Indian policymakers must balance growth amid global energy, tech shifts

After a blistering 8.2 per cent growth in gross domestic product (GDP) last financial year, India is now returning to its trend growth rate of 6.5-7 per cent. Some moderation was anticipated for three reasons: A lower fiscal impulse, interest rates remaining elevated for 21 months, and tighter lending norms.

 

The sharp deceleration in the second quarter of 2024-25 is a blip caused by slower-than-expected capital expenditure by central and state governments due to the prolonged elections and the impact of weather vagaries.

 

While the economy is expected to recover in the second half, growth for this full financial year will be slower than initially projected. The Reserve Bank of India now forecasts 6.6 per cent, compared with 7.2 per cent earlier. CRISIL has countenanced a downside to its 6.8 per cent growth forecast.

 

Nevertheless, medium-term prospects for India remain healthy. CRISIL estimates average annual growth through the end of this decade at Rs 6.7 per cent. Typically, there are three drivers of long-term growth: Capital, labour and productivity. Higher productivity means more output with the same inputs.

 

We see the bulk of the growth coming from capital investments, which are currently driven by government infrastructure projects and household investments. Infrastructure development is critical for a developing economy, as it not only drives short-term growth through higher multiplier effects but also enhances the economy’s long-term growth potential. Notably, the government’s infrastructure push has led to positive growth surprises following the Covid-19 pandemic. However, India’s private corporate sector has yet to fully engage in investment activity, despite favourable conditions such as low leverage, reduced corporate taxes, and benefits from government infrastructure investments.

 

We anticipate a measured increase in private corporate investments as sectors such as steel and cement benefit from ongoing infrastructure projects. The full potential of the production-linked incentive (PLI) scheme will manifest as it shifts to higher value-additions, which, by nature, are capital-intensive.

 

Additionally, CRISIL Research predicts new investments in semiconductors and energy transition/electrical vehicles will grow, reducing reliance on government spending over time. However, this shift will be gradual due to uncertainties from US tariff actions and uneven domestic demand.

 

Labour’s contribution to growth is expected to be relatively low in the base case due to inadequate workforce quality and low female labour force participation. While India’s female labour force participation improved to 42 per cent in 2023-24, it remains low compared to 60 per cent in China and Vietnam. Improving education and job opportunities in labour-intensive sectors could enhance growth prospects.

 

Productivity, the third growth driver, will play an increasing role throughout the decade. Improvements in physical infrastructure, digitalisation, and ongoing economic reforms such as goods and services tax (GST) will drive efficiency.

 

Among these, digitalisation has progressed the fastest since the pandemic, followed by infrastructure development and economic reforms. To accelerate growth further and remain competitive, India must continue its infrastructure development and propel the PLI scheme. Digitalisation, being less capital-intensive, in an enabling environment will foster innovation and efficiency. The advent of generative artificial intelligence promises productivity gains, especially in repetitive tasks. GST needs further refinement, including the inclusion of petroleum products and alcohol. Labour and land reforms will boost private corporate investments and enhance growth potential when fully implemented.

 

Other challenges loom as well. Climate change and geopolitical uncertainties, including tariff wars and insular policies, will test our mettle. Incidentally, many of the developed economies did not have to worry about this during their transit to high-growth phase.

 

India’s pursuit of higher growth will crank up its carbon footprint, as fossil fuels remain a key component of its energy supply. Additionally, India is working to shift its growth composition in favour of industry and infrastructure, which are traditionally more carbon-intensive than services. This makes decarbonisation while growing a unique challenge. Thus, India’s ability to manage the trade-off between high growth, energy security, and energy transition is being tested. Adroit policy decisions will be key.

 

Technological breakthroughs in carbon capture, long-term storage, and green hydrogen are crucial for a faster energy transition. For instance, the sharp reduction in solar prices has allowed India to adopt it at a fast pace. But this will be a non-linear path, so fingers crossed. India has rightly committed to net-zero emissions by 2070, considering its development stage and growth needs.

 

While energy transition is a long-term goal, urgent attention is needed to adapt to shocks from climate change. Rising temperatures, as seen in 2023 and 2024, impact food inflation and monetary policy. This impact is already visible in high food inflation, particularly vegetable inflation, which has hindered interest rate cuts by the Monetary Policy Committee of the RBI. The Committee targets headline inflation, which cannot be lowered without taming food inflation.

 

CRISIL Ratings has assessed that intense heatwaves have affected the collection efficiency of microfinance institutions, increasing delinquencies. Geopolitical uncertainties, rising tariff wars, and industrial policies to boost domestic production are gaining momentum as countries focus on resilience more than efficiency.

 

This issue is expected to heat up as Donald Trump returns to power in the US, likely imposing tariff measures against China. India, with a trade surplus with the US, will need to stay alert to these developments.

 

Such tariffs will slow the Chinese economy and intensify deflationary pressures. The resulting overcapacity and lower prices will enhance the competitiveness of Chinese exports, which will be a key factor for India to monitor as it faces a large trade deficit with China. Lower tariffs on imports of raw material and components have benefitted sectors such as electronics and pharmaceuticals in India. This strategy will remain significant for value-added manufacturing.

 

One thing is certain, though: With so many moving parts, policymakers will remain on their toes in 2025. 

The author is chief economist, CRISIL