Thursday, April 24, 2014
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What’s Troubling India?

CAMBRIDGE – India’s recent fall from macroeconomic grace is a lamentable turn of events. After many years of outperformance, GDP growth has slowed sharply. Annual output will most likely rise by less than 5% this year, down from 6.8% in 2011 and 10.1% in 2010.

Reform has stalled amid profound political paralysis. All of the major emerging economies face weakening external demand, but India’s slowdown has been exacerbated by a drop in investment that reflects a deeper loss of official direction and business confidence. Even the International Monetary Fund’s forecast of a modest improvement in 2013 is predicated on the government’s ability to breathe life into a spate of stalled economic reforms.

India’s recent torpor has underpinned a remarkable shift in global opinion. Just a couple of years ago, India was developing a reputation as the cool place to invest. Heads of state tripped over one another to meet business leaders in Mumbai, hoping to pave the way for a significant expansion of trade and investment. Now their interest has faded, along with the macroeconomic numbers.

And yet changes currently afoot might just turn things around. India’s octogenarian prime minister, Manmohan Singh, has recently awakened to the desperate need for renewed momentum. Economists around the world have taken note of the arrival of Raghuram Rajan as chief economist in the finance ministry. Rajan is a superstar academic researcher, a brilliant writer on political economy, and a former chief economist for the IMF. But it is far from obvious that Sonia Gandhi, President of the Indian National Congress and the country’s most powerful politician, shares Singh’s reform agenda.

True, the cabinet is being reshuffled to elevate younger ministers. But the process points to a continuation of the tradition whereby most ministers are appointed on the basis of their loyalty to the Gandhi family rather than their merit and accomplishments.

Unfortunately, for a country as poor as India, only sustained rapid growth can lead to enduring development gains. India’s poverty rate (an indicator that is admittedly both conceptually and practically difficult to measure) fell by half between 1981 and 2010, to just under 30% – a remarkable achievement. But faster-growing East Asia has experienced significantly greater progress, with the poverty rate falling from 77% to 14% over the same period.

Why has India’s growth acceleration fizzled? For many years, India benefited from the long-lasting impact of economic liberalization in the early 1990’s. Back then, Singh, as finance minister, played a central role. He could count on the IMF – which had real policy leverage, owing to India’s need for a bailout program in 1991 – to provide external support to counter the huge internal obstacles to reform. Today, however, there is no external counterweight to the domestic political pressure that is stalling further liberalization.

True, India’s government must now consider growing threats to the country’s investment-grade credit rating. The major ratings agencies are increasingly complaining about the country’s lack of a growth strategy and its outsize budget deficits. But the impact has been limited, owing to the authorities’ ability to stuff debt down the throats of captive local banks, insurance companies, and pension funds.

Indeed, this “financial repression” tax on domestic savers remains a huge opaque source of funding for India’s debt-ridden government. It also prevents funds from being channeled to private-sector investment projects with far higher rates of return than the government can offer.

The good news is that, from an economic perspective, there is still plenty of low-hanging fruit for restoring growth. Although India is right to avoid taking financial liberalization to the extreme that the United States did in the decades before the recent meltdown, it can do quite a lot without assuming inappropriate risks, as a commission headed by Rajan detailed a few years back.

The retail sector is a huge source of inefficiency that effectively places a massive tax on India’s poor by driving up prices. Instead of suing foreign retailers like Wal-Mart, India should be finding ways to emulate and benefit from their hyper-efficient methods. Infrastructure is slowly improving, but roads, ports, water access, and the electricity grid are still horrific across large parts of the country.

Of course, India’s democratic government cannot simply bulldoze through people and the environment to create infrastructure. But the obstacles also include layers of corrupt bureaucrats and politicians – a vast network of resistance to reform.

Some argue that central-government paralysis is inevitable in a democracy of 1.2 billion people, and that the only way to re-energize India is to establish a looser confederation of its constituent states. Devolution would unshackle the economically more successful states. And, by combating the culture of aid dependency in economically weaker states, India’s poorer regions might benefit in the long run as well.

As dysfunctional as a decentralized Europe seems to be these days, India might benefit from moving a few steps in that direction, even as Europe itself struggles to become more centralized. Devolution might sound unrealistic, but once upon a time so did the European Union. If Singh’s new reform agenda is again blocked, perhaps it will be time for a more radical assessment.

Read more from our "Falling BRICS?" Focal Point.

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  1. CommentedHimadri Mayank

    Dear Kenneth, I disagree!

    The demographic dividend that India is projected to reap over the next couple of decades is going to be largely provided by the economically weaker states of Bihar, West Bengal, Uttar Pradesh, Rajasthan and Orissa, where fertility rates are still high. Devolution is not the key, rather a consistent focus to improve education, healthcare, training, livelihood in these states is important to create a workforce, that can provide dividends. So, welfare and budgetary devolution is not only unwise, but also unjust.

    Further, a fair amount of efficiency is reduced not because of economically weaker states dragging the stronger ones, but because of corruption, which is rampant across all regions. Maharashtra, Karnataka, Andhra Pradesh or Tamil Nadu, all are equally infested with graft. The recent anti-corruption drive might go a long way in making the basis of next general elections to be corruption, and probably institution of a constitutional authority of Ombudsman. Only by achieving more economic efficiency through less corruption can India achieve a sustained growth.

    Having said that, given that India has a federal structure of governance, to some extent, policy devolution is already taking place. States have been given a discretion in allowing FDI into multi-brand retail trading within their territories. The JNNURM incentivises state governments to undertake urban policy reforms to get financial assistance from the central government.

    And such measures, although still undesirable due to potential economies of scale, are inevitable, and probably work, in a democracy of 1.2 billion, as you have written.

  2. CommentedIDIKULA MATHEW

    Indian dynamics are not really comparable with the falling dynamics of global economy. Indian government and the central bank is doing the balancing act very well and maintaining a steady growth as well.
    Reforms are not stalled - I am not sure what is the reason on this comment. Reforms being executed is always slow in a massive democracy and there are several non economic but constructive reforms rolling out in parallel too.
    estimated from IMF etc are for world to be pacified and manipulated rather .These rating agencies are to pacify and hold wealth in some nations. India follows its dynamic balancing and growth irrespective of the IMF estimates.

  3. CommentedProcyon Mukherjee

    Understanding India would need a torturous journey a few hundred kilometers from the periphery or from any large city, into the interiors where a vast majority is living, very close to the Dark Ages. With rivers as the only source of running water, with no access to toilets, no schools, and health centers with no equipment and medicine, we have multitudes of people surviving on government sponsored Rs.2 /kg (4 cents/kg) rice. Statistics is very simple, 55% of people living in a rural economy where the whole of agriculture contributes to less than 25% of the GDP and is not growing as productivity is shrinking every year as more hands depend on less area of land. Industrialization and diversification of agriculture in some States like Guajarat have augured well, but lack of governance, which is exacerbated by corruption and lack of political will had taken its toll in most of the other States. Local politics, which is just a way to prolong the agony, takes the round to make the society be based on more divisive forces, so that leadership cannot take root to integrate the ideas of salvation. The core sector cannot function in such a sorry ground of constant in-fights where land acquisition is virtually stalled with no end in sight.

    Reforms, in retail included, is just one other whiff of wishful thinking that would change nothing in the interiors of the country.

    Procyon Mukherjee

  4. CommentedAndrés Arellano Báez

    Who cares what rating agencies said? Why they still exist? We are talking about a group of companies with an incredible record of failure after failure. They should be eliminated of our society.

  5. CommentedAmit Sheth

    FDI is a fickle thing- it can turn on as fast as it is turned off. As pointed out by M. Patel, structural reforms and transparency, are more important. Granted India is not doing too well there right now but some states, led by Gujarat and its dynamic leadership, are showing promise, and consequently, parts of India are growing faster and smarter. Let's hope that the vote for development, rather than caste politics, in states like Bihar and Gujarat spreads further. In the long term, India will do better not to rely too much on central government and its 5 year plans.

  6. CommentedLinda Jamin

    Even economists need to study the POLITICAL and social realities of a region before offering an "analysis" and/or predictions regarding its socioeconomic future. Ancient cultures with complicated social systems in over-populated regions respond well to top-down economic reforms in dictatorships but aren't we supposed to all be cheering for the "democratization" of emerging economies? Or are we just disappointed that the Ghandis and their cronies aren't tough enough. Maybe they need to take a few lessons from the House of Assad or study the tactics used in Bahrein? In any case it's clear that it's necessary to read Aruhundhati Roy as well as K.Rogoff in order to understand what's at play in India and what its future might be.

    1. CommentedVaradarajan Seshamani

      Not just the political and social systems and situations prevailing, but also the laws, their complexities, their vaguenesses, the discretionary powers in the rules associated with such laws and the resultant parallell systems that operate and are powers untom themselves. Beyond that, one should look at the effects of this type of top down environment on the people weilding the powers - who are part of the powers that be and you may begin to see, in about 2 decades what a mess it all is.

    2. CommentedM Patel

      It's actually very simple. Culture and Social systems are extremely poor predictor of prosperity. Neither the religion nor the culture could explain the vast gap between two germanys or two koreas or two latin countries. Compare North Korea with South Korea or East Germany with West Germany. Here is 1 country, 1 people and 1 culture which gets vivisected into 2 parts with 1 part embracing Socialism and another part embracing free-market. 50 years later, Socialist part is dirt poor and non-socialist part is well-off.
      Corruption and poverty is positively correlated with red-tape and Socialist/Communist type economic model. Solution is to cut the red tape.

  7. CommentedM Patel

    Nehruvian Socialist license permit system, and absolute discretionary governmental power are troubling India because they hamper growth and promote crony corruption. Structural reforms (i.e. abolish Nehruvian system and take-away discretionary power) is the solution.

    Most article on India's economy falsely equates FDI permit with Reform. This articles are lobbying for foreign investment with little regard for how sweet heart deals are cut. Investments are important but much more important is structural reforms.

    Permit is an oxymoron of Reform. Current system of doling out sweet heart permits to chosen investor, in a non-transparent manner, will result in bad investments and corruption ( example: In 1993s, Enron lobbied and got a sweet heart deal to setup a power plant at Dabhol, India. Government of India owned banks were arm-twisted to provide loans to dabhol power corporation. The power plant built had very high fixed and operational cost making it unviable. After a bankruptcy, writeoff of billions of rupees, and in midst of a power crisis, The plant is still making losses and not running even at 50% capacity).

    Walmart/McDonald should be welcomed to India but it is wrong to say that it will benefit India's poor because only upper middle class Indians can afford them. Poor would be simply shooed away at the entrance.


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