2020 was a challenging year for the Indian economy, witnessing its first recession since the 1980s. According to the latest IMF World Economic Outlook report (January 2021), the Indian economy is expected to contract by 8 percent in 2020-21, making it the second-worst performer in Asia.

The year started with countrywide protests by farmers, including the siege of the capital, New Delhi, amid clashes with security forces. Domestic unrest coupled with alarmingly high Covid infection rates is likely to continue to weigh on the economy in the short term.

However, the world’s fourth-largest economy has built solid foundations for growth over the last three decades through reforms aimed at opening the economy through liberalisation of trade and investment regimes. Markets are betting on a V-shaped recovery in 2021 driven by higher government spending and an ambitious countrywide vaccination drive. The IMF forecasts a strong rebound in growth to 11.5 percent in 2021, driven by policy actions to support pick up in economic activity.

The structural reforms initiated in the 1990s included the liberalisation of the trade regime, encouraging foreign direct investment (FDI) and technology inflows, opening the capital market for foreign institutional investors (FIIs), and permitting domestic companies to access foreign capital markets. Rationalisation of custom tariffs and liberalisation of trade reduced costs of the Indian industry. Relieving production bottlenecks encouraged competition and promoted technology upgrades and export orientation of the industry. The liberalisation of the investment regime through automatic approvals of FDI in certain sectors and a single-window approval process in other sectors has led to FDI inflows rising from $103 million in 1990 to around $57 billion in 2020 (UNCTAD).

These reforms have helped the Indian economy sustain a high growth rate of around 7 percent for the last two decades and achieve this without causing macroeconomic imbalances. In the same period, Pakistan has seen short spurts of growth, which have led to a balance of payment crisis, reversing all gains.

So the big question is, can the Indian economy rebound in 2021? Will the economy be able to recover the losses of 2020? And will the recovery be sustainable? Smart money is betting big on a strong turn around with significant investments flowing into India, $57 billion in 2020 (UNCTAD). India and China were the only two countries that saw FDI rise in 2020, with all other developing countries reporting a sharp decline. Long term institutional investors, including Sovereign Wealth Funds (SWFs), invested $14.8 billion in India in 2020, compared to $4.5 billion in China.

Long term institutional investors see a strong track record of reforms, a big consumer market and most of all, the digital economy investments made over the last two decades paying strong dividends in the years ahead. The biggest investment in 2020 was made by the Facebook-owned subsidiary Jaadhu Holdings, which paid $5.7 billion for a 10 percent minority stake in Mukesh Ambani’s Reliance Jio platforms – the largest telecom giant in India and the third-largest mobile network operator in the world with over 400 million subscribers.

This deal is expected to help Reliance and Facebook take on the Indian digital payment space, which is expected to rise five-fold to reach $1 trillion by 2023. India is home to the largest user base for Facebook, with around 300 million users, while the company’s messaging app WhatsApp has 400 million users. The partnership is expected to revolutionise digital payment services in India.

However, key risks to the economy remain due to growing political and social unrest in the country. On Republic Day, the protesting farmers leading a tractor rally entered the capital, clashed with the police, stormed the iconic Red Fort and hoisted the Nishan Sahib, the flag of the Sikh community. The Modi regime has hinted that the red line has been crossed, and the government is likely to crack down hard on the protestors in the coming days. The Modi government’s heavy-handed tactics will likely make matters worse, while opposition parties, including Congress led by Rahul Gandhi, will see this as an opportunity to weaken the very popular Modi regime.

The other critical risk to the recovery is the rising Debt challenge, with the government debt estimated to have jumped to 90 percent of GDP in 2020 (IMF). This makes India the most indebted major economy after Brazil and Argentina among the emerging markets, and worse off than Bangladesh, Nepal and Pakistan. High debt levels will limit the government’s ability to give stimulus to the economy in the wake of the pandemic driven slowdown. Hence, India’s relief package during the Covid-19 pandemic has been relatively small compared to other countries. It is estimated that India’s stimulus package was around 1 percent of GDP, lower than the 3 percent announced by Pakistan in March 2020.

The Modi government will have to walk the fine line of stimulating growth while keeping government finances in check. Any further deterioration in the debt profile can lead to a rating downgrade by the international agencies.

The writer is a Financial Markets Specialist with over 18 years of experience working in international financial institutions and a visiting faculty member at the Institute of Business Administration (IBA) Karachi. His Twitter handle is @SayemZA