Originally Written July,2012 published in Mandarin in the Shanghai based Social Outlook magazine.
“India Shining” has been the unofficial slogan for India since the turn of the 21st century. India averaged 8% annual GDP growth in the three years before the recent global financial crisis (see chart 1). Armed with population strength of more than a billion people, India is now the 11th largest economy in the world. According to data, from India’s Planning Commission, rapid economic growth has contributed to a decline in the poverty rate with 37.2% in 2005 to 29.8% in 2010, a drop of 40 million people in the absolute number of the country’s poor. Per capita income doubled during those five years. Internationally, India has become an important actor. Forming the ‘I’ in the BRICS group of nations, India plays a very important role in the leadership of the emerging markets and developing nations. India boasts a culture of entrepreneurship and innovation, pioneering the global IT services industry, and has a global Diaspora that are leaders in various fields. On paper, India’s potential is immense, with approximately 500 million people between the ages of 18-25; its best years seem to be ahead. Polls have revealed that the Indian youth and business people are bullishly confident of a bright future in India. This potential is reason why India is tipped to become the largest economy by 2050. However, potential does not always translate to growth, and India has been learning this the hard way. An economy that once was shining is now rapidly losing that shine. India is at a serious risk of plunging itself into a crises, one that might soon be too large to be defeated by policy.
(Chart 1 )
1991 is often used as the central year for economists and other experts when discussing the Indian economic growth story. In June of 1991, then finance minister, Manmohan Singh, passed widespread reforms that liberalized and opened India’s economy to the world. However, 1991 is also the year the last time India has passed economic reforms of such significance. Over the past 12 months the optimistic mood within India’s economy has taken a sharp dip. GDP growth slowed to 6.3% in 2011-12; the worst it has been in 9 years, and the first quarter of 2012 India grew a measly 5.3%, according to some estimates. While a slowdown in GDP growth has been relatively recent, India has been battling with a rising inflation for the past two years, which included food inflation at between 15-25%. The Rupee has been in a sharp decline, decreasing by 25% in value of the past 6 months to become one of the worst performing currencies in the international market. Although a weakening external demand, due to the Eurozone crises and US economic slowdown has contributed to the slowdown, India’s economy is very much based on internal demand, which has slowed recently partly because of private consumption dropping from 5.5% in 2011/12 from 8.1% the previous year. India’s economy is showing signs of overheating with a growing demand and inability to match it with supply. Leading domestic business people have exerted frustration at the economic situation. Since business confidence is at a low, the IMF, OECD and financial rating agency S&P are all issuing warnings to the Indian government. They all unanimously call for….
Reform, Reform, Reform
In its current form, the Indian economy is like a car stuttering forward and now slowly running out of fuel.
India is in desperate need of reform of its tax laws. For over two years it has delayed passing laws on the goods & services tax which will allow the central government to regulate taxing on services and certain goods, rather than the current system of state regulations. In the current system, it is extremely difficult for business to run operations across the 28 state lines, stifling growth. Foreign investors have raised concerns on two Indian provisions seeking to tax indirect investments and combat tax evasion. The first gives India power to retroactively tax the indirect transfer of assets. The second targets tax evaders via the General Anti-Avoidance Rule (GAAR), putting the responsibility on investors registered in countries with special tax exemptions with India to prove they do not intend to explicitly avoid tax. Investors are fretting and such policies are threatening to drive away private investment rather than encourage it. Major hedge funds such as Macquarie’s Asia hedge fund which manages over $50 billion in emerging markets, have began pulling out.
A situation unthinkable a couple of years ago, India is feeling significant strains on its fiscal budget. When India was growing at 8% a few years ago, no one questioned the governments spending. The Indian government spent freely on a variety of populist subsidies programs, racking up a fiscal deficit that it allowed itself due to GDP growth. India considered this deficit sustainable. The deficit currently stands close to 7% and the government must reign in on its spending, and it must discontinue these subsidies programs and allocate money to other sectors. For over a year the central government has attempted but failed to institute such reforms.
India is in urgent need of reform on Foreign Direct investment (FDI) rules, particularly in its retail sector. Outdated technology, lack of organization and inefficiency has seen the Indian retail industry slowly and steadily pull down India’s economy. The Indian retail industry’s has an annual revenue of $500 billion as of 2011 and employs the 2nd most number of people after agriculture- a sector that is intrinsically linked to the retail sector. Yet, the Indian retail industry is also one of the most unorganized sectors in the country. 90% of the retail industry is controlled by small scale family run operations with big chains making up just 10% of the market. Thus far, Indian suppliers have not been able to deliver to the consumer.
Indian Commerce Minister Anand Sharma asserted that 30% of agricultural produce does not reach the market, and of the remaining 70%, more than 50% is lost due to poor transportation and storage technology. This is a gross waste in any country; especially in a developing country where there are still hundreds of millions bellow the poverty line. This lack of organization has led to much inefficiency, which is the root for many of India’s problems, especially inflation. Over the past two years basic foods have been suffering an inflation of 15-20% and they have been directly linked to the inefficient supply chain- poor agricultural productivity, lack of corporate involvement in agriculture, ceilings on landholding size, existence of middlemen, hoarding, and insufficient cold storage facilities and transportation infrastructure. Increasing the cap on FDI in the retail sector will allow foreign firms to enter the country and make major investments that will significantly modernize the sector and will set the country on a path towards further modernization, increase in consumer spending, as well as undertaking the food inflation.
When the shoe doesn’t fit anymore
Probably India biggest challenge is its infrastructure deficit. If you have travelled to India you have experienced tremendous traffic on poor roads burdened with bottle necks. India’s infrastructure deficit problem is nothing new, and the government has been trying to catch up for years. However, India’s economy has grown to a size that without a sizeable improvement in infrastructure it will be very difficult for both new businesses to enter the market and existing business to expand. According to Management consultants Mckinsey, India is suffering a shortfall of $190 billion in the infrastructure sector and is in urgent need of capital. India’s roads are often unsuitable for large vehicles and they even literally form blockades for progress. The railways and roads dominate the country’s transport landscape. Within these two modes, 2% of road length carries 40 per cent of all road traffic of the country, and one-sixth of the rail network, forming the golden quadrilateral and its diagonals, carries over two-thirds of all rail traffic. With the fragmented character of the industry, road transport services in India are generally poor and logistics costs high. Clocking the world’s lowest average speeds, trucks in India are used for 60,000-100,000 km annually — less than a quarter of the average in developed countries. A quick comparison with an immediate neighbor to the north-east gives you an idea. The time to travel by rail or road between India’s political capital New Delhi and Financial hub Mumbai is over 12 hours to cover 1180 km. In China, between Beijing and Shanghai, a train covers the 1071 km in approximately 5 hours.
India needs to boost growth in this sector, and fast. Indian Urban Development Minister Kamal Nath stated, “With growth preceding infrastructure, we are not building for the future, but for the past”. There is a sense of saturation within the economy that is proving to be a damper for business. The government has steadily increased spending, but some wounds are self-inflicted. Private business have been desperately calling for reform in land acquisition, and in its current state, the lack of reform means companies are facing problems making large capital investment. Without such reform or encouragement for further private investment through allowing foreign funds and mutual insurance funds; India will continue to be building for the past.
The root of India’s economic woes, in all the areas mentioned above, all find themselves leading to one common problem: The central government. India is in crises of politics and the center of the Indian government is stuck in a paralysis.
In Office But not in Power
India’s center of governance lies in the parliament in the capital city of New Delhi. However, power seems to lie everywhere, but in the center. The way India’s parliamentary system works is the ruling party holds together a coalition of smaller parties who come together to form a majority in the parliament. The current ruling coalition since 2009, called the UPA, is weak and fragmented, while the incumbent Prime Minister has shown himself to be to inept. The parliament has no significant majority and the center is loosing power to regional parties who consistently threaten to pull support from the coalition over major reform issues, forcing the leadership to back down. The opposition party, BJP, has shown itself more committed and content to reveal the weaknesses of the congress than to work towards a solution. The word ‘political paralysis’ has now become synonymous when discussing the Indian economy.
Bills on subsidy reduction, tax reform, land acquisition reform and FDI reform all exist, but a divided parliament is unable to pass such bills, and continues to be laborious and indecisive. The government has attempted to answer the calls for an end to the fiscally straining fuel and fertilizer subsidies that totally amount to 2.5% of GDP. However, these subsidies are extremely popular measures and the government has consistently faced opposition from regional parties. During the last 12 months, each time the central government has attempted to repeal the subsidies, regional parties carried out “All-India Bandhs,” enforcing the closure of all business for a day, using force if necessary. Acts such as this have only crippled the country further, diminishing the central government’s power and preventing reform. However, perhaps the biggest symbol of the political paralysis has been the attempt to raise the cap for FDI in the retail industry.
In December 2011 PM Manmohan Singh announced that he was set to approve the bill on raising the cap from 21% to 49% FDI in domestic retail. There was a sense of relief for this would have a revolutionary impact on the retail industry. However, relief was short lived as Mamata Banerjee, Chief Minister of West Bengal, and an important UPA ally, threatened to pull support if this bill was passed, forcing the PM to once again pull back.
There is a popular saying in India that all “economic growth in the country has been in spite the government, rather than because of the government,” and this tells a tale of frustration among Indian and foreign business people. Corruption has “paralyzed the government,” reckons the chief executive of one of India’s most prestigious firms. Further asserting, “We know what the problems are and we have done nothing…somebody’s neck has got to be on the line,” says the leader of a bank. What Indians always knew, is now beginning to reveal itself internationally
Business confidence in India is taking a big hit. Beaurocracy and red tape continue to scare foreign investors away. For example, regulatory and other obstacles recently delayed a proposed $12 billion steel investment deal from Korean company POSCO, who joined the list of other countries who have faced similar restrictions. Standard & Poor recently announced, in a special report, that India is in serious risk of being downgraded from its current BBB+ to BBB-. This downgrade is mainly connected to India’s slowing economic growth and weakening fiscal profile. S&P cited poor governance and political paralysis as the key root to India’s economic woes.
What lies ahead?
The most encouraging sign, although equally frustrating, is that the answers lie in its own hands. Reform bills, if passed, will take effect in a very short time, speeding business up while also inspiring confidence, that will encourage investors currently too afraid or unable to open their cheque book, to rest assured and begin investing again. The government recently announced the controversial bill on retroactive bill will be changed, which is a boost for foreign investors and is also a sign that the government is still capable of making decisions. Although still affected by the European debt crises and the global slowdown, India is still not as dependent on the international economy and is mostly inward looking. The service sector is continuing to grow and perform well. India’s monetary policy has proved extremely resilient, and helped carry India through from the financial crises until now. Masking inaction under conservatism or simply suffering from a grid locked parliament will not help India’s cause. When times are tough a country needs its leaders to stand up and be counted. The unfortunate truth is PM Singh is not capable or powerless to do so, as he answers to Congress head Sonia Gandhi, and holds no true power base of his own. The last 2 years have seen a diffusion of power from the center to regional parties and this is alarming for the country. Regional parties are playing to popular vote policies, with short term rather than long term in interest. The situation is not as bad as it was in 1991 but it seems like it would take a crises of that magnitude to bring about the change. So far, high economic growth has legitimized the UPA’s inaction; however, that growth is no more. Ultimately, India is a democracy, and the government is responsible to the people. If reform does not come the “Indian shining” story will be no more.