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Economic and Market Commentary

Secular Stars: Why India and Indonesia Are Set to Shine as Global Economic Leaders

We believe the two resource-rich economies – once labeled fragile – will be global growth leaders over the next several years, driven by prudent policies and stable macro fundamentals.

In 2013, India and Indonesia were notoriously named among the so-called “Fragile Five” emerging market (EM) economies that depend heavily on foreign investment to finance growth. A decade later, their fortunes have flipped: The two Asian nations are now seen as rising secular stars amid a challenging global economic outlook.

Growth in India is expected to outpace that of China this year and next – with Indonesia following closely behind in third place among major economies – according to the Organization for Economic Cooperation and Development (OECD). In 2023, the OECD forecasts India to grow 6%, China to expand 5.4%, and Indonesia to grow 4.7%, while the global economy grows 2.7%.

Over the secular horizon, we expect annual real GDP growth for India at 6-7% and Indonesia at 5-6% due to continued reform-oriented governance and macro stability. Both countries, with a combined population of 1.7 billion, benefit from younger demographics in contrast to the rapidly aging populations in China and developed countries. In spite of uncertain external conditions, India and Indonesia have effectively managed inflation and fiscal financing.

Against this backdrop, we see scope for currency appreciation and growth outperformance, along with increased capital inflows.

Here, we take a closer look at six themes driving growth in the two countries.

1. Demographics

The size and age of the workforces of India and Indonesia will play a significant role in their economic growth in the coming years. Each has a young and growing labor force that is expanding faster than the number of dependents, with 68% of both populations currently aged 15-64 years and only 7% above 65. In contrast, in more developed regions, the old-age dependency ratio is much higher, with 20% above 65 years, and 64% aged 15-64. India alone will have over 1 billion working-age persons by 2030 and is expected to contribute about 24% of the additional global workforce over the next decade.

The median population age is projected to remain under 40 until 2070 for Indonesia and 2057 for India, in contrast to 2027 for China. This translates to a competitive advantage not only in terms of workforce, but also an opportunity to unleash the consumption, savings, and investment power of a young population.

2. Infrastructure

Infrastructure development is crucial for India to achieve its 2047 vision of a U.S. $40 trillion economy and reclassification from a developing economy to a developed economy. Prime Minister Narendra Modi’s Union Budget for fiscal year 2023-24 allocates 10 trillion rupees (U.S. $122 billion) to infrastructure development – five times the amount spent in the previous nine years. Studies by the Reserve Bank of India (RBI) and the National Institute of Public Finance and Policy estimate that for every rupee spent on infrastructure, there is a 2.5 to 3.5 rupee gain in GDP.

Infrastructure has also been a particular focus for Indonesia’s President Joko Widodo. Since he assumed leadership in 2014, there have been 2,042 kilometers of toll roads and 5,500 kilometers of non-toll roads constructed, as well as 16 airports, 18 seaports, and 38 dams, according to the president’s Cabinet secretariat.

3. Reforms

Modi’s sustained structural reforms are widely credited for helping the Indian economy enhance its overall efficiency, strengthen its fundamentals, and shed its “Fragile Five” tag. Bolstered by digital technology, the reforms are fundamentally aimed at improving the ease of living and doing business. They are guided by four broad principles: creating public goods, adopting trust-based governance, partnering with the private sector, and boosting agricultural productivity.

The 'Make in India' initiative launched in 2014 with the goal of making India a global manufacturing hub. With a transparent and user-friendly framework, and sector-specific production-linked incentives (PLI), it has helped foster innovation and increase foreign direct investment (FDI) in key sectors like railways, defense, insurance, and medical devices.

India’s macro stability has improved significantly since 2013, with the RBI building reserves and implementing effective liquidity management measures. Its flexible inflation-targeting policy, and central bank and government coordination on supply side measures, helped curb currency volatility and tame inflation without sacrificing growth. Its bank non-performing assets ratio is at the lowest in a decade (see Figure 1), bank profitability has improved, and corporate balance sheets have deleveraged. This will help ensure efficient credit provisioning, contributing to higher growth in the coming years through higher investments and consumption.

The bar graph shows how the gross non-performing assets (NPA) ratio of India’s commercial banks – a measure of stress in the sector – has changed annually from fiscal year (FY) 2002 to FY 2023. Overall, the gross NPA ratio has been declining since FY 2018, from 11.2 per cent to 3.9 per cent in FY 2023, suggesting that the asset quality of banks has improved. The NPA is currently at its lowest since FY 2014. Correspondingly, the stressed assets ratio, which is the gross NPA plus restructured assets, has also been declining since FY 2018 and is at its lowest since FY 2019. The source of the data is the Reserve Bank of India, as of 25 July 2023.

Indonesia’s turnaround has been driven by infrastructure investment, structural reforms, Bank Indonesia’s (BI) prudent policy mix, and the strength of its exports. Globally, the commodity boom has helped the resource-rich archipelago shore up its economic resilience and reduce its current account deficit.

BI set up its domestic non-deliverable forward foreign exchange program, and promoted greater use of currencies other than the U.S. dollar in trade and investment. Regulatory and tax changes resulted in higher local investor ownership of government bonds. These measures helped to curb currency volatility (see Figure 2), and with its burden-sharing agreement ensured financing costs were manageable during times of stress. Meanwhile, government reforms have reduced restrictions for foreign investors, streamlined permitting processes, and lowered foreign investment limits, which helped increase FDI.

The line graph shows how Bank Indonesia’s domestic non-deliverable forward (DNDF) programme, which was introduced in September 2018, has helped to curb currency volatility of the Indonesian rupiah between July 2019 and July 2023. There are two lines in the graph: one for outstanding DNDF in U.S. dollar billions, and the other for the U.S. dollar and Indonesian rupiah spot exchange rate in rupiah. Overall, there has been a declining trend in outstanding DNDF since March 2021, from over 5 billion U.S. dollars to about 1.3 billion U.S. dollars in July 2023. The spot exchange rate has been fluctuating between a range of about 13,900 rupiah and 15,800 rupiah between Oct 2020 and July 2023. The source of the data is Bank Indonesia, Bloomberg and Citi Research, as of 26 July 2023.

4. Shifting global value chains

As global companies adapt their manufacturing and supply chain strategies to build resilience in an increasingly fractured world, India and Indonesia stand to gain.

India’s services exports have been fueling overall export growth (see Figure 3), with a 14% compound annual growth rate (CAGR) over the last two decades. IT and business process outsourcing services make up 62% of total services exports. India has also become a leading global capability center (GCC) hub, accounting for over 45% of GCCs in the world outside of the home country. With a large talent pool and wages about 8-10 times lower than developed markets, we expect India to continue to gain share in global IT services spending.

As for goods exports, India has sectoral advantages in automotives, chemicals, pharmaceuticals, industrial machinery, and electronics. We expect manufacturing as a share of gross value addition (GVA) to grow to 21% of GDP over the next 10 years, vs. 16% in the last decade (9-10% real growth). Its manufacturing push and strong U.S. ties make India a top destination for firms’ “China-plus-one strategy”. A sign of early success: India assembled a record $7 billion worth of iPhones last fiscal year, accounting for 7% of global iPhone production (vs. 1% in 2021), and expected to reach 25% in the next few years.

The table shows the compound annual growth rate (CAGR) of India’s services exports over three, five and 10 years. The first column of data shows total services exports, which has CAGR of 15.1 per cent over three years, 10.8 per cent over five years, and 8.4 per cent over 10 years. The second and third columns of data are for software services and professional & management consulting services, which are two key segments of India’s services exports. Both segments have been experiencing accelerating annual growth since 2009, with a 3-year CAGR of 16.4 per cent for software services and 28.2 per cent for professional & management consulting services. The source of the data is the Reserve Bank of India, as of 25 July 2023.

For Indonesia, further downstream processing of its natural resources would be a key driver of its growth potential, as shown by its success with nickel, a key ingredient in lithium-ion batteries used for electric vehicles (EVs). Home to 22% of the world’s nickel reserves, Indonesia’s ban on exports of unprocessed nickel since 2020 has lured foreign investment into locally-based processing plants and smelters, and enabled it to move up the resource value chain.

As a result, Indonesia has become a basic balance surplus economy on the back of drastic improvements in the metal trade balance (see Figure 4). Its exports of processed nickel have soared from $1 billion in 2015 to $30 billion in 2022, and it is expected to account for half the global production increase in nickel up to 2025. It is looking to replicate this success with bauxite, tin, and copper.

Tourism is another key focus area for Indonesia with the nation’s “Five New Balis” plan, which seeks to invest in and promote five "super priority” Indonesian tourist destinations, in order to further boost tourism receipts, which as of 2019 stood at just 1.6% of GDP vs. 11.3% for Thailand.

The bar graph shows how Indonesia’s metals trade balance and basic balance (which is the net balance of the current plus capital accounts) have changed annually since 2012. From 2012 to 2019, both measures saw deficits annually, with the exception of the basic balance in 2017 where it had a surplus of 0.23% of gross domestic product (GDP). Since Indonesia banned unprocessed nickel exports in 2020, however, both the metals trade balance and basic balance have improved, recording surpluses (meaning greater exports than imports) and increasing in tandem. In 2022, the metals trade balance was 1.35 per cent of GDP, while the basic balance was 2.15 per cent of GDP. The source of the data is Bank Indonesia, as of 25 July 2023.

5. Energy transition

Indonesia’s advantage lies in commodities, buoyed by rising demand due to the global energy transition. By 2030, it is expected to be the world’s fourth-largest producer of “green commodities” used in batteries and grids, behind only Australia, Chile, and Mongolia.

With its edge in nickel, Indonesia is poised to be Southeast Asia’s hub for the EV ecosystem. Coupled with aggressive growth estimates for EV domestic demand (based on Indonesia’s energy transformation commitments to reach net zero by 2060), we expect to see greater FDI flows into the country.

Meanwhile, India’s aggressive energy transformation agenda, especially with solar energy and its push for green hydrogen, should help drive India’s potential growth higher.

6. Digitalization

Prior to 2009, India had no nationally recognized form of identification. Today, more than 1.2 billion Indians (including over 99% of the adult population) have a biometrically-secured digital identity known as Aadhaar. Launched in 2009, the Aadhaar program is part of the “India Stack”, India’s open-source digital public infrastructure that also consists of complementary payment systems and data exchange.

The India Stack has been harnessed to foster innovation and competition, expand markets, close gaps in financial inclusion, boost government revenue collection, and improve public expenditure efficiency. Meanwhile, the “Digital India” initiative, launched in 2015, seeks to improve online infrastructure and increase internet accessibility for citizens, empowering them to become more digitally advanced.

According to European Commission data, the pace of digitalization in India was the fastest among most major economies in the world during 2011 to 2019. India’s digital economy grew at 15.6% CAGR from 2014 to 2019 – 2.4 times faster than the overall economy. In 2021, there were 48.6 billion real-time payments in India, compared to 18.5 billion in China. Digitalization has also enabled the growth of micro, small and medium-sized enterprises (MSMEs), which contribute almost a third of the country’s GDP, but have long struggled to gain access to formal credit.

Indonesia has also made enormous strides in digitalization – accelerated by the COVID-19 pandemic – in terms of digital infrastructure, pro-digital legislation and regulation (such as the Digital Indonesia Roadmap for 2021-2024), and improvements in citizens’ digital literacy and proficiency. In 2021, there were 202 million internet users contributing U.S. $70 billion to Indonesia’s digital economy, with U.S. $146 billion projected in 2025. Similar to India, digitalization is accelerating the growth of Indonesia’s MSMEs, which contribute 61% of the nation’s GDP and provide employment for 97% of the total workforce.

Implications for investors

India and Indonesia went through a series of reforms before and during the COVID-19 pandemic under the leadership of Modi and Widodo, which have played a key role in developing resilience in both economies. Both countries emerged strong from the pandemic and Russia-Ukraine crisis, which challenged their institutional stability and political resolve.

We believe currency valuations have not fully reflected these positive developments. Given favorable cyclical dynamics, we see scope for currency appreciation and growth outperformance, along with increased capital inflows. We expect stable sovereign credit ratings with a potential for an upgrade. However, due to taxes and tight valuations, we do not find duration and credit to be attractive in either country.

The 2024 elections in both countries pose a risk to our view should they usher in a change of government, but we broadly expect policy continuity.

1 In 2013, Morgan Stanley coined the term “Fragile Five” in reference to the emerging market economies of Brazil, India, Indonesia, South Africa and Turkey, due to their high vulnerability to capital outflows and a currency slump whenever global interest rates rise.

2 OECD Economic Outlook, June 2023

3More developed regions, as defined by the UN Population Division, are Europe, North America, Australia, New Zealand and Japan.

4 United Nations Population Fund (UNFPA) State of the World Population 2023 report 

5 https://www.ey.com/en_in/india-at-100

6 https://database.earth/population/

7 Investindia.gov.in

8 https://www.ey.com/en_in/india-at-100

9 https://www.ey.com/en_in/india-at-100

10 The “China-plus-one strategy” is a policy of managing risk by locating plants and facilities in China and one other Asian nation.

11 In a balance of payments, the basic balance is the net balance of the combination of the current account and the capital account.

12 https://www.aseanbriefing.com/news/indonesia-sectors-to-watch-for-in-2023/

13 https://www.economist.com/briefing/2022/11/14/indonesia-is-poised-for-a-boom-politics-permitting

14 EY Economy Watch, April 2023

15 Reserve Bank of India, December 2022 monthly bulletin

16 ACI Worldwide, Prime Time for Real Time 2022 report

17 https://www.weforum.org/agenda/2022/05/digitalization-growth-indonesia-msmes/

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