Monday, November 24, 2014

What Happened to India?

CHICAGO – Emerging markets around the world – Brazil, China, India, and Russia, to name the largest – are slowing. One reason is that they continue to be dependent, directly or indirectly, on exports to advanced industrial countries. Slow growth there, especially in Europe, is economically depressing.

But a second reason is that they each have important weaknesses, which they have not overcome in good times. For China, it is excessive reliance on fixed-asset investment for growth. In Brazil, low savings and various institutional impediments keep interest rates high and investment low, while the educational system does not serve significant parts of the population well. And Russia, despite a very well educated population, continues to be reliant on commodity industries for economic growth.

Hardest to understand, though, is why India is underperforming so much relative to its potential. Indeed, annual GDP growth has fallen by five percentage points since 2010.

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: basic infrastructure like roads, bridges, ports, and power, as well as access to education and basic health care. And, unlike many equally poor countries, India already has a very 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.

Satisfying the demand for such goods is itself a source of growth. But, also, a reliable road creates tremendous additional activity, as trade increases between connected areas, and myriad businesses, restaurants, and hotels spring up along the way.

As India did away with the stultifying License Raj in the 1990’s, successive governments understood the imperative of economic growth, so much so that the Bharatiya Janata Party (BJP) contested the 2004 election on a pro-development platform, encapsulated in the slogan, “India Shining.” But the BJP-led coalition lost that election. Whether the debacle reflected the BJP’s unfortunate choice of coalition partners or its emphasis on growth when too many Indians had not benefited from it, the lesson for politicians was that growth did not provide electoral rewards.

In any event, that election suggested a need to spread the benefits of growth to rural areas and the poor. There are two ways of going about that. The first, which is harder and takes time, is to increase income-generating capabilities in rural areas, and among the poor, by improving access to education, health care, finance, water, and power. The second is to increase voters’ spending power through populist subsidies and transfers, which typically tend to be directed toward the politically influential rather than the truly needy.

In the years after the BJP’s loss, with a few notable exceptions, India’s political class decided that traditional populism was a surer route to re-election. This perception also accorded well with the median (typically poor) voter’s low expectation of government in India – seeing it as a source of sporadic handouts rather than of reliable public services.

For a few years, the momentum created by previous reforms, together with strong global growth, carried India forward. Politicians saw little need to vote for further reforms, especially those that would upset powerful vested interests. The lurch toward populism was strengthened when the Congress-led United Progressive Alliance concluded that a rural employment-guarantee scheme and a populist farm-loan waiver aided its victory in the 2009 election.

But, while politicians spent the growth dividend on poorly targeted giveaways such as subsidized petrol and cooking gas, the need for further reform only increased. For example, industrialization requires a transparent system for acquiring land from farmers and tribal people, which in turn presupposes much better land-ownership records than India has.

As demand for land and land prices increased, corruption became rampant, with some politicians, industrialists, and bureaucrats using the lack of transparency in land ownership and zoning to misappropriate assets. India’s corrupt elites had moved from controlling licenses to cornering newly valuable resources like land. The Resource Raj rose from the ashes of the License Raj.

India’s citizenry eventually reacted. An eclectic mix of idealistic and opportunistic politicians and NGOs mobilized people against land acquisitions. With investigative journalists getting into the act, land acquisition became a political land mine.

Moreover, key institutions, such as the Comptroller and Auditor General and the judiciary, staffed by an increasingly angry middle class, also launched investigations. As evidence emerged of widespread corruption in contracts and resource allocation, ministers, bureaucrats, and high-level corporate officers were arrested, and some have spent long periods in jail.

The collateral effect, however, is that even honest officials are now too frightened to help corporations to navigate India’s maze of bureaucracy. As a result, industrial, mining, and infrastructure projects have ground to a halt.

Populist government spending and the inability of the supply side of the economy to keep pace has, in turn, led to elevated inflation, while Indian households, worried that no asset looks safe, have taken to investing in gold. Because India does not produce much gold itself, these purchases have contributed to an abnormally wide current-account deficit. Not much more was required to dampen foreign investors’ enthusiasm for the India story, with the rupee falling significantly in recent weeks.

As with the other major emerging markets, India’s fate is in its own hands. Hard times tend to concentrate minds. If its politicians can take a few steps to show that they can overcome narrow partisan interests to establish the more transparent and efficient government that a middle-income country needs, they could quickly re-energize India’s enormous engines of potential growth. Otherwise, India’s youth, their hopes and ambitions frustrated, could decide to take matters into their own hands.

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    1. CommentedPaulo Sérgio

      What is the connection - if any - between India's caste system, and the much spoken of corruption within the state, and India's huge infrastructure backlogs/bottlenecks?

    2. Commentedvishi gondi

      Here's how you fix it: By "Improving access to education, health care, finance, water, land, food and power"

      Technology will take care of education, health care, finance over the next decade.

      Water, land, food and power are resources that have to be actively managed and planned for. I can't see the government managing them.

      I'd say, privatize them, but regulate companies to give 30% of their revenues to subsidize the same resources for people with ration cards. Political parties win by distributing ration cards and picking on issues like gay marriages.

      Building the UUID platform will make the ration card management dynamic and fool proof.

      Mr. Nilekani is on to something.

    3. CommentedMehul Gupta

      Correct! Current economic scenario is also result of conservative approach followed by bureaucrats in their decision making(thanks to CAG). This is a golden opportunity for us(India) to get the system in shape(reduce non-transparency and improve accountability) as the world outlook is not that good. Otherwise we will end up being third world for forever.

    4. CommentedMrudang Mehta

      I appreciate Dr. Rajan's views. He has expressed something many in the country are talking. His views could be understood by even those who do not have much knowledge about economics.

      There are few thoughts which are coming into my mind regarding country's somewhat intentional failure to reform and grow.

      While it is necessary to grow, it is also necessary to see the impact of growth on society.

      Conventional wisdom says that when money comes suddenly more than we have expected, it corrupts mind. People forget that what one needs to live life is not huge cash stored in bank which your 7 generations can not spend in their life time. Moreover, it spoils social culture which may lead to existential threat to the country. It blinds people. So, we must grow at a rate which our society can absorb.

      Another thing is that if you are growing and people are getting money, suddenly if your growth slows down and income stops, people will become desperate and it would create another kind of trouble. Hence, it is essential that if country is growing, it should continue to grow and benefits of growth should spread among people to avoid social unrest.

      Either we made some mistakes in past of growing at 8-9% which we should not have done, or we are doing mistake now of not growing at 8-9%. Only future historians and economist will be able to write in their books what Happened to India in history? Sunrise or Sunset!

    5. CommentedMurali Krishna Hari

      Dr. Rajan,
      Thanx for highlighting corruption as main reason. We might have lost at-least 2 lakh crores in this 5 years because of corruption in various policies. Also economic reforms should not end up in crony capitalism, where Industry controls policy. For example, Government is considering taxing disel vechils , but industry is opposing it. Also Government has still to do lot in Education/Health Care. Atlast, all freebies except food items should be banned

    6. CommentedManish Maheshwari

      Dr. Rajan's speciality is to connect economics and politics, and he does that brilliantly again.

      However, this analysis needs to be taken to the next level. Here's what I think the next level of analysis should look like --- Economics doesn't operate in a vacuum; it operates in a social and political context. Politics, in turn, works in a social context. Ultimately, then, it all boils down to the internal dynamics of a society.

      The common theme running through all the attempts by Indians to pull the country out of the current mess is the inability of indian society to channelise individual angst into collective action. Everyone is individually disgusted with the state of affairs but they have no social dynamic via which they can all come together to fix what's wrong. This fragmentation reflects in small political parties with little more than a caste leader's family holding them together, which leads to weak coalition governments that make compromises and dole our largesse and misuse state resources to buy votes. The vicious circle goes on and on.

      The ancient civilisational bonds which could be used to build trust, create consensus and mobilise the citizens to agree to a common course of action, have, instead of being strengthened when India emerged from 800 years of subjugation, all been destroyed over the last 60 years by Nehru and his Marxist flunkeys at NCERT. What is left is a 1.2 billion-strong mass of brainwashed people who have been totally deracinated and left rootless as well as directionless. They have almost zero sense of a collective interest; they define their interests in the narrowest manner possible. And then these 1.2 billion competing definitions end up clashing with one another. What results in the by now familiar Indian cacophony.

      I also think Rajan has omitted naming specific individuals who have destroyed India's economic revival between 2004 and 2012. Sonia Gandhi and her dynastic slave-monkeys must take all the blame; they have subverted every institution of the Republic --- President, Chief Election Commissioner, Chief Vigilance Commissioner, Collective Responsibility of the Cabinet etc etc --- to perpetuate the Nehru-Gandhi family's stranglehold on power, thus reducing an ancient civilisation to abject helplessness. In contrast, The BJP-led NDA government was rooted in India's civilisational heritage, so was able to conceptualise a collective interest and in service of that collective interest, it provided good governance.

    7. CommentedVivek Chand

      Excellent article...and I will continue to live in hope. One day our politicians will change and put the country's interest ahead of their own.

    8. CommentedSankaran Sivaramakrishnan

      India's growth is hampered by the collusion between the elite business class and the corrupt politicians. All that the top business houses have done is to avail all benefits to themselves and enrich their companies.

    9. CommentedAlok Shukla

      Very aptly said about License Raj becoming Resource Raj.
      Though it seems to me public has short memories, every election cycle whoever promises bigger dole and applies a right arithmetic of religion and caste ends up winning elections. And the Raj flourishes again may be in different manisfestation.

    10. CommentedVarghese David

      Well-explained India story. And rightly pointed out the eruption of "Resource Raj" or "Discretion Raj" whatever you may call it following the end of "License Raj" which is the real menace. I believe whatever is happening is good for the economy. If there is rampant corruption in resource distribution, it has to end somewhere and earlier the better. Today, the world is in revolution mode and so should be India. Let there be some turbulence and let the politicians learn a lesson or two from this. The problem is in spite of so much happening, they seem to be arrogant as ever which is really a bad sign.

    11. Commentedsrinivasan gopalan

      Well, Mr Rajan's piece reads like a well-recounted story about the faltering growth story of India even as it chastises the government of the day for not taking a few steps to bring in transparency and efficiency in governance in consonance with its status of a middle-income country. It is not as if the government did not know where the faultlines and fissures had developed but it is amply alive to the problems. In a coalition government, the head had to adjust itself to the tails which more often than not wag disproportionate to their stature as is the case in India. With people increasingly getting parochial by selecting their own brand of leaders at sub-national level and with the national parties such as Congress or BJP do not encourage collegum of le

        Commentedsrinivasan gopalan

        encourage regional leaders, the governing class at the Centre is unable to execute its well-crafted reform agenda. It is time India learned the hard lessons that empowering poor people with basic amenities such as education, primary health and a decent standard of living with assured and regular income, no sound superstructure or cruising on a high growth trajectory on illusory promises of prosperity would deliver. India's options narrow down to ensure sound and salutary development of the bottom of the pyramid before it boasts of being in the league of developed countries.

    12. CommentedAmar Harolikar

      Hi Raghuram,

      This is no doubt an excellent analysis around the political and governance issues that are a drag on the economy, however I am not so pessimistic on India.

      My sense is that the long term growth story is still intact and the current problems are more of short term/ cyclical in nature. And as for governance issues, they have always been a part and parcel of the India story. Furthermore, India grew at a fantastic during the past six years, notwithstanding all the scams, global recession, dollar volatility and oil prices of more than 150

      Pasting below an analysis I did just a few days back

      India’s Growth Story Intact: Interpreting macro numbers and trends the right way

      There has been a lot of debate about India’s growth story coming to an end, with many top brokerages like Morgan Stanley and Goldman Sachs cutting GDP forecasts to sub 6% levels. However, my analysis shows India’s growth story is not only intact, it continues on a robust path.

      The gloom-and-doom scenarios being painted today are an exact repeat of the phenomenon that happened during 2008-09 when the debate started that India’s growth story might be over and the Morgan Stanleys and Goldman Sachses of the world cut the GDP forecast for FY10 to sub 6% levels and some to even sub 5% levels.

      What happened next?

      In FY10, India posted a GDP growth rate of nearly 8%!

      So what went wrong with all the doomsday scenarios for India? Two things went wrong.

      First, an undue importance was placed on year-over-year (YoY) growth rates without looking at the trend in absolute GDP. That’s a simple number interpretation issue. A case in point is all the gloom surrounding the sub 6% YoY growth rates posted in the last two quarters of fiscal 2008-09 and the latest 5.3% YoY growth posted for the March 2012 quarter.

      Second, not looking at the long-term trend and the impact of business cycles. That’s an economic analysis issue. Take a look at the chart below. I have compared the trend in absolute values of India GDP with that of U.S. GDP since 2005. I have compared just the India and U.S. trends in order to clearly explain how long-term growth rates and business cycles need to be interpreted. To facilitate a comparison, I have indexed the GDP values by initializing the starting values to 100.

      As you can see, the chart speaks for itself. The trend in U.S. GDP is like a straight line, having grown only a total of 7% in the past six years. India GDP, on the other hand, is on a strong uptrend, having grown more than 80% in the same period. Within this long-term trend, the ups and down of a normal business cycle can clearly be seen.

      Understanding long-term trends and business cycles, more often than not, does not need complex models. Most of the time simple charts and a bit of common sense work well enough. For those who would rather look at complex models, the RBI website is the right source, not brokerage research reports. There is some fantastic analysis available on the RBI site, the summary of which is that a growth rate in the 8% range is now the new normal.

      Current Economic Problems: More imagined than real

      The U.S. economy faces some structural issues, which are very real. Meanwhile, in India, the challenges to the long-term growth trend are more imagined than real.

      The problems facing the Indian economy today are more tactical and cyclical rather than of a strategic or long-term nature. It’s not as if everything is hunky dory – no it’s not. There are challenges around fiscal deficit, current account deficits, governance and reforms. But all these challenges have pretty much existed for the past six years during which the economy continued to grow at a very healthy rate.

      So, Is India’s Growth Story Intact?

      As of now, yes.

      As the chart clearly shows, the long-term trend in India GDP is fully intact and issues like the slowdowns in 2008 and 2011 are simply the business cycle playing itself out.

      So, is there nothing that can derail the growth story? Of course, there are many factors which can do so. But it’s only major structural changes that can derail India’s growth story, things like a significant fall in competitiveness in services exports, a rollback of reforms and such like. Not factors like dollar volatility, oil prices and minor variances in fiscal deficit.

      India has continued to grow at a steady pace for six years, a period characterized by a slowdown in reforms, the Lehman meltdown, dollar volatility, high fiscal deficits, high food prices and what not. Factors like these have only caused the normal ups and downs of a business cycle in India, and I forecast that they would only cause normal business cycles going forward, too.

      So, What Happens Next?

      In the next phase of India’s business cycle, the continuing drop in commodity prices, oil prices and interest rates will speed up the recovery process. Corporate profitability, which has already improved significantly, would post some handsome growth numbers. All these would result in a continuing GDP uptrend.

      Amar Harolikar
      Unknown Insights

    13. CommentedSunil Mishra

      Excellent article, sir. However, on the point of "collateral point about honest bureacrats also not executing decisions", I would beg to differ - if anyone is really honest, they need not fear anything. And that's the extent of the malaise. No file is moving in the bureacracy and that is because each one has a skeleton in the cupboard. Sad but true. If Manmohan Singh is so honest, he could have moved the world. Being personally clean is not sufficient in today's world.

    14. CommentedKuldeep Nayar

      What happened to India? A good question but this is not about economics. Rather India's current situation arises from shortsighted & utterly irresponsible politicians; uncontrolled population; vote banks; educational system that spews out unemployable youth; absolute lack of civic sense; a justice delivery system that make a snail feel like Ussain Bolt; a police force so corrupt that ordinary people go to local hoodlums to get justice; a food delivery system that wastes more than delivers; a power transmission system that loses electricity into thin air; badly built apologies for roads; an antiquated, creaky, and leaky railway system, legacy of the British; and above all a populace that refuses to do their jobs diligently and honestly. Nothing happened to India and nothing has happened for the last 65 years and nothing will happen for the next 65 unless the restless youth decide to take matters into their own hands!

        CommentedManish Maheshwari

        // Nothing happened to India and nothing has happened for the last 65 years and nothing will happen for the next 65 unless the restless youth decide to take matters into their own hands!//

        --- and what is the vision or theme that will guide these youths? More of Nehruvian nonsense? if we aren't careful, then such "youth movements" can degenerate into mutants of the Red Guards of China.

    15. CommentedProcyon Mukherjee

      Raghuram has made all the right points about India and his reference to the apparent reluctance of the polity to create conditions of growth as the fundamental driver of prosperity, is correct, although it could be entirely driven by the politics of coalition.

      The current statistics is rather harsh and brings to the fore the sad state of core sector growth, which has come to a grinding halt. Land acquisition had played a vital role, although it is the primary factor for any expansion, but there are other factors at play. The institutions of governance and of gatekeepers of statutes have a bizare way of hastening the impending gloom; environment clearances in two stages need seven years for any mine and some could go to more than ten years. After these clearances are obtained one finds that the infrastructure is woefully inadequate to transport anything (from iron ore, to bauxite to coal). The economy has a backlog of thousands of MW of electricity, which in this plan period would touch ten thousand; new power projects have all been stalled as coal block allotments have virtually stopped. Coal India, the public sector behemoth is running a shortfall of 30-40 Million ton (against fuel supply agreements contractually done); there is no question of fresh agreements to be signed when the old ones are not honored. Some people say that the next twenty year's coal is already contracted, going by the shortfall versus contractually agreed.

      It is scary, to say the least, India has surprised many.

      Procyon Mukherjee

    16. Commentedprashanth kamath

      Easy - It has become a high cost economy with it's land prices soaring. From 2004, non agricultural land prices have risen by more than 600%. Large portion of population is engaged in holding and trading in land/ real estate.

    17. CommentedFrank O'Callaghan

      The closing warning here should echo around the world. We are entering a phase where change may be more rapid that anyone has so far suggested. As Lenin said: “There are decades where nothing happens; and there are weeks where decades happen.”

      the problem in any society where wealth is so unequal and power is abused is broadly the same and it is that there is no investment by the great mass of people in the survival of the status quo. When a passing alternative offers itself there is very little inertia. We are in the age of the dissolution of inertia.