There is a general sense that India is an inward-looking economy. After all, agriculture makes up a fifth of the economy, and India is more domestic demand-driven than some export-led Asian neighbours. Having said that, we find that India has grown at its fastest pace in periods of rising integration with the world.
We use the rolling correlation between India and world growth as a measure of global integration and find that 2000-2010 stands out as a period of rising global integration. Back then, India was slashing import tariffs and integrating further into global trade networks, resulting in a higher share of global exports and stronger GDP growth. In the following decade, 2010-2020, India became more protectionist and started to raise import tariffs. This period marked a fall in the country’s global export share and GDP growth.
We also find that in the last few years, those following the pandemic, there has been a move back towards stronger global integration, though so far it remains a tad one-sided — more financial integration, less trade integration.
One may argue that higher global integration exposes a country to global volatility, which may be negative for growth. We find that the positive impact of being more integrated with the world outweighs and is longer lasting than the negative impact of being exposed to global shocks. All said, deeper interlinkages with the world have led to higher growth, more than offsetting the negative impact of the rise in volatility.
Next, we look at how India’s global integration has impacted different sectors. We find that consumption is most integrated with world growth (95 per cent), followed by investment (70 per cent), and then exports (35 per cent). Surprising, as one would imagine exports would be the most globally aligned.
One reason for this could be that India’s global connections are stronger in finance. Indian equity markets have become far more aligned with global equities over the last two decades. And this impacts consumption. But integration remains weaker in trade, which influences exports and investment.
We delve deeper, breaking down consumption into two parts — discretionary (good-to-have) and essentials (must-have) — and find that discretionary consumption has a much higher correlation with world growth. This is understandable. If indeed financial integration has been strong, it is likely to have impacted incomes at the top of the pyramid. High-end consumers, who are typically high-income earners, tend to be better-integrated with (or invested in) financial markets. Meanwhile, those associated with sectors like agriculture and small firms, where incomes may not be as high, are in general limited to consuming the essentials. This consumption group may not have extra money left over to invest in financial markets.
Within investment, we find that corporate investment has a higher correlation with world growth compared to household investment. Again, this is not surprising. We find that corporate capex globally moves in unison, driven by common factors like risk sentiment that impact the flow of foreign direct investment (FDI). But household investment, which makes up a larger share of investment, and includes both real estate and investment by small firms, is not as globally integrated.
We also look at the surprisingly low level of integration of India’s export growth with global growth. The fall in integration here was more pronounced in the decade when India was raising import tariffs, which we believe hurt export performance, especially in a world of value-added supply chains.
We divide exports into high-tech exports (like electronics, drugs and pharma and automobiles), and labour-intensive mid-tech exports (textiles, footwear, furniture, and toys). We find that growth in high-tech exports has been strong, but mid-tech exports have been sluggish for a decade. From this, we can deduce that India’s trade integration with the world has been weak, mainly due to sluggish mid-tech exports.
Bringing all the sectors together, we now have two distinct groups in the economy — one with “stronger financial integration” with the world, and another with “weak trade integration”.
Those who have been able to enjoy the gains of financial integration have seen incomes and discretionary consumption rise. Many of these individuals are associated with large firms (where global capex is globally correlated) or new businesses (for example, the rapid rise of professional services exports).
On the other hand, lower global integration in mid-tech exports explains weaker growth and incomes, and why individuals in these sectors are largely focused on consumption of essentials, without much surplus left over for investment. To us, measures that raise mid-tech labour-intensive exports can boost India’s trade interlinkages, mass consumption, and GDP growth. An opportunity to deepen trade linkages is knocking on the door.
If supply chains are rejigged during the second Trump presidency due to higher tariffs on large exporters, and the world is looking for new producers, India may get a chance to integrate more deeply with global value chains. If sectors such as electronics, textiles, furniture, and footwear are where global opportunities from potential supply rejigging lie, as we have seen from Vietnam, which made significant progress in the first Trump presidency, it is worth noting that India is already a player, with room to grow further, given advantages such as low wage costs. Incidentally, China’s excess capacity in these mid-tech sectors is less pronounced. Space for another manufacturer may well exist.
But first, India needs to make changes. And there is good news here. Potential US tariffs may have become a catalyst for external reforms, such as lowering the import tariffs India levies on others and fast-tracking trade deals. Some domestic reforms are also being pursued, for instance, a deregulation drive across the central and state governments, which could help improve the ease of doing business. These are steps in the right direction. But for results, these reforms will have to run deep.
The writer is chief India economist, HSBC
Those who have been able to enjoy the gains of financial integration have seen incomes and discretionary consumption rise. Many of these individuals are associated with large firms (where global capex is globally correlated) or new businesses (for example, the rapid rise of professional services exports). (Illustration: C R Sasikumar) 
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