India: Four factors explain Obama’s outreach
In the decades following India's independence from British rule in 1947, the country was known mainly for being the largest democracy in the world, with a population that is currently more than three times that of the United States. From an economic viewpoint, the country's low income level, poor infrastructure, corruption and inefficiency in government, and its "Hindu rate of growth" were points of focus. The last term referred to the fact that in past decades, average annual GDP barely sufficed to offset a 2 – 2.5 percent annual increase in population despite the presence of a large, young and educated work force. What then explains President Barack Obama's recent visit to India, making him the first U.S. president to visit the country twice during his tenure? Obama even moved his State of the Union address to be able to accept Indian Prime Minister Narendra Modi's invitation to be the chief guest at India's Republic Day parade on Jan. 26.
The simple explanation for the changed circumstances is that relationships between nations, as well as global investment flows, follow rates of change of desired attributes rather than simply pursue stable levels. That is the crux of explaining Obama's desire to develop closer economic, financial and strategic links with the country. It is instructive to examine what has made India more attractive in the eyes of foreign governments and investors. I discuss below four of what I consider to be the most desirable attributes:
Pace of economic growth: A gradual relaxation of constraints on investments under the previous government led by Manmohan Singh resulted in real GDP growth accelerating to double-digit levels in 2010 and 2011. The 11 percent rate of annual growth posted in the first quarter of 2010 (solid line in the chart below) almost matched growth in China (dotted line). Even though growth has trailed off since then, optimism about the new government's proposed measures to reduce corruption and increase efficiency are already resulting in a surge of new investments. And as Chinese growth is expected to decelerate further during coming years, India’s expansion may exceed the China’s pace from 2016 onward, providing opportunities for investors.
Optimism in the stock market: Investor reaction to the Modi government is also reflected in the equity market. Compared with the roughly 23,000 level the Bombay Sensex Index was at in April – May 2014 when nationwide elections were held, it is approaching 30,000, an all-time record. Even though valuations are a concern - - equities are deemed to be richly priced at a price-earnings multiple in excess of 20 - - investors are betting that faster economic growth, regulation and new export opportunities will further boost equities.
Among the factors supporting share prices is the plummeting price of energy - - India's largest single import - - that has transformed the current account of the balance of payments from its traditional deficit to surplus. In turn, lower oil prices brought down inflation, leading Raghuram Rajan, head of the Reserve Bank of India, to cut interest rates recently. This is a move that a development that equity investors welcomed heartily. More rate cuts are anticipated.
Growing size of working population: According to World Bank data, India's work force of 481 million in 2013 was the second-largest in the world after China. However, the median age of the Indian population is only 27 years, compared with 37 in China - - a big difference in demographic terms. In turn, the relatively young Indian population makes for a growing labor force compared with China where the size of the work force may peak soon because of aging and the government's one-child policy. A rising middle class and a growing number of income earners are making India a target market for foreign producers of consumer products.
Coincidence of security interests between the United States and India: Apart from economic factors, the Obama-Modi summit was motivated by a similarity of strategic interests in the Asian region. Both the U.S. and China view each other warily, and China's growing assertion of military power in the South China Sea has been observed with concern in Washington. India fought a border war with China in 1962 and lost territory. Any deterrence of perceived Chinese intentions due to a closer U.S. – India relationship would be welcomed in New Delhi. Concern about a China link also partly explains the increasingly warm relations between Modi and Japanese Prime Minister Shinzo Abe. Japan and China have a long-standing dispute over disputed islands in the region. And it is no coincidence that the U.S. and Japan consider themselves allies on global security. Nothing promotes alliances more than the concept "the rival of my rival is my friend."
Obama's embrace of Modi last week – literal and figurative – must seem timely and welcome.