India’s Faltering Economy
September 13, 2013
Recent weeks have seen no shortage of headlines calling attention to India’s nose-diving economy. While fears of a collapse are overblown, there is real reason to believe that serious reform is still needed. The following is meant to provide some context and clarity about this latest crisis, why it needs to be taken seriously, and what can be done to get the economy back on track.
Q1: What is the current economic situation in India?
A1: India is in the midst of its worst economic slowdown since 1991. Sluggish growth, declining investor sentiment, a high current account deficit, rising inflation, and a depreciating rupee have sent the economy into the doldrums. GDP growth slowed to 4.4 percent in the latest fiscal quarter, marking the country’s slowest growth in four years. The manufacturing sector recently contracted for the first time in four years, and the rupee has fallen around 15 percent against the dollar this year.
Q2: Why is India’s economy stumbling?
A2: Amid signals that the U.S. Federal Reserve intends to scale back its stimulus program and reduce bond purchases, emerging markets have experienced significant capital flight and greater currency volatility. A general economic slowdown in India’s exports markets has also contributed to the slowdown.
However, larger domestic structural factors are also at the heart of the current downturn. India’s wide current account deficit (CAD), which reached $70 billion or 4.8 percent of GDP in the most recent fiscal year, has been called “unsustainably large” by the country’s prime minister and continues to constrain growth. A confluence of factors, specifically poor infrastructure and energy access, stifling labor laws, a cumbersome bureaucracy and regulatory regime, rampant corruption, and a weak emphasis on manufacturing and job creation, has placed a heavy burden on the economy.
Since the “big bang” economic reforms of 1991, politicians and policymakers have treated the economy as though it were on autopilot and have unfortunately not invested nearly enough in skilling up India’s workers through higher quality education and vocational training. Leveraging the country’s human capital pool and promoting greater worker productivity would enable still-anemic sectors of the economy such as manufacturing to expand at faster rates.
Q3: What policies could help the Indian economy rebound?
A3: In the past two months, the government has taken some positive steps to facilitate investment by raising foreign direct investment (FDI) caps in the insurance and telecom sectors, permitting greater foreign investment without prior government approval, and easing investment norms in the coveted multi-brand retail sector. Retail chains have been allowed to set up shop in cities with less than a million people and will face less stringent sourcing requirements upon entry.
There are a host of monetary policies that the new governor of the Reserve Bank of India, Raghuram Rajan, could also take to stabilize the rupee and further liberalize India’s financial system. But most observers note that he has little political independence, that major policy decisions will remain subject to New Delhi’s consent, and that “the biggest problems bedeviling the Indian economy are beyond his control.”
Ultimately, India’s economic future depends much more on good governance than on monetary policy. In order to regain the once-buoyant investor sentiment toward India, a more business-friendly environment is needed. This could be created through the fast-tracking of infrastructure and energy projects; the implementation of a goods and services tax (GST); expediting land acquisition and legal cases; and continuing to ease FDI norms. Cutting bloated food, fuel, and fertilizer subsidies (the main drivers behind the large CAD) will also help put India on the path toward fiscal consolidation and macroeconomic stability.
Q4: What are the consequences if India’s economy continues to falter?
A4: India is at risk of a possible credit-rating downgrade to “junk” status, which could erode the country’s ability to further attract foreign investment and also diminish long-term growth prospects. Standard & Poor’s, which currently maintains a “negative” outlook on India, predicts a one-in-three chance of a downgrade over the next two years. A credit-rating slide would make India the first BRIC country to lose investment-grade status.
In addition, a falling rupee will drive up food and consumer goods prices, hitting India’s poor the hardest. Given that the country is preparing for a national election, politicians are likely to pay very close attention to inflation (running close to 10 percent), as any further rise in the price of basic goods and food could cost them the election. Reduced consumer spending and economic activity will also undercut prospects for further economic expansion. Already, a number of major Indian multinationals have hinted at greater overseas investment due to mounting frustration over inadequate domestic infrastructure and various regulatory hurdles. Restoring high economic growth will become all the more difficult if economic activity moves abroad.
By all accounts, India needs to maintain a 7–8 percent economic growth rate in order to continue pulling millions of its citizens out of poverty. Already, India has commendably reduced poverty to 22 percent, but sustaining this progress will depend greatly upon generating more inclusive economic growth in the years ahead.
Q5: Will the current crisis trigger much-needed structural reform?
A5: This is not likely in the near term. With the 2014 national elections fast approaching, revitalizing the economy may take a backseat to political populism. This has generated greater uncertainty about the future trajectory of the economy, and a number of investors have adopted a “wait and watch” approach. The past few weeks alone have seen the government expand the country’s costly food subsidy program and approve a farmer-friendly land acquisition bill that could make the process more difficult for industry. Both parties bank on such measures to shore up voter support.
Persis Khambatta is a fellow with the Wadhwani Chair in U.S.-India Policy Studies at the Center for Strategic and International Studies in Washington, D.C. Samir Nair is an intern scholar with the CSIS Wadhwani Chair.
Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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