India's GDP growth will overtake China's over 2016-18: Goldman Sachs

Forecasts FY16 GDP growth at 6.5% and FY17's at 7% on strong FDI inflows and a cyclical recovery

A day after global brokerage firm Macquarie painted a rosy picture of the Indian economy and raised its target level for the stock indices for the next 12 months, Goldman Sachs said India was set to overtake China and become the fastest-growing emerging market during 2016-18.

Goldman Sachs India managing director and chief India economist Tushar Poddar and chief Asia-Pacific strategist Timothy Moe said on Thursday they believed the Indian economy was beginning a new growth cycle, driven by reduced macro imbalances, benign global conditions (lower commodity prices) and structural reforms.

The Asia-Pacific research division of the foreign investment banking firm believes the Indian economy is on the mend. In 2015, Goldman Sachs expects the markets to give 13 per cent returns (after factoring in currency depreciation). The brokerage expects Nifty to close at 9,500 by the end of 2015, which is, however, less than 9,960 predicted by Macquarie.

Structural reforms and the focus on reviving the economy is expected to boost India’s gross domestic product (GDP) growth to 6.3 per cent in calendar 2015 (6.5 per cent in FY16) and 6.8 per cent in calendar 2016 (7 per cent in FY17), forecasts Goldman Sachs. In contrast, it expects China to grow by seven per cent in 2015 and 6.7 per cent in 2016. India’s growth is expected to accelerate in the coming years, while China would witness a gradual slowdown in growth, which economists prefer to describe as “long-landing”.

China's growth in the coming years is expected to remain below seven per cent, while India’s growth revives in the coming years, making it the fastest-growing emerging market. Other emerging markets such as Brazil, Russia and South Africa are expected to grow at a much slower pace on weaker commodity prices.

Even though Prime Minister Narendra Modi has been faulted for his many foreign trips and absence of “big bang” reforms, Goldman Sachs believes that a cyclical recovery has already begun with demand picking up. Financial conditions have significantly eased and liquidity conditions have improved. The government is looking at easing investment conditions in India and focusing on project clearances. Also, 2015 is expected to see a rush of foreign direct investments (FDI) coming into India, thanks to liberalising the defence, insurance and construction sectors.

Moe believes Modi’s recent foreign trips will result in close of $36 billion of FDI in the next calendar year. If the monthly inflow of $3 billion of FDI flows materialises, as anticipated by Goldman Sachs, it would outpace the $29 billion that came into Indian equities in 2010 — the highest in 10 years. In calendar 2013, foreign institutional investors poured in $20 billion into Indian equities, while this year has seen inflows of $16 billion so far.

Goldman Sachs also expects the Indian rupee to remain largely stable against the dollar, thanks to the capital flows. This means that even as the US Federal Reserve begins to increase rates next year, India will not see the kind of turmoil seen in 2013. However, India's rupee could appreciate strongly against other developed market currencies such as the euro and the British pound.

The biggest risk to India's growth story will come from the tardy implementation of reforms. The government has its task cut out as far as reforms in the financial sectors and in governance, labour and technology are concerned. Goldman Sachs believes the government will be able to push through reforms to boost manufacturing and infrastructure, implement goods and services tax, use technology to cut red tape and create a more friendly business environment. However, where the government can falter are labour reforms and pushing through changes in the civil services.