Tuesday, November 25, 2014

Why India Slowed

NEW DELHI – For a country as poor as India, growth should be what Americans call a “no-brainer.” It is largely a matter of providing public goods: decent governance, security of life and property, and basic infrastructure like roads, bridges, ports, and power plants, as well as access to education and basic health care. Unlike many equally poor countries, India already has a strong entrepreneurial class, a reasonably large and well-educated middle class, and a number of world-class corporations that can be enlisted in the effort to provide these public goods.

Why, then, has India’s GDP growth slowed so much, from nearly 10% year on year in 2010-11 to 5% today? Was annual growth of almost 8% in the decade from 2002 to 2012 an aberration?

I believe that it was not, and that two important factors have come into play in the last two years.

First, India probably was not fully prepared for its rapid growth in the years before the global financial crisis. For example, new factories and mines require land. But land is often held by small farmers or inhabited by tribal groups, who have neither clear and clean title nor the information and capability to deal on equal terms with a developer or corporate acquirer. Not surprisingly, farmers and tribal groups often felt exploited as savvy buyers purchased their land for a pittance and resold it for a fortune. And the compensation that poor farmers did receive did not go very far; having sold their primary means of earning income, they then faced a steep rise in the local cost of living, owing to development.

In short, strong growth tests economic institutions’ capacity to cope, and India’s were found lacking. Its land titling was fragmented, the laws governing land acquisition were archaic, and the process of rezoning land for industrial use was non-transparent.

India is a vibrant democracy, and, as the economic system failed the poor and the weak, the political system tried to compensate. Unlike in some other developing economies, where the rights of farmers or tribals have never stood in the way of development, in India politicians and NGOs took up their cause. Land acquisition became progressively more difficult.

A similar story played out elsewhere. For example, the government’s inability to allocate resources such as mining rights or wireless spectrum in a transparent way led the courts to intervene and demand change. And, as the bureaucracy got hauled before the courts, it saw limited upside from taking decisions, despite the significant downside from not acting. As the bureaucracy retreated from helping businesses navigate India’s plethora of rules, the required permissions and clearances were no longer granted.

In sum, because India’s existing economic institutions could not cope with strong growth, its political checks and balances started kicking in to prevent further damage, and growth slowed.

The second reason for India’s slowdown stems from the global financial crisis. Many emerging markets that were growing strongly before the crisis responded by injecting substantial amounts of monetary and fiscal stimulus. For a while, as industrial countries recovered in 2010, this seemed like the right medicine. Emerging markets around the world enjoyed a spectacular recovery.

But, as industrial countries, beset by fiscal, sovereign-debt, and banking problems, slowed once again, the fix for emerging markets turned out to be only temporary. To offset the collapse in demand from industrial countries, they had stimulated domestic demand. But domestic demand did not call for the same goods, and the goods that were locally demanded were already in short supply before the crisis. The net result was overheating – asset-price booms and inflation across the emerging world.

In India, matters were aggravated by the investment slowdown that began as political opposition to unbridled development emerged. The resulting supply constraints exacerbated inflation. So, even as growth slowed, the central bank raised interest rates in order to rebalance demand and the available supply, causing the economy to slow further.

To revive growth in the short run, India must improve supply, which means shifting from consumption to investment. And it must do so by creating new, transparent institutions and processes, which would limit adverse political reaction. Over the medium term, it must take an axe to the thicket of unwieldy regulations that make businesses so dependent on an agile and cooperative bureaucracy.

One example of a new institution is the Cabinet Committee on Investment, which has been created to facilitate the completion of large projects. By bringing together the key ministers, the committee has coordinated and accelerated decision-making, and has already approved tens of billions of dollars in spending in its first few meetings.

In addition to more investment, India needs less consumption and higher savings. The government has taken a first step by tightening its own budget and spending less, especially on distortionary subsidies. Households also need stronger incentives to increase financial savings. New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability.

If all goes well, India’s economy should recover and return to its recent 8% average in the next couple of years. Enormous new projects are in the works to sustain this growth. For example, the planned Delhi-Mumbai Industrial Corridor, a project with Japanese collaboration entailing more than $90 billion in investment, will link Delhi to Mumbai’s ports, covering an overall length of 1,483 kilometers (921 miles) and passing through six states. The project includes nine large industrial zones, high-speed freight lines, three ports, six airports, a six-lane expressway, and a 4,000-megawatt power plant.

We have already seen a significant boost to economic activity from India’s construction of its highway system. The boost to jobs and growth from the Delhi-Mumbai Industrial Corridor, linking the country’s political and financial capitals, could be significantly greater.

To the extent that democratic responses to institutional incapacity will contribute to stronger and more sustainable growth, India’s economic clouds have a silver lining. But if India’s politicians engage in point-scoring rather than institution-building, the current slowdown may portend stormy weather ahead.

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    1. Commentedrahul srivastava

      I do not agree that the country was or is not prepared for the scale of economic growth that was on offer. Its not the financial institutions which were not mature enough - this is a direct result of the intellectual incompetence of the Indian political class.

      All through 80-90s they did all they could to stop economic development and education - it works for them. uneducated population is easy to pacify and raises less questions.

      I feel there is a big gap how the educated middle class looks at the situation- the get the job done approach in comparison to the political class of how to leave things as they are.

      We need serious political reforms to get the wise and educated in the main stream- it does appear that the supreme court has understood the point and is making significant changes quietly.

    2. Commentedkiers sohn

      "the government’s inability to allocate resources such as mining rights or wireless spectrum in a transparent way led the courts to intervene and demand change. And, as the bureaucracy got hauled before the courts, it saw limited upside from taking decisions"

      That's it in a nutshell. The government sabotaged it ON PURPOSE. Hopefully the son-prince of the current "family" ruling the country can undo what hath been done.

      Setting up, then Undoing of obstacles is normal for India. every Indian could not be bothered. Ho Hum. buy gold.

    3. CommentedJay Nair

      India imports about 1000 tons of gold (roughly 40 billion $) every year. It is the second biggest contributor to high trade deficit, after crude oil import. Gold is not contributing to the economy as it is unproductive, unless people circulate it back into the market.
      My question is what has our government done to reduce the domestic demand and import of gold? This is signifcant money which could potentially make big change to the economy and investment.

    4. CommentedNandita Rao

      Sir, the argument certainly has some truth in it but thats not all. Case-in-point, land acquisition for SEZs. (1) look at the geographical distribution of the proposed SEZs across india. The only outcome would be accentuated geographical divide in growth. This geographic distribution of business centres should have been more dispersed, to promote infra dev in distant areas. The geo distribution also points to the nasty game of land grab! (2) For a while, lets accept the argument that land related clearances are difficult. So alteast those projects which got such clearances must be really flourishing. Its is worthy to check out of 180 (approx) SEZs approved and land ear-marked, only a very small number has actualized. So it is not all about clearances and land titles.

    5. CommentedJagan Rampal

      With due regards for Dr Rajan's viewpoint, I still think I can detect a justification of abdication of responsibilities in this article. The main tasks for any government are (1) Policy formulation (2) Marshall national resources (3) Provide governance and facilitation. If the allocation of mines, land, spectrum, or building policy framework or ensuring an enabling governance system etc is such a tough task that government can not perform it efficiently and transparently each time, the incumbent government/leaders should consider retiring. However, politicians and cricketers never retire in India even if they score ducks endlessly. Let us face it, India is being held back by poor leadership.

    6. CommentedProcyon Mukherjee

      Institutional intransigence, coupled with the polity's lack of concern to arrive at solutions that must bury the moral divide when it comes to the vital elements of country's progress, gets the better of priorities in the public arena.

      The permits needed to make a proposal move from the Environment and Forest Department through an environment clearance and consent to establish and operate is a five to eight year affair if a forest is remotely involved and the conditions that are put after a clearance is given are sometimes so difficult to implement that it feels like it is better not to expand any operation.The fundamental problem then starts through land acquisition as for any growth whether it is Coal mining or infrastructure development, the incremental piece of land is just not available as the norms for making it available at a price is non-existent. Even if an industry gets a piece of land, it is not certain whether it could be put to any use as the people around that land (may not be remotely connected) would have to be appeased and till their demands are met the land cannot be even demarcated. The machinery around government land acquisition (the levers start to act from government councils at the State levels to the district levels) have perverse incentives that delay the process through upper-division and lower division clerks and any file would need to touch anything between twelve to twenty touch points, before it gets to the district level where the Collector, Sub-Collector, Additional District Magistrate, Land acquisition officer, revenue inspector, Tausildar and the Land demarcation officer are waiting to act till it progresses for registration.

      The rehabilitation package even after the government machinery has stepped in would never be enough and there is hardly any way one can ensure that the 'final' word on this is ever made. The process goes on and on...

      Big projects in India take more than a decade to move, if one is found to be shorter from concept to final output, it is due to sheer luck (not preparation meeting opportunity, but simply accident).

    7. CommentedKrishna Kumar

      yes, I was thinking, somewhat same reason, for a long time. I am tired of the political blame game by both NDA and UPA on each other!

    8. CommentedGanesan Srinivasan

      For India to prosper, attitudes need to change. There is no leadership at the top with a long term strategic view, which educates the public and promotes healthy debate and consensus building. The general public is largely isolated from the decision making process, which is no way to build public support for any policy. And it is left to the Supreme Court to make administrative decisions, simply because the politicans and the bureaucrats have largely abdicated their responsibility. Social attitudes are also a significant drag on the economy by denying significant sections of the populations access to education, jobs and economic opportunities. But, we have to start somewhere. At least, Raghuram has outlined the key issues and a way out. We can only hope that Raghuram can convince the politicans to stick with the plan and see it through.

    9. CommentedSridhar Subramanian

      My sympathy to Mr. Rajan...his article reads more like an excuse for non-performance of this Government.

      The PM and this Govt. sat on law relating to land reforms for God knows how many years....

      The power situation in many states, is due to the apathy of the Central Govt. and add to this the problems and scams in coal.

      The 2G spectrum - the less said the better. First they do something...when questioned, they do something else and then just to excuse themselves they manipulate the actors to disprove the critics....who are they trying to fool.

      The law-and-order is only to violate and benefit for the rich and the powerful.

      Tax authority over-reach all the time to enable politicians get some score to extract and enrich themselves for their electoral games.

      CBI mandate is only to investigate and spy on "others". No people in power to be touched...no fair investigation on anything including 2G. No fair JPC as well....

      They meanwhile milk the tax from middle-class and hard-working and spend it on things that do not deserve any attention, meanwhile important planned projects can wait....and people can suffer without electricity, water and other basic necessities...

      This Government needs to be taught a lesson. CEO-CM deserves a chance...to see if he can think and work like Narasimha Rao and turn-it-around for the country.

    10. Commentedsrinivasan gopalan

      It is always a delight to dip into the pellucid thinking and incisive writing of the country's Ministry of Finance Chief Economic Advisor as his intellectual credentials are too immense to be ignored. Yet working within the system of government, it would be audacious on his part to claim that institutional incapacity continues to be a binding and besetting constraint on the further development of the country. If after six score of years of Independence, the country's politicians and bureaucrats had failed the people by their pathetic focus on short-term populism or garnering votes or aggrandising themselves with little compunction instead of pushing development, what else could be achieved now when the same set of politicans and bureacurats with whom Prof. Rajan has the misfortune to work now! Unless structural constraints and supply side bottlenecks are removed lock, stock and barrel coupled with a firm commitment to marshal more outlays for social and physcial infrastructure through purposive policy interventions, India's tryst with destiny woud at best be a work in progress in perpetuity with no tangible development in reality. One should remember in complete reverence to the perspicacity of the former Prime Minister of India Narashima Rao under whom the present prime minister Dr Manmohan Singh worked as his finance minister from 1991 to 1996 that the double-digit growth the Indian economy witnessed in the early part of the last decade became possible, despite with warts and all! It is another tragedy that the same Dr Singh at the helms could not deliver higher growth now because he was heading a viscesrally fractious coalition government with no personal authority to ensure that his writ runs and runs absolutely for the benefit of the people. Looking back with a minority government Narashima Rao brought about far-reaching economic liberalization measures that the subsequent governments including the one presently headed by Dr Singh could not even think of repeating such a feat. It is time political parties evolved a consensus in pushing for ensuring basic amenities to millions and a decent standard of living before attempting to putting the economy on a high growth trajectory. But the way politicians conduct themselves with the bureaucrats not being able to call the shots in the prevailing milieu of scams and scandals , the future is fraught unless good sense prevails for a better and decisivse governance and a salutary leadership that will not let the sink of ship of State! G.Srinivasan, Journalist, New Delhi, India

        CommentedFrank O'Callaghan

        "after six score of years of Independence". 120 years? Really? I think not. Not quite yet!

        I make mistakes too. It is a shame we cannot edit our comments subsequently.