pradesh, which was to the benefit of regional parties, has shown how much local issues and good governance matter and will make national decision-making even more complex.

Therefore, given the government’s weakened position and lack of consensus within the UPA coalition, the political stalemate risks to further delay much-needed structural reforms (e.g. tax reform) until the next general election of 2014 unless snap elections are organized. This is a source of concern in the context of an economic slowdown even though states have the ability to implement business-friendly reforms which allow them to perform better such as in Gujarat, Maharashtra or Karnataka. Unfortunately, national elections as such are not necessarily going to solve problems that are inherent to the current Indian political landscape.

After all, many had high hopes for the Congress Party after it won a landslide victory at the 2009 polls. The ruling coalition’s internal problems and lack of strong and emerging younger political leaders among main national parties might extend political instability.

Persisting and volatile security risks

India’s security climate is still suffering from sporadic interreligious and communal clashes, especially between Hindus and Muslims. Socioeconomic conflicts have become more pronounced over time as a result of India’s fast economic growth, posing an additional risk after the wealth gap deepened as the majority of the population remains poor and is excluded from the economic boom. This is particularly the case in several northeastern and eastern states (Chhattisgarh, Jharkand and Orissa), where security has gradually deteriorated over the past few years, 2010 being the bloodiest year ever due to the naxalite (or Maoist) insurgency. Naxalite operations have spread to more than half of India’s 28 states, but naxalite militants are particularly active in poor and rural states, and frequently engage in violent action against the authorities and (foreign) businesses with the aim to extort money, fight income disparities, land sales and environmentally destructive activities. PM Singh has called the naxalite insurgency the biggest threat to India’s internal stability. Bringing about more inclusive growth seems the only way out of the conflict after a massive military response from government forces failed in 2009-2010. A relative drop in violence has been reached, however, since the start of negotiations with the Maoists.

On the external front, besides long-standing territorial disputes and a long-term struggle for regional hegemony with China that is generally conducted in a pragmatic and peaceful way, India’s foreign policy is dominated by historically tense relations with neighbour and nuclear power Pakistan. The peace process was resumed early 2011 but is fragile given tensions in the disputed Kashmir region and the persisting threat of terror attacks from extremists on both sides. In the near to medium term, no significant breakthrough is to be expected on controversial issues given that both governments are weakened and have more important domestic problems to deal with. Nonetheless, ongoing plans to normalize and increase cross-border trade are a positive sign of improving ties.

Weaker momentum, possibly lower growth trajectory ahead

After years of robust GDP growth averaging 8.5% in 2003-2010 and having been moderately affected by the 2008 global financial crisis, India’s economic momentum has been losing pace since 2011, which is especially the case for the industrial sector. It might become difficult for India to keep up its strong performances due to a number of hurdles that have accumulated, one being the negative impact from the global slowdown through decelerating exports to advanced countries, though the latter contribute comparatively less to India’s economic growth, and the negative impact from high commodity prices. These two factors combined are likely to widen India’s current account deficit to about 10% of export receipts before resulting in a downward trend. With oil prices above the USD 100 a barrel threshold and the threat of an oil shock caused by a conflict over Iran’s nuclear program, India’s heavy fuel bill - amounting to a  third of its imports of goods - will continue to weigh strongly on its balance of payments.



Previous ambitious growth prospects have been revised downwards as India may shift to a lower economic growth path around an average of 7.5% by 2015. India’s broad-based economy will remain primarily driven by strong internal demand inside a huge domestic market and a resilient services (IT) sector. The problem is that loans to the private sector and investments are still being crowded out by high interest rates as a result of a two-year monetary tightening. Even though the recent shift to a more accommodating monetary policy will improve the situation and allow a rebound in domestic demand as inflation abates - from an average 10.4% in 2010 to 6.9% in Q1 2012-, the latter might stay high as it is experiencing upward pressure from imported oil and recurrent food supply constraints. Consequently, there is a risk that monetary conditions may not ease enough and continue somewhat to penalize growth.

High borrowing costs and uncertainty about the global economy only partially explain the substantial decline in corporate investment. In fact, this has been taking place in a climate of waning investor confidence due to bad governance and the lack of economic reforms as reflected in decreasing FDI inflows over the last two years (to less than USD 20 bn), a notable exception in Asia, where FDI inflows continue  to rise. This evolution is caused by a deteriorated business environment (corruption, red tape, infrastructure bottlenecks, etc.) and has increased India’s vulnerability to capital outflows and led to a growing use of external borrowing to finance its current account deficit. Hence the government’s decision  to allow foreign nationals to invest directly in open stock markets and pension funds. This rare case of recent (financial) reform is supposed to encourage portfolio investment inflows, which are hit by the eurozone turmoil and banks’ capital repatriation.

Poor public finances limit room for manoeuvre

The economic outlook is also clouded by the chronically poor budget situation in a context of political deadlock. Compared with other emerging economies and the rest of Asia, India’s public finances are among the weakest with a general government budget deficit at 8% of GDP in FY2011/12 (higher than targeted), a public debt stock at 66% of GDP that is almost entirely domestically financed (but decreasing) and heavy public interest payments close to 25% of total revenues.

India_Graph3EN India_Graph4EN

This leaves the Indian government with very limited room for manoeuvre to stimulate a slowing economy. It nevertheless keeps raising its public investment plans in infrastructure, thanks to the contribution from cash-rich state companies, with the government hoping that the private sector will maintain a high participation level in projects. The government’s continued commitment to fiscal consolidation implies raising the general government budget revenue-to-GDP ratio (under 18% in 2011) to finance massive spending in infrastructure, education and anti-poverty policies. However, the process is expected to be slow depending on economic developments, and difficult to implement two years before the next general elections, so that slippages could reoccur.

A major (indirect and direct) tax reform is still in the pipeline, the privatization program is underway but badly needs better market circumstances, whereas cuts in rising non-food subsidies – total central government subsidies exceed 2% of GDP - are planned. Nonetheless, given the unpopularity of the latter decision, the government might have to soften, cancel or postpone as has been the case for many other measures (e.g. opening of the multi-brand retail sector to foreign investors, train fare hikes…) since last year, which clearly highlights the adverse impact of the political deadlock on economic reforms. The fiscal consolidation process will therefore have to be assessed over the medium term.

Despite being faced with a gloomier economic context, limited economic policy options and political uncertainty in a country where still over a third of the population lives in utmost poverty, India’s huge economic potential keeps the country’s bright prospects alive. India’s economy is bolstered by high investment and savings rates (over 30% of GDP), a vast and dynamic internal market boosted by a rising middle-class and young population which allow the economy to retain its tremendous ability to weather shocks and be resilient over time. However, tackling structural weaknesses – with transport and power infrastructure heading the list – and launching supportive economic reforms are more than ever required as they will determine India’s growth trajectory and sustainability. With regard to these objectives, the extreme difficulty to find political consensus and the weakened political will threaten to make India lose two more years.

Favourable debt position and external liquidity

Contrary to its domestic debt, India’s external component is highly favourable as it is likely to remain around a sustainable 20% of GDP in future. Increasing external borrowing is forecast to be offset by sustained economic activity although uncertainty clouds the magnitude of future performance. India’s external liquidity position is strong as well, with an easy financing of debt service and nearly double cover of short-term debt. However, as a result of the widening trade account deficit due to higher import costs following notably significant rupee depreciation in 2008 and 2011, the trend in foreign exchange reserves has gradually moved downwards. Volumes have decreased to a level currently allowing an import cover of less than 6 months, which is still comfortable but nearly half of the 2007 peak. The expected economic trend appears to indicate a continued progressive deterioration for the years to come.

Risk outlook

While India’s weaker economic performance is partly explained by cyclical factors and external shocks, there is a structural component in India’s less favourable developments. Therefore, in a more challenging economic context, the implementation of reforms and an end to the political stalemate are essential to restore investor confidence and exploit India’s huge economic potential. The country risk has increased but any modification of the political risk classification is unlikely in the short term thanks to India’s intrinsic economic resilience. However, given the deteriorated business environment, a downgrade of the commercial risk classification might be considered sometime in future.

Analyst: Raphaël Cecchi, r.cecchi@credendogroup.com