India’s economic momentum post-Covid-19 has been the inheritance of its own actions — it comes from a few years of heavy lifting on policy. The story goes back to 2007, when profit share of GDP was soaring. But the rise got arrested following a major move in policy via the Rural Employment Guarantee Act.
Implemented in 2006, this law marked a transfer from profits to wages. Eventually, higher wages should result in higher profits as they lift demand, but this does not quite work in India. Given India’s surplus labour and uneven (and often short) supply of goods and services, higher wages have led to a rise in consumer price inflation and stagflation rather than a rise in real growth. For India, a policy to boost profits — and then investments which create jobs and wages — appears to be a more reliable approach to generating higher real growth.
Indeed, the experiment between 1999 and 2004, which then caused profits to boom between 2004 and 2007, is evidence of the success of this approach. The government ultimately announced policies to lift the share of profits in GDP starting September 2019. It started with a meaningful reduction in the corporate tax rate, making the regime comparable to the rest of Asia. The rate was reduced from 34.9% (effective) to 25.2%, and a special lower rate of 17% was announced for new manufacturing companies.
Furthermore, the government took calibrated, sector-specific steps and, during the pandemic, has undertaken further policies directed at lifting the share of profits in GDP, including production-linked incentive schemes and increased infrastructure investment. These changes since 2019 top some tough reforms in the preceding five years, including the Goods and Services Tax law, the Real Estate Regulation Act, the Bankruptcy Code and the new inflation framework. The change in policy should not be underestimated since historically India has used tax revenues to fund social spending rather than corporate earnings.
During Covid-19, a silver lining emerged for India as global CEOs became more comfortable with both work-from-home and work-from-India. The number of global in-house captive centres that opened in India over the last two years was almost double that for the prior four years. During the two pandemic years, the number of people employed in this industry in India rose from 4.3 million to 5.1 million, and the country’s share of global services trade rose 60 basis points to 4.3%. In the coming decade, the number of people employed in India for jobs outside the country is likely to at least double to over 11 million, and we estimate global spending on outsourcing could rise from $180 billion per year to around $500 billion by 2030. This will have significant effects on both commercial and residential real estate demand. If India is already the “office to the world”, it is increasingly becoming its factory as well, as manufacturing capex rises helped by government policies, and Morgan Stanley’s multipolar world thesis, which is prompting localisation of supply chains. Multinational companies are seeking to diversify production but are also attracted to India’s growing domestic market, and government policy is making the decision to locate factories in India an easier one. We estimate that manufacturing’s share of GDP will rise from 15.6% currently to 21% by 2031, which implies nominal output jumping from $447 billion to about $1.49 trillion.
India is also undergoing digital transformation at population scale driven by the success of Aadhaar, which is designed to process high volumes at low cost with small-value transactions and is the basis for IndiaStack. India’s internet model is different from the world, as it is founded on IndiaStack, a public utility that is a highly inclusive, transaction-led model and provides interoperability, democratises data and is decentralised. The reasons for the success of IndiaStack include government support for technology-based solutions, its ability to solve market and social needs and open-source, AI-driven technology built at population scale and supporting institutions for implementation (NPCI for UPI, RBI for Account Aggregator, ONDC for digital commerce, UIDAI for Aadhaar). The stack has four layers: eKYC, Digilocker, eSign and multiple payment layers, including UPI.
This has changed the way India processes documents, invests and makes payments. The stack adds three significant layers that will alter the way India lends, spends and insures. The first, OCEN (Open Credit Enablement Network), is disruptive to incumbent banks but will simultaneously raise credit penetration by transitioning the system to cash flow-based lending. It also has the potential to lower credit costs due to enhanced data access from multiple systems. This will democratise credit at a population scale for both consumers and businesses. The second, ONDC (Open Network Digital Commerce), will aid the onboarding of merchants across the country, give consumers access to products hitherto available at higher cost, and enable interoperations between buyers and sellers. This is a major disruption to the consumer sector as products move from unbranded to branded and small traders modernise, with OCEN enabling credit at scale. The third new layer, a digital health ID, will enable a unified interface that will be interoperable across health service providers. It will allow customised insurance solutions and give the population better healthcare access. All these layers are based on user consent, and we expect rapid adoption, as we have seen with payments.
India is experiencing a major shift in energy dynamics. Access to energy is fundamental to prosperity. India’s daily per-capita energy consumption is around 800 watts (excluding food). This compares with 9,000W/capita/day for the US. Given the big upgrades to transmission and distribution over the past few years, we see a step change in India’s energy consumption to about 1,300W/capita/day over the next decade, bringing with it economic prosperity. A simultaneous shift in energy sources from fossil fuels to renewables —with twothirds of India’s new energy availability to come from clean sources like solar, biofuels and hydrogen — underpins a major shift, even as legacy capacity using fossil fuels will not be destroyed due to growth in energy consumption. This will improve India’s terms of trade, entail about $726 billion in capex, reduce inflation volatility, improve living conditions by lowering pollution and create new demand for electric solutions.
With these changes, by 2031 we expect India’s GDP to more than double to over $7.5 trillion, the stock market to compound annually at 11% to around $10 trillion, a discretionary consumption boom led by a rise in per capita income from $2,000 to over $5,000 and a quintupling of households earning in excess of $35,000/year to over 25 million, a rise in credit to GDP from 57% to 100%, causing a 17% annual compounding of credit growth, and a doubling of India’s share in global exports. We believe India is set to become the world’s third largest economy and stock market by the end of this decade. As a consequence, India is gaining power in the world economy and, in our opinion, these idiosyncratic changes imply a once-in-a-generation shift and an opportunity for investors and companies. We estimate this New India will drive a fifth of global growth through 2031, led by a combination of offshoring, unique digital infrastructure and energy transition.
Of course, many things could go wrong, including a prolonged global recession or sluggish growth, adverse outcomes in geopolitics and/or domestic politics, policy errors, shortage of skilled labour and steep rises in energy and commodity prices. That said, we believe the pieces are in place to make this India’s decade.
Desai is MD & Head, India Equity Research, Morgan Stanley
