Future Growth: India’s ‘new’ economy


All told, the ‘digital’ dream is impressive, but for it to reach its potential, the ‘physical’ economy must rise in tandem.

By Pranjul Bhandari, Aayushi Chaudhary & Priya Mehrishi

The supply and the demand for risk capital into Indian start-ups have risen. The world is awash with liquidity as central banks have stepped up to support growth. There is appetite to put money into growing businesses. Venture Capital funding has risen sharply at a global level.

More stringent rules surrounding internet companies in some other countries could potentially direct more funds to India.

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New Indian firms have sprouted at a rapid pace, largely in the digital economy. As they grow, these firms have demanded funds at various levels. FDI, FII, VC and PE inflows are all on the rise. A breakdown of FDI inflows into ‘digital’ and ‘physical’ shows that about 50% is going into digital, versus 40% five years ago, and 20% ten years ago. Between 2015 and 2020, c$60bn has been invested in India’s tech start-ups, and this number is expected to rise by $20bn in 2021.

These digital start-ups are likely to benefit the economy in many ways, from culture to jobs. We go on to test the jobs impact econometrically. We find that real wage growth and real interest rates have explained India’s consumption patterns rather well in the past. But over time, an additional variable that captures the rise of e-commerce is growing in importance. We find that the online purchases to total consumption ratio, an indicator of e-commerce penetration is rising.

We marry this ratio with growth in real GDP, to get to a combination metric, which helps us determine whether the combination of higher convenience from shopping online and buoyant income outlook do indeed increase total consumption in the economy. All variables are significant and of the right sign. Our model suggests that e-commerce can in fact raise overall consumption.

A higher consumption pie will require more people to service it. We had earlier reported that e-commerce will lead to an increase in jobs across logistics & delivery, customer care, IT and management. True, several brick-and-mortar stores could shut. We modelled this carefully to find that, on net, e-commerce would create jobs. Business-as-usual estimates suggest that India could have a shortfall of 24mn jobs over the next decade. E-commerce could fill half that gap.

We believe these new-age firms will also do capex. Gross fixed capital formation can be broken down into tangible and intangible capex. The former mainly comprises dwellings & structures and machinery & equipment. The latter comprises Intellectual Property. New age firms could contribute a bit to each of these categories, directly or indirectly.

Digital companies could raise India’s GDP growth. Here, we attempt to quantify some of the growth gains. We limit our analysis to the e-commerce sector, for which we have a workable model. India’s e-commerce penetration is running a decade behind China’s. We assume that India can cover half of the gap with China in a decade. As the consumption pie rises, so will GDP growth. However, there is one complication that still needs to be addressed. The rapid rise in e-commerce over the last decade coincided with a sharp rise in personal credit growth. After having burnt their hands with industrial credit led bad loans, banks shifted focus to the still small personal loan market. Our regression may not be able to disentangle the impact of rising personal credit growth from the e-commerce convenience variable. We will have to net it off separately.

Using our estimate of the credit growth multiplier, we subtract off the growth impact of a more sustainable personal credit growth over the next decade. What we are left with is our clean estimate of e-commerce impact on growth.
We find that, over the next decade, if (a) India can close half the e-commerce penetration gap it has with China, and (b) banks continue to fund part of the consumption growth but in a more sustainable way while (c) growth and income prospects remain bright, rising e-commerce penetration could add 0.25ppt per year to India’s GDP growth.
Let’s put this in context. We had that pegged post-pandemic potential growth to likely fall from 6% to 5%. The rise of e-commerce, we calculate, can offset a quarter of the fall.

Where will the growth show up? A Cobb-Douglas production function framework shows that growth is driven by labour, capital and TFP. We think new-age digital companies will have most impact of TFP, via efficiency enhancing processes, followed by capex, and then labour.

But ‘physical’ economy limits can’t be ignored. The digital and the physical economy will feed off each other. Over time, the ‘digital’ economy will benefit the ‘physical’ economy in innumerable ways. But the digital economy will also be a large user of the physical economy, especially infrastructure and manufacturing.

New age firms will be big users India’s roads, ports, rails and other infrastructure. True that these firms will do some of their own capex, for instance in warehousing and data centres. But they will also be large users of the capex they do not do. Furthermore, they will also be intermediaries in the domestic trade of goods, which the physical economy manufactures. And here-in lie the constraints. India’s investment rate has fallen over the last decade. Public capex, which leads the infrastructure build-out in the economy, has been stagnant, even as private capex, which uses the infrastructure, has risen. The ‘physical’ infrastructure needs to rise in tandem with the ‘digital’ economy, to enable it to reach its full potential.

Similarly, sectors like e-commerce sell the products made in the ‘physical’ economy. If the consumption pie rises, but India’s manufacturing sector does not keep up, and the digital economy relies on imported goods, it could hurt India’s external finances, and become unsustainable. Even as overall FDI inflows have soared, the rise has been limited to the ‘digital’ economy. ‘Physical’ economy FDI, has been sluggish at low levels. All told, the ‘digital’ dream is impressive, but for it to reach its potential, the ‘physical’ economy must rise in tandem.

Edited excerpts from HSBC Global Research’s Economics India report, dated September 08

Respectively, chief economist (India), economist, and associate,
HSBC Securities and Capital Markets (India) Private Limited

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