by Akhil Paliath
In the spring of 2008 while the rest of the world was still reeling from the shenanigans of Lehman, Freddie, Stanley and Co., India was all smiles because high growth rates meant that the government could offer a generous fiscal stimulus to survive the downturn. Prime Minister Manmohan Singh predicted that eight percent growth would soon become standard for the economy. Policymakers were patting each other’s backs for avoiding the pitfalls of the loose and unregulated western markets. However, in 2013, things are not looking up. Between July and August, the Indian Rupee depreciated by more than 13 percent. The World Bank slashed growth forecasts from 6.1 to 4.7 percent, and inflation is the only indicator consistently reaching double digits, as reported by Reuters.
Indian policymakers were victims of the very phenomenon that they had prided themselves for avoiding. During the economic bubble of the boom years of 2003-2007, India enjoyed all of the advantages of its economic liberalization. Companies were eager to enter the 1.2 billion strong consumer market, and as a result were willing to put up with the ineffectiveness and red tape that came along with doing business in India.
Indian companies with their inherent labor advantages due to the number of available workers were aggressively expanding abroad, and thus made excellent investments for foreign investors. However, the worldwide economic boom obscured the fundamental flaws in the economy. As the financial recession became an economic one, the inherent weaknesses of the Indian economy became much harder to ignore. Foreign companies were forced to tighten their belts at home and there was little spare cash for India. The government failed to make sufficient investment in infrastructure or fiscally consolidate their finances for a rainier day, while endemic corruption and legendary red tape was too much for companies to deal with during a crushing global meltdown.
This meant that the investment flows, which traditionally stabilized India’s current account deficit (CAD), were missing. High inflation also meant that imports of gold have increased substantially as a hedge against inflation. Not surprisingly, the CAD is at an all-time high, and as a result, manufacturing has almost ground to a halt. According to the Indian news outlet Mint, HSBC’s manufacturing Purchasing Managers’ Index (PMI) contracted for the third month in a row in October 2013. High cost of inputs and wage inflation means that many small and medium enterprises have had to lay off employees. Even the traditionally strong service-based sectors like banking, IT and financial services are lagging because of the global recession. HSBC’s services PMI in September has been at its lowest since 2009.
The largest problem, is the near total policy paralysis at the center. Many necessary reforms like public land acquisition and an increase in foreign direct investment (FDI) limits were delayed for months on end. Land acquisition for large projects remains one of the biggest hurdles in the country and may take months or even years to accomplish. When reforms were announced, political distortions were made to satisfy powerful interest groups and compromises almost rendered them void. For example, the increase in FDI limits in multi-brand retail, is something for which companies like Walmart have been lobbying for years. However when the measure was passed, opposition parties forced the government to include such high local content requirements that Walmart actually reduced their existing operations, saying that investment in India with such strict provisions was “unfeasible.”
A slew of large corruption scandals have further eroded trust in the government. Top bureaucrats and prominent business tycoons have been indicted, but many politicians remain off the prosecution radar. This means that files take longer to pass through, approvals are slower and decision-making is non-existent. To top it off, national elections are scheduled for May 2014, and early opinion polls predict a hung parliament. It is quickly becoming clear that no significant reform can take place until the elections are over and the ruling coalition has achieved a sizable working majority. In the meantime, the government keeps passing populist bills in preparation for the elections, according to the Mumbai think tank, the Gateway House. In most countries this is business as usual, but with a staggeringly high fiscal deficit of 10 percent, India can’t afford the usual populist pandering that precedes an election. A worsening of the deficit will push already high government bond yields to a level where India may soon be forced to return to 1991, when it could no longer afford to pay for import of essential goods and had to be bailed out by the IMF.
All is not lost, however. Most of India’s problems are domestic and can thus be solved. The government must liberalize and reform labor markets, attract more investment for infrastructure projects and ensure that doing business in the country becomes easier. Austerity might be a good idea, as reducing the fiscal deficit to a more manageable seven percent would help inflation and the beleaguered rupee. Privatization of public sector companies could provide the required solution. According to Finance Minister P. Chidambaram, the government hopes to raise $6 billion from sales of public sector enterprises over the next few years. However the falling rupee and fierce resistance from trade unions cast doubt on the feasibility of this number. Taxation reform is also necessary, as currently only three percent of the population actually pay taxes. The proposed Goods and Services Tax (GST) would significantly improve this, but like many things, it is stuck in a political quagmire.
India still retains many of its natural strengths that created the boom in the first place, which includes a large, educated and inexpensive labor force. India’s market of 1.2 billion consumers and workers is just too big to be ignored. Not operating in the country means you ignore 17 percent of the world market. It’s the largest economy in the neighborhood and inexorably linked to the world economy. The growth and significance of the country is a testimony of the hard work and innovation of is population and businesses. It’s about time that policymakers catch up.