India’s Crisis: a catalyst for change?

Engines of the world economy. That was the moniker analysts gave to the world’s largest emerging economies not too long ago. Simultaneous slowdown has turned praise to pondering the causes and possible duration of the downturn. India is no exception. Growth is faltering in the economy many expect to ultimately take the lead among large emerging markets. Are yesterday’s bold predictions just a myth, or is the current malaise just another temporary setback?

Current economic data are not inspiring. Two years ago when Western economies were struggling to engineer a recovery, India boasted steady 8 per cent growth. Latest numbers are just 5.5 per cent – handsome growth to the average developed economy, but barely enough to keep unemployment from rising in India. Weakness has worsened India’s public finances. Its budget deficit swelled to
8 per cent of GDP in 2011, and avoiding a repeat in 2012 will be challenging. At 68 per cent of GDP, public debt is manageable, but it is due to deteriorate in 2012 for the first time since 2004. The down-turn in India’s fortunes has been hard on the rupee: it is off 21 per cent since mid-2011.

Most pundits would agree that India’s economic potential is far higher than today’s reduced growth. The country’s massive and growing labour force – long beset by high unemployment and widespread under-employment – is perhaps its most potent driver of future growth. Add to that the aggressive investment that is building modern India, and the productivity gains achieved by recent progress, and you get an economy that can sustain annual growth of 8 per cent, possibly more, well into the future.

Why the nascent faltering? A softer world economy is partly to blame, although India’s relatively small international trade exposure and its resilience to the last wave of weakness suggest that it’s at best a minor role. Public stimulus is likely a bigger factor. The vaunted US $1 trillion program came in with great fanfare, giving a major boost to growth. Since then, programs have been impeded by internal rigidities and increasingly scarce foreign capital. Growth has also been dented by the maturation of the spending cycle – a dynamic where lots is being spent, but with little additional bottom-line impact.

Crisis has spurred the government into action. A week ago, fuel subsidies were slashed, and a day later came proposed measures to open up the lucrative retail market and the aviation sector. Plans to divest the public stake in state owned enterprises were also unveiled. This is good news for the economy, but it has been tried before, unsuccessfully, and has many local opponents. Will these latest reforms actually see the light of day, or are they doomed to die on the table once again?

Passing these measures will be no cakewalk, but there is hope. The current sense of crisis on its own is a powerful motivator. On the flipside, there are millions of Indians aspiring to a better life, and wanting immediate economic solutions that produce high growth. There’s also a rising awareness that greater commercial openness leads to greater prosperity. Finally, last week’s proposals were made by a proven and trusted reformer, whose party faces a huge electoral test in less than two years.

The bottom line? The task for India’s leaders is to turn last week’s rhetoric into reality. If enacted, the proposals will bear fruit: vast amounts of capital and technology that promise to expand the depth and breadth of India’s current development, ensuring sustained high growth well into the future.

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