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28/2/2025
Though the medium-term growth outlook looks resilient, a stronger manufacturing sector is needed to create jobs.
India's economic trajectory is changing. For several decades, the share of services in gross domestic product (GDP) has been rising steadily, as our chart of the week shows. The success of the services sector has been reflected in a rapid increase in this sector's share of global exports, while the importance of manufacturing has steadily declined.
The growth picture has been volatile in recent years. In the years 2021-23, India's GDP grew at robust rates of between 7% and close to 10%. This momentum slowed significantly last year for several reasons. First, growth rates normalized after some years, driven by the rise of several high-tech sectors (the so-called "New India") of unsustainably strong growth. A deceleration in public investment growth from extremely high levels and adverse weather also contributed to the slowdown. In addition, adverse weather conditions weighed on GDP growth last year.
It is, nonetheless, important to raise India's growth potential back to 7-8%. And the near-term outlook has already improved. We expect seasonal disinflation in food prices to support the purchasing power of rural consumers. The prospect of falling interest rates also helps. Furthermore, the latest budget envisages a more supportive role for public sector investment, which had fallen from the high levels seen last year before the May election.
As services thrive, India’s manufacturing is stagnating
| % share of GDP |
But what are the medium-term growth prospects? The explosive growth of the post-pandemic years, driven largely by the high-tech sector, was not sustainable. Our medium-term forecast is for annual growth of around 6.5%. This slight reduction in the pace of growth from past years is something India can live. But the structure of growth needs to change. A large manufacturing sector is needed to create enough jobs to match the rapidly growing labor force. Job creation in manufacturing has been much lower than in services.
Comprehensive reforms are needed to increase the importance of the manufacturing sector and raise potential GDP growth overall. Other priorities include raising agricultural yields, improving climate resilience and increasing female labor force participation. Although India's overall debt level is moderate by global standards, the high level of public sector debt calls for prudent fiscal policies to reduce the fiscal deficit and debt-to-GDP ratio. While the services sector is driving India's global export competitiveness, a balanced approach that includes both manufacturing and services would consolidate India's economic recovery.
Achieving this structural change, with the historically stagnant manufacturing base revitalized to counterbalance the burgeoning services sector, requires adjustment strategies and steady reforms.
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