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India: Watch out for these external shocks

Thierry Falise | LightRocket | Getty Images

A disorderly slowdown in China and regional geopolitical tensions could derail optimism surrounding India's outlook next year, according to a new report.

Asia's third-largest economy is closing out the year with a bang as cheap oil boosts its fiscal position and investors cheer Prime Minister Modi's pro-business reforms, making Indian markets one of the world's best performing hedge fund strategies this year, according to Hedge Fund Research (HFR). The renewed confidence is crucial to India maintaining its status as the current favorite among emerging markets.

"From the Indian perspective, how China manages the readjustment of its economy and how secure South Asia remains will be two major determinants that will influence world affairs in 2015," warned Mumbai-based think tank Gateway House this week.

South Asian security risks include another Mumbai-style terror attack in India, a military coup in Pakistan, the resurrection of the Taliban in Afghanistan, as well as the resumption of anti-India terrorist groups in Bangladesh.

Meanwhile, stalled economic activity in Beijing poses considerable risks for the entire world since Beijing is the largest trading partner for several nations, including India. Trade between the two economies totaled $65.5 billion last year and $66.5 billion in 2012.

Read MoreWhy China won't be Asia's dominant power

The group outlined the two worst-case scenarios for India depending on these two factors.

Scenario 1

An unstable South Asia that overlaps with an orderly Chinese economic slowdown could strengthen China's authority in new institutions, setting it on course for parity with the United States, sidelining India from the global stage, Gateway House said.

This could see New Delhi lose its reputation as a global swing state, with the U.S. and China making all the global decisions, the group said. India may also be excluded from new global trade agreements like the Trans Pacific Partnership (TTP) and the Free Trade Area of the Asia Pacific (FTAAP).

In this case, the group advises New Delhi to strengthen relations with other powers like the European Union, Japan, and actively excluded powers such as Russia.

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Scenario 2

If both South Asia and China are unstable – South Asia because of security and China because of the economy – then the U.S. will consolidate its power and retain its unipolar dominance, overshadowing India's political might, the report stated.

"Co-operation with Pakistan for a tidy drawdown of troops from Afghanistan is on the cards, as is surrender by India on trade and climate change negotiations. The dollar strengthens with the U.S. exercising exorbitant privilege. BRICS (Brazil Russia India China and South Africa) and G-20 recede in importance, and the World Bank and IMF (International Monetary Fund) call the shots again."

"It will be back to the 1970s, when India depended on the U.S. for capital, technology and innovation," the report added.