This week’s meeting between the Chinese premiere Xi Jinping and his Indian counterpart, Narendra Modi provides the perfect backdrop to kick off MacroCentral.com. We take a look at India in particular, with a brief analysis of the successes achieved to date on the economic front by the government and the RBI, as well as as the economic challenges that the country faces going forward.

The two heads of state, who represent a grand total of more than 2.5bio people, surely have had a lot to discuss, as they need to balance their diplomatic issues with their economic interests. India is seen by many as a China-in-the-making, with the former lagging the latter by about 10years. The WSJ ran a great comparison between the two economies recently, showing how the two countries look alike.

What has India been doing right so far? One word, or rather, one person. Rajan. The Chicago – educated RBI governor has been successful so far in reigning in India’s chronically high inflation by raising rates and improving RBI’s communication strategy; opened the capital account, allowing foreigners to invest into Indian Government Bonds (there were severely high restrictions for non-residents to buy Indian GBs until a few months ago), and put measures in place to improve loan recovery by banks, helping reduce NPLs. More importantly he has given people confidence to keep more of their savings in rupee rather than gold (historically India’s main stock of wealth), helping reduce the country’s current account deficit.

Rajan’s scorecard – Source: India Economic Times

All these steps, combined with Modi’s election based on a pro-market agenda, have been instrumental in changing the perception of India as a good place to invest, and the currency has been among the most stable to date compared to its EMFX peers.

What are the challenges that India faces going forward? We can see the upcoming reduction in monetary stimulus, the lack of infrastructure and technological changes in the global manufacturing industry as the main hurdles.

Emerging markets in general, and India in particular, have been the main beneficiaries of the unprecedented amount of monetary stimulus that central banks around the world has the dramatic fall in global yields, particularly in G10 economies, pushed capital towards higher yielding destinations. As Western economies recover and the market perception about developed market yields changes, western money will soon start flowing back towards the US, UK or any country that’s “home”. Emerging economies could find themselves in trouble, particularly if they have not been able to make the most of the easy financing so far, by building buffers, developing domestic capital markets and leaning less on foreign currency denominated debt. The RBI has already raised the flag, highlighting the perils in sight

Given the stage in its development cycle, a solid infrastructure is key to build the next stage of economic growth and Modi has a lot of work to do in both areas.
The country’s lack of roads, railways, an unstable energy grid are bottlenecks need to be dealt with sooner rather and India is still very reliant on foreign capital to finance investments.  Modi has been thinking strategically in this sense, and the meeting with the Chinese premier is a step in the right direction, (China has committed to USD 100bio worth of infrastructure investment in India), as well as his call to arms for the huge Indian diaspora in the US to invest more money back home.

Lastly, manufacturing might not necessarily be the best destination for Indian investments. As the WSJ points out, the majority of India’s neighbours have already grown into major players in the production of garments, machines and computer parts, increasing competition and barriers to entry for new players, and making investments in these sectors a lot less obvious than they were 10 years ago. More importantly, the recent technological advances that already allow people with little manufacturing expertise to build objects in their own living room, using 3D-printing technology that’s likely to become affordable to the masses in a matter of years, will threaten the traditional manufacturing business model. Industries where unskilled labour makes up the majority of the workforce will not be there in 25 years time.

India should therefore focus on becoming a powerhouse in a different arena, where its highly capable engineers, mathematicians and scientists will be able to add value, and create wealth and innovation at home, rather than having to move to the US or London. To this end, investment aimed at the low margin manufacturing business should, instead, be diverted towards education today, in order to tackle the country’s huge illiteracy problem, helping increase the pool of talent from which the next generation of innovators will come from and thrive.

After all, why shouldn’t the next Google be based in Bangalore?