Why India can't run much faster in 2018

By Ruchir Sharma

Blaring titles like “Boom Shaka-laka”, Wall Street forecasters are predicting that the global growth surge of 2017 will roll on next year. And they expect India to crash the party, finally.

Though it was the only major economy that didn’t accelerate in 2017, thanks to its own policy mistakes, India is a consensus pick to gain speed in 2018.


That’s possible. India’s economy has long tended to move in sync with the rest of the world, and it fell out of step last year largely because it was tripped up by the poorly designed GST, and the unorthodox demonetisation scheme. As those selfinflicted shocks fade, India should fall back in step, but for one big caveat.

Forecasters hyping a return to the 1990s and another “Goldilocks” age of high growth and low inflation in the global economy may be too optimistic. Several key economic trends are peaking worldwide, which means that India could jump back on the global economic bandwagon just as its growth rate may be about to lose momentum.

The big change since the Goldilocks era of the 1990s is demographics. The world’s capacity to generate economic growth is in good part a function of how many people are entering the workforce, and over the past decade a sharp fall in working age population growth has shaved a full point off the world’s growth potential, dropping it to around 2.5%.

The global economy just had its best year in a decade, with growth accelerating past 3%. Already then, growth is running hot, well above its new, significantly reduced potential. The world economy is thus much more likely to fall back than to accelerate next year. Sustaining a growth rate above 3% was feasible in the 1990s, when more young people were entering the global workforce, but not in 2018.

A dwindling workforce also puts upward pressure on wages, which will eventually spillover into higher inflation. That didn’t happen last year, but the pressure continues to build. A global unemployment rate calculated by JP Morgan since 2000 is down to 5.6%, tying its previous low. From the United States to Germany, Japan and Britain, unemployment in developed economies has fallen into single digits—lows last hit in the 1990s, or earlier.

In short, with economic growth and employment peaking across the globe, growth is likely to slow in 2018 while rising wage pressure finally pushes up inflation. Central banks across the world are now acknowledging these boom-like conditions and gradually stepping back from their post-crisis easy money policies. The US Federal Reserve and the People’s Bank of China are already raising interest rates and could be joined by more central banks next year. If the rest of the world starts to lose speed as a result of these tighter policies, it is less likely India’s growth rate will accelerate much beyond its current pace.

Moreover, even if the world economy does not slow, India faces a second series of constraining peaks in the domestic economy. Since 2013, India has made big strides reining in past excesses. The deficit in the current account, a measure of trade and financial flows that shows how heavily a country relies on foreigners to finance its spending habits, fell from nearly 5% of GDP — a risky level — to a low of less than 1%. The central government deficit, a symptom of the chronically spendthrift bureaucracy, came down from 5 to 3.5%. And inflation, which reflects in part weak investment and overconsumption, plummeted from double digits to below 4%.

Now, the progress on all these three key macro variables has peaked, and possibly turning for the worse. Higher prices for oil and other imports are leading to a widening of the current account deficit. Though the government expects its fiscal deficit to continue falling, there are reasons to think it won’t.

GST was designed to streamline the tax system while raising revenue, but appears to be falling short on the revenue side. While the government deserves credit for bringing more discipline to public spending, there are signs that it is slipping back into populism, offering giveaways and subsidies to the beleaguered rural sector. And the temptation to indulge in populist spending will only grow in the run-up to the national elections in early 2019.

Meanwhile, after a long period of sluggish investment growth and strong consumption growth, inflation is showing signs of turning higher. The excesses that haunted India for years, and appeared to have been beaten back, are thus poised for a comeback. The Indian bond market is already reflecting a peak in India’s macroeconomic fundamentals with bond yields steadily moving higher in recent months.

That doesn’t mean India is headed for a downturn; just that the country’s economic picture in 2018 is unlikely to look any better than what we saw this year. As growth and employment peak worldwide, the global economy is more likely to see slower growth (with higher inflation) than to relive the “Goldilocks” conditions of the 1990s. That will pose a headwind to India’s export growth prospects, and any domestic-driven rebound is likely to come at the cost of heavier spending, higher deficits, and possibly higher inflation. It’s thus hard to see how India can run much faster in 2018, and do it safely, when growth drivers are peaking on both the global and local fronts.