Lingering Doubts about India's Economy

June 27, 2016Indiaby East Asia Forum

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Is India really growing as fast as it purports?

After two years of the Modi government, the Indian economy presents a mixed picture. Despite claims that it is the fastest growing large economy in the world, doubts linger about its actual health.

These doubts stem from confusion about GDP estimates since the new series was announced in January 2015. Many seasoned observers continue to suggest that the growth in gross value added (GVA) recorded in these estimates overstates India’s actual economic performance. The macro estimates seem to strongly differ from micro phenomenon.

For example, while the GVA calculates that manufacturing growth is above 7 percent, the Index of Industrial Production, which measures the growth in physical output in the industry sector, yields an industrial growth of less than 2 percent. This can only be explained by a sharper fall in input prices compared to the price of final output and may reconcile with stagnation in volume terms.

This discrepancy reflects significant weakness in the corporate sector, which by all accounts is not generating new jobs. Investment and capacity expansion is at a virtual standstill. Growth in credit offtake from commercial banks by private industry is languishing at 9 percent — the lowest growth in recent times. In addition, exports have been declining for 18 months.

The good news is that the economy has successfully weathered two years of subnormal monsoons and anaemic global economic growth. India has firmly emerged out of the group of the ‘fragile five’, which it found itself in the second half of 2013.

With foreign exchange reserves at an all-time high of US$363 billion, a current account deficit of just 1.3 percent of GDP, external debt of less than 25 percent of GDP (of which 83 percent is long-term debt) and foreign direct investment (FDI) inflows topping US$30 billion during 2015–16, India is perhaps the only of the BRICS still standing.

This augurs well for the future. In addition, with the government undertaking FDI liberalisation measures, the country could well be poised for a major reform initiative before the next general elections in 2019.

The Modi government has already undertaken a very large number of incremental reforms across a range of sectors. The focus of these measures has been fourfold.

The first aim was to expand financial inclusion by opening as many as 200 million new bank accounts. The second was to improve the delivery of subsidies by moving towards a system of direct cash transfers, which better targets beneficiaries. Both measures are intended to pre-empt charges by the political opposition that the government is anti-poor.

Third, the government has sharply focused on improving India’s inadequate physical infrastructure. The construction of national highways has been accelerated. The government has allowed FDI in the railway sector for the first time, giving a major boost to railway modernisation projects. In the energy sector, the mess that the government inherited in the coal-thermal power generation sector has been quickly resolved and an innovative financing scheme launched to try to liberate state distribution utilities from the debilitating impact of debt.

Finally, the Prime Minister has, as expected, taken up the challenge of improving governance. There is visibly less slack and sloth in government offices because of an overall tightening of administrative practices. The use of digital technology has been expanded, making government processes, procedures, regulations more transparent and relatively more compliance friendly.

Large scale rent seeking and corruption is conspicuously lower. Alongside further liberalisation of FDI inflows in key sectors like defence, insurance, pharmaceuticals and commercial aviation, this has aided the business climate. All these policies represent a large body of reform measures that are beginning to yield positive results.

However, the government has not attempted some critically needed structural reforms. Major sectors like agriculture, education, health, public sector enterprise management, judicial reforms and a much-needed overhaul of the administrative machinery have remained virtually untouched, perhaps because they are considered too politically risky.

Modi’s strategy seems to be to try to kick-start the investment cycle and extract the maximum possible growth from improvements in governance and incremental reforms, while leaving more radical reforms for later. Hopefully, this will generate sufficient growth in the remaining three years of his term to ensure his re-election in 2019.

In the next phase of Modi’s reform agenda, he will need to tackle the more difficult challenges and implement radical sector reforms if India is to sustain its growth momentum and generate the 10 million jobs each year required to absorb fresh entrants into the workforce. To achieve that, the government will have to accelerate the reform agenda and confront long-standing but clearly distortionary practices in agriculture, education and labour markets, for example.

While focusing on economic reforms, the Modi government will also need to ensure that India’s ongoing social and political transitions remain on track. This challenge of tackling three simultaneous transitions makes India’s development an inordinately complex and difficult experiment.

The social transition, if not carefully handled, could generate inexorable stresses that will surely push back any progress made on the economic front. Politically too, India will have to constantly strive to reinforce those forces that support cooperative federalism.

These are extraordinarily complex policy challenges that confront Modi today. If he succeeds, as one must hope he will, the Indian experience could serve as a model for other emerging economies navigating economic transitions while simultaneously trying to deepen their democratic institutions.

Can Modi deliver on Indian growth? is republished with permission from East Asia Forum

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