Monday, November 24, 2014
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The Case for India

NEW DELHI – Indian cricket fans are manic-depressive in their treatment of their favorite teams. They elevate players to god-like status when their team performs well, ignoring obvious weaknesses; but when it loses, as any team must, the fall is equally steep and every weakness is dissected. In fact, the team is never as good as fans make it out to be when it wins, nor as bad as it is made out to be when it loses. Its weaknesses existed in victory, too, but were overlooked.

Such bipolar behavior seems to apply to assessments of India’s economy as well, with foreign analysts joining Indians in swings between over-exuberance and self-flagellation. A few years ago, India could do no wrong. Commentators talked of “Chindia,” elevating India’s performance to that of its northern neighbor. Today, India can do no right.

India does have serious problems. Annual GDP growth slowed significantly in the last quarter, to 4.4%, consumer price inflation is high, and the current-account and budget deficits last year were too large. Every commentator today highlights India’s poor infrastructure, excessive regulation, small manufacturing sector, and a workforce that lacks adequate education and skills.

These are indeed deficiencies, and they must be addressed if India is to grow strongly and stably. But the same deficiencies existed when India was growing rapidly. To appreciate what needs to be done in the short run, we must understand what dampened the Indian success story.

In part, India’s slowdown paradoxically reflects the substantial fiscal and monetary stimulus that its policymakers, like those in all major emerging markets, injected into its economy in the aftermath of the 2008 financial crisis. The resulting growth spurt led to inflation, especially because the world did not slide into a second Great Depression, as was originally feared. So monetary policy has since remained tight, with high interest rates contributing to slowing investment and consumption.

Moreover, India’s institutions for allocating natural resources, granting clearances, and acquiring land were overwhelmed during the period of strong growth. India’s investigative agencies, judiciary, and press began examining allegations of large-scale corruption. As bureaucratic decision-making became more risk-averse, many large projects ground to a halt.

Only now, as the government creates new institutions to accelerate decision-making and implement transparent processes, are these projects being cleared to proceed. Once restarted, it will take time for these projects to be completed, at which point output will increase significantly.

Finally, export growth slowed, not primarily because Indian goods suddenly became uncompetitive, but because growth in the country’s traditional export markets decelerated.

The consequences have been high internal and external deficits. The post-crisis fiscal-stimulus packages sent the government budget deficit soaring from what had been a very responsible level in 2007-2008. Similarly, as large mining projects stalled, India had to resort to higher imports of coal and scrap iron, while its exports of iron ore dwindled.

An increase in gold imports placed further pressure on the current-account balance. Newly rich consumers in rural areas increasingly put their savings into gold, a familiar store of value, while wealthy urban consumers, worried about inflation, also turned to buying gold. Ironically, had they bought Apple shares, rather than a commodity (no matter how fungible, liquid, and investible it is), their purchases would have been treated as a foreign investment rather than as imports that add to the external deficit.

For the most part, India’s current growth slowdown and its fiscal and current-account deficits are not structural problems. They can all be fixed by means of modest reforms. This is not to say that ambitious reform is not good, or is not warranted to sustain growth for the next decade. But India does not need to become a manufacturing giant overnight to fix its current problems.

The immediate tasks are more mundane, but they are also more feasible: clearing projects, reducing poorly targeted subsidies, and finding more ways to narrow the current-account deficit and ease its financing. Over the last year, the government has been pursuing this agenda, which is already showing some early results. For example, the external deficit is narrowing sharply on the back of higher exports and lower imports.

Every small step helps, and the combination of small steps adds up to large strides. But, while the government certainly should have acted faster and earlier, the public mood is turning to depression amid a cacophony of criticism and self-doubt that has obscured the forward movement.

Indeed, despite its shortcomings, India’s GDP will probably grow by 5-5.5% this year – not great, but certainly not bad for what is likely to be a low point in economic performance. The monsoon has been good and will spur consumption, especially in rural areas, which are already growing strongly, owing to improvements in road transport and communications connectivity.

The banking sector has undoubtedly experienced an increase in bad loans; but this has often resulted from delays in investment projects that are otherwise viable. As these projects come onstream, they will generate the revenue needed to repay loans. In the meantime, India’s banks have enough capital to absorb losses.

Likewise, India’s public finances are stronger than they are in most emerging-market countries, let alone emerging-market countries in crisis. India’s overall public debt/GDP ratio has been on a declining trend, from 73.2% in 2006-07 to 66% in 2012-13 (and the central government’s debt/GDP ratio is only 46%). Moreover, the debt is denominated in rupees and has an average maturity of more than nine years.

India’s external debt burden is even more favorable, at only 21.2% of GDP (much of it owed by the private sector), while short-term external debt is only 5.2% of GDP. India’s foreign-exchange reserves stand at $278 billion (about 15% of GDP), enough to finance the entire current-account deficit for several years.

That said, India can do better – much better. The path to a more open, competitive, efficient, and humane economy will surely be bumpy in the years to come. But, in the short term, there is much low-hanging fruit to be plucked. Stripping out both the euphoria and the despair from what is said about India – and from what we Indians say about ourselves – will probably bring us closer to the truth.

The author became Governor of the Reserve Bank of India on September 4. This commentary was written before he took office.

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    1. CommentedSubhash Garg

      About India becoming a manufacturing giant: China grew at first by manufacturing American products thereby expanding their sales. Why can't India create the same equation with Japan? Would Japanese products made in India not be stiff competition for American products made in India?

    2. CommentedNikhilendra Marupaka

      I do agree external deficits are narrowing but isn't it more because of rupee depreciation rather than government actions?

    3. CommentedVS Aditya

      Its often side-tracked & became common to the bureaucrats of our country to question the stability & speaking of its strenthening - I do come across cases where development & strenghthing our fundamentals were just terms restricted to make power speeches. Never to forget & is indeed wrong to blame excessive imports or gold for its cause.

      We need to start working towards an act of achieving self-sustainity in the products (necessities) that we currently import - Providing the required infrastructure & technologies for enhancing the existing capabilities (both human & mechanics) should be a constant efforts from all.

    4. CommentedKarthik M

      Ensuring finance at cheap interest rates to the stool maker in Jobra village doesn't make an economy humane.

    5. Commentedbhuvan sethi

      "These are indeed deficiencies, and they must be addressed IF India needs to grow" I have been hearing this for a long long time.. Wonder when will we actually address them instead of listing them down. We know whats wrong. When will be get off the chair and do something about it..

    6. CommentedJonathan Lam

      Gamesmith94134: the case for India
      Bi-polar, it is. It seems like China ten years ago, SOE or private Enterprises are being blame on corruption that the second generations started their runs to exit China as the operation came to a halt. Many gave up Long term debt and short term debt on a swap or synched in a merger; after central bank sustained its tight policy on the cash flow and inflation kicked in after the outflow.
      Can Mr. Rajan maintain his control of the cash flow or mergers that sold rupees cheap? Read China’s policy. The case for India, 4% inflation and 15% off the rupee may be in unison in its bi-polar after the thundering in politics, and many SOE may not be scare off by thunder. Sonic cracked the pot. It may not be the case like China, but ………..
      I am not sure if Indian would be adaptive to the new system as Mr. Rajan claimed; but I think we must back to basic. Kung fu star does well in movies. I have to accommodate with Tai Chi, just because I am aged.
      May the Buddha bless you?

    7. Commentedvivek iyer

      'But India does not need to become a manufacturing giant overnight to fix its current problems.'
      This is a disappointing statement. It sends the signal that India will revert to a license permit Raj with Capital controls. What would restore faith in India is a consensus that India must manufacture or perish. What other mechanism is there to lift people out of poverty and to generate the jobs for the so called demographic dividend? The determination shown by the South Koreans in following Irma Adelman's advise in the early sixties led to a tripling of per capita income within a decade.
      Currently, what is needed is a new deal within the banking sector such that resources are allocated to build long term viability and infrastructure.

    8. CommentedJay C

      The challenge for Dr Rajan will be bringing the political forces in the country to do the right thing, not just the populist thing at the moment.
      The question is.. can he bring them inline...will take all his intelligence, knowledge.
      For example India should stop the guarented 100 day employment scheme - hopefully someone has done a study of how helpful it has been...?
      I am still an optimist on Rajan. Kudos for coming back to India and what looks like a sincere effort.

        CommentedKarthik M

        in a democracy the populist thing is the right thing, atleast in the indian democracy.
        Thanks for your advice.

        CommentedJay C

        Karthik -There is a difference between measured optimism and blind optimism. Good you are neither, but you need to read posts/articles with what I call "neutral" mind set. For someone who is neither an optimist nor pessimist - should come easy. No?

        CommentedKarthik M

        The politics in the country will remain populitist for quite some time now, I don't see any change in that. In several ways it has always been populist, but now the nature of the populism is changing.
        And I think it is your kind of optimism which Mr.Rajan tries to point to. No offence.
        I am not exactly a pessimist. I am, as slavoj zizek put it, "an optimist, for the very same reasons I am a pessimist".
        Regards.

    9. CommentedJasdeep Singh

      Optimistically and coherently written article. I think optimism and willingness is required from India to get on its lost trajectory. The solution is in India itself its just the strategy and willingness to go for it that is lacking thatbwill help us get our lost trust back.

    10. CommentedMridula Ramesh

      Dear Dr.Rajan,
      Thank you for an alternate viewpoint. However, several issues - corruption, crony capitalism and lack of investment in infrastructure and ballooning (and value-destructive) government staff expenditure - are not addressed at all. To illustrate, we are a young country. To ensure good growth, the training of these young is paramount. Last year, India stood second from the bottom in the PISA test rankings (the students were selected from Tamil Nadu and Himachal Pradesh). Teachers are paid handsomely but quite a few rarely show up for class. They are not held responsible for their charges training and disciplinary action (against erring teachers) is rare, if not absent.In the meanwhile, with all (and more) of the education budget taken up with salaries, infrastructure like bathrooms, blackboards and in many cases, roofs, are given a go-by. Without the necessary training and the mandatory pass until 8th standard, increasing numbers of candidates with impressive credentials but no employability are the reality many companies face.
      Sir, there are many solutions to this. But we need to recognize and understand the problem first. Not addressing it is no answer.
      With best wishes,
      Mridula Ramesh

    11. Commentedhari naidu

      Rajan's initial statement to the press was a market maker and it certainly changed the financial index in Mumbai....

      However, in spite of Rajan/RBI, PMO has more or less controlled RBI decision-making on interest rates historically.

      The bottom line today, from a political perspective, is whether Indian democracy can be sustained or not for the long term.

      The political fault-lines are forming - right now - and next general election will decide the path forward.

      Gerontology is the curse of Indian politics - dominated by old men - and until younger generation take over in Delhi there is little or no chance to change the current policy making paradigm in the subcontinent.

    12. Commentedprashanth kamath

      You talked of increased investment in Gold by Indians. But when bank interest rates are consistently negative (since 2009, at least!) isn't that the natural option? If Indians are investing in gold, government is largely responsible.

      Indians have no option in investing directly in Apple shares. They are not listed in India. True, one is allowed to take money out of India.

      Inflation has been higher than CPI in India consistently. The problem is that this makes the economy more inefficient, as real estate prices rise disproportionately.

      How can new capacity come up with high real estate prices? Service sector does not get deterred by high real estate prices as it can rent its premises. But it is a big hindrance for manufacturing - who can afford all the government clearances on a rented premises.

      Isn't the problem with land acquisition partly created by negative interest rates and the resulting asset price bubble?

      The previous RBI governor fought well in his second term. But he held his horses in 2009, when he had to raise interest rates. Could be his appointment for the second term was looming large? (Ref: Subir Gokarn)

      Industry will always plead for a low interest rate regime and project the lowest among price indices (CPI, WPI) etc.) to buttress its case.

      It is the CPI that affects the largest portion of the GDP, i.e. consumption.

      As an RBI governor you cannot do much about fiscal matters, but what you can do is watch inflation. Thankfully, you do not have to worry much about a second term, you can always go back!

    13. CommentedDeepak Tiwari

      Excellent write up by Dr. Raghuram Rajan. His article produces a resurrection of hope. Having said that, he should not underestimate India's challenges. Moreover, will he deny that India has become a hallmark of crony capitalism, corruption, rent seeking regulations, policy reversals, inaction and ineptitude of the lawmakers and leaders and that India's problems are self-inflicted and hence this self-flagellation?

    14. CommentedVijayalakshmi Shankar

      I like the use of "open, competitive, efficient, and humane economy". It is necessary to have the term humane there. Let us not drool over him or his looks but just wait to see what he does. Many a time we have all seen that "saying" is so different from "doing".

    15. Commentedtrizar rizqiawan

      Rajan always famous for his analysis and forecasting the financial market movement. But again it will be very different acting as an outsider and a policy maker. He made some policies, some good, some miss. Nonetheless, it is really important to show that someone is taking charge and giving the signal that the economy is on the right track, in this case, Rajan is quite succesful.

    16. CommentedSumit Gupta

      I liked the way you make it so simple to understand. The cricket example is perfect.

    17. CommentedGanesan Srinivasan

      Stable policies, strong institutions, property rights, rule of law and transparency are what have historically led to strong growth over millennia. Also, the rent seeking caste system has historically short changed India's growth potential. India still has a long way to go in this regard.

    18. CommentedScott Wolfel

      Good on big picture/macro, but brushes over many structural issues, like cronyism, red tape, infrastructure, etc. as others point out.

      In order to unleash India's potential over the long-term, as opposed to short-term tinkering with the policy variables, need to breakdown old institutions and priveleges and build a world class institutional and legal framework where enterprise can thrive. Also need to address poverty, education, etc. to leverage tremendous human capital, but this addresses a millennia old social system that oppresses many and gives tremendous privelege to the few. By building modern institutions and a legal framework that address these problems at their root, this cuts out the heart of many of the structural factors that are holding India back. The transition will be difficult as current elites fight back, and results won't occur overnight, but the longer term benefits will compound.

      So yes, pulling the macro levers and reforming at the margin, but a larger vision of India over the long-term.

      Also, as with other emerging markets, India's fate still remains tied to developments in the overlevered core.

      The manic depressive reaction to sports and economics is universal, although India may be more volatile because of the structural deficiencies and global dependencies. Bull markets/booms paper over a myriad of deficiencies, and everyone's a genius, but as the tide turns, the cracks are revealed and under pressure the structure fails.

      The ground is shifting, and we're still in the early innings of this phase of the crisis. The volatility of India's macro variables uncovers underlying structural weaknesses and dependence on the global core. As with a good sporting match, depending on how things play out in coming quarters and years, Governor Rajan willl either look like a genius or a dunce.

    19. CommentedMargaret Bowker

      I enjoyed the sporting analogy at the begining of Raghuran Rajan's article. Its accuracy made me smile. The piece had a sense of measured confidence in the way forward, which latest market and rates data generally supports, and offered a degree of certainty appropriate to the situation. including reasonable reform and smoothing regulation. In addition, it showed that a more realistic perception of what it takes to make steady progress is required; a calmer perception that doesn't expect growth and rebalancing to accelerate unreasonably, or not experience challenges. As other have said, a good article.

    20. CommentedTom W

      All fair points, but real appreciation had been much too rapid in recent years.

    21. CommentedProcyon Mukherjee

      Again a brilliant article from Rajan, and it is so true that what we think of ourselves as Indians would hold the key; not despair, not giving up but making change happen in our own areas.

      Betwixt popular measures that are also extremely important like land reforms and norms for land acquisition from land holders for the purpose of industry, we do not have a clear path that makes a common good look so simple and fair; the struggle for progress boils down to solving this puzzle, which is never so simple, where poverty has a breeding ground where industry would have made them better off otherwise.

      If coal production in India does not improve, which actually depends on land acquisition and rehabilitation process only, we do not have other alternatives to increase output in manufacturing. In that case diversification of agriculture also gets constrained, which is a way to move millions out of rural poverty as well.

    22. Commentedcaptainjohann Samuhanand

      Sir, The root cause of our Ills are the people like Kaushik Basu,Montek Singh Ahluwalia and ofcourse Shri.Manmohan singh along with you who were projecting FII as the sole panacea for all ills.This is what IMF and World bank people advocate so that Crony capitalism of India merges with western capitalism and becomes its slave.The very fact FIIS have no taken out money from stocks but only from debt shows they are very clever and knows how to milk the Indian stocks.today we have crony capitalism aligned with FIIs and then aligned with Politicians and pliant Media creating a giant NGO.It ensured coal blocks are syphoned off and then exposed so that imports have to be resorted to from Indonesia and Australia which are aligned with FIIs(IMF and World bank).Ditto is the case of manufactured goods like Iron ore in which we are in abundant supply and now forced to buy from China. Ofcourse Gold is another sickness.matter.Basically this NGO works in unison and corrupts the Indian babus,politicians etc. One can say How Indian banks are forced to swallow bad loans given to guys like Mallayya who pays $ i million a month to his CEO and slashes money on F1 while not paying salary to his airline employees.

    23. CommentedABHINAV Bhatnagar

      Though Mr. Rajan could warn the world of the global financial crisis, he did not make a single statement in the last 1 year warning Indian govt of overspending.
      Can he tell us why?

        CommentedRohan Chawla

        It's unreasonable to expect one person to predict everything with pinpoint accuracy. Just because he predicted the mortgage meltdown doesn't mean he is a seer of some kind. If you remember, his dire warnings about mortgage meltdown were ignored till it actually happened. Maybe he was ignored this time too. Who knows? Also, if you read the blog again, there are many low hanging fruits that he has mentioned or at least hinted at - projects getting held up because of red tape, ease of financing, subsidies that will hurt us in the long run. I do agree with you on one point. He should have put more emphasis on the blatant corruption this govt is guilty of and crony capitalism/nepotism.

    24. CommentedABHINAV Bhatnagar

      He speaks like the govt's parrot.
      If there is no structural problem, then what is the problem.
      Of course, corruption, crony capitalism, favoritism are not the problems either.

      He has been awarded for the advices that he had given as Chief Economic adviser in the last 1 year.
      Can anyone including Mr. Rajan tell us what he did in the last one year in Delhi, sitting next to PM.

    25. CommentedABHINAV Bhatnagar

      You were adviser in chief when the budget deficit ballooned, can you tell the readers what you and other were doing in Delhi when the budget deficit went out of control.

    26. CommentedABHINAV Bhatnagar

      There were not overwhelmed, there were simply working for the choosen few and assuming that the rest of the country will silently accept the crony capitalism. Decision making is not less averse, it simply works under pressure like FDI in retail etc.

    27. CommentedABHINAV Bhatnagar

      Banking sector bad laons, like the ones to King fisher airlines and many politically connected real estate players are result of corny capitalism. Wake up Mr. Rajan.

    28. CommentedRaghuraman MV

      Good Article.

      "India’s institutions for allocating natural resources, granting clearances, and acquiring land were overwhelmed during the period of strong growth "

      A clearer interpretation would be how much Indian policies are reactive at its best.Now that effects of globalisation is showing too much on the economy, India is running to get things done.Markets and commentators tired of self flaggelation are celebrating the change in Mint Street,knowing well weakness is elsewhere.

    29. CommentedArshad Shaikh

      I am impressed with Mr. Raghu's vision and his way of critical thinking. He has simple solutions to these fundamental problems. I wish him luck for meeting this challenge.

    30. CommentedHrishikesh Utpat

      This single article must have done much more to revive the Indian economy, than steps taken by the government in the past 5-6 months.

      Although, I would like to add this: Mr. Rajan says that trade deficit is decreasing on the back of increasing exports. I think it would be more prudent to wait for export performance over the next few months before commenting conclusively about that.

    31. Commentedsanthosh kumar

      i personally admire raghuram rajan for his great intellectual spirit and confidence with which he does his work.....i would like to know from rajan sir , as he mentioned in this present article "for the most part , india's current growth slowdown and its current account and fiscal deficits are not structural problems"

      this raises a number of questions.....!) if india doesn't face structual problem, why did subba rao, rajan predecessor , tightened monetary policy as food inflation has contributed to inflation despite agricultural surplus in the country?2) what was the need to tighten monetary policy if indeed rajan 's absense of structural problems is right?

      3) we are importing all the items, that can be produced domestically in india....electronic gadgets, power and heavy equipments.. so , rajan sir has to answer , why he is still advocating the same fii flows, which are hot and volatile, instead of long-term fdi investmnet to revive manufacturing in idnia , which can reduce trade deficit?

      4) why are we increasing our bureaucratic structures( planning commission, PMEAC)..plannning commission has served its purpose.its hight ime it is to be winded up and integrate intellectuals in advisory council and make it strong and give teeth to finance commission.?

      5) why dont we have RBI, blog and finance ministry blog, so that students like us know what the problems indian economy is facing , so that it gives students and economists a research capability ?

    32. CommentedMukesh Adenwala

      Perhaps the biggest deficiency of India story is that it has failed to evolve. Since 1955 we have heard time and again that India is in take-off stage; something that not only has failed to materialise, but continues to be doubtful of appearance. We continue to ravel as and when we get hold of low hanging fruits and most of the time we have not grown them either.
      It has been eminently observed that development is a transformation - a larva turning into butterfly; some fundamental changes that enhances the functionality. And such transformations, wherever they have occurred, have occurred within a short span of 30 odd years.
      I can say this not only because of my convictions but because there is no onus on me to be politically correct, something that will not be shared by people in high places.

    33. Commentedananda gundurao

      Critical thinking is not our forte, thanks to education system and cultural hang ups. Further, we believe in rights without responsibilities. In a rush to get to the top without commensurate effort and misplaced assumption of our superiority, anything goes wrong is because of system or external reasons; how often we sit back and think our own role in creating the chaos? I saw on a TV show, parents talking about increase in cost of educating their son in US and how they are advising him not to return as there is nothing to look up back in India! How many parents in US can afford $60K per year education to their children? These guys did not even once think how much country must have contributed to their ability to be able to send their ward to US for education? So much about educated lot! What will take us forward is a clutch of people like RR and few others who will do right things unmindful of noise around

    34. CommentedFrank O'Callaghan

      The phrase "Humane economy" is key. If an economy is not humane then it is not fit for purpose. Indian diversity and complexity are also key to it's future. It will be more innovative and productive than expected. It's total potential may be greater than that of any other "emerging" economy. Lifting the masses of India's poor is both a humane and economic imperative.

        CommentedKarthik M


        "It will be more innovative and productive than expected."
        Not necessarily, Frank...
        Regards.

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