India is losing its lure as emerging market darling

SERIOUS MONEY: INDIA HAS BEEN viewed as a tiger economy – rather than a lumbering elephant – ever since it embraced outward-looking, market-friendly policies in 1991.

Income per capita has increased from just $300 three decades ago to $1,700 today, and the economy has not experienced a single year of contraction since the Iranian oil shock and a bad monsoon struck in 1979.

A poor growth mix in recent years, however, has undermined the subcontinent’s status as emerging-market darling.

Persistently large fiscal deficits, a deteriorating external position, and stubbornly high inflation have led to a change in concerns over India’s ability to sustain its high-growth performance to whether it can simply maintain overall stability. Corrective measures are required urgently if the country wishes to avoid a return to the status of lumbering elephant.

The Indian economy endured centuries of sub-par performance until recently. Indeed, income per capita stagnated for almost 350 years following the arrival of the British at Madras in 1602. The economy fared little better in the decades that immediately followed independence in 1947, as the subcontinent withdrew into autarky and socialism.

Economic growth averaged 3.5 per cent a year – the so-called “Hindu” rate of growth – from the late-1940s through the 1970s, or roughly half the rate achieved by Asian tigers with outward-looking, market-friendly policies. The economy’s performance was particularly disappointing over this period, given that the population grew at 2.2 per cent a year. Indeed, the modest annual increase in income per capita meant India made little headway in reducing mass poverty.

The first efforts to dismantle socialism and reform the domestic economy were introduced following the election of the Janata Party in 1977, and further economic liberalisation took place in the 1980s under prime ministers Indira Gandhi and Rajiv Gandhi. The reforms, alongside profligate public spending, helped to accelerate the rate of GDP growth to 5.5 per cent in the 1980s, but the expansion was based on unsustainable borrowing, and a crisis erupted in 1991 when the country ran out of foreign exchange.

The foreign exchange crisis induced India to abandon its inward-looking policies and embrace the economic reforms recommended by the International Monetary Fund (IMF).

The new direction was not without its critics, and opposition parties argued that the new policies would result in a “lost decade” of economic growth, as had been seen in other lesser-developed countries that supposedly adopted the IMF-model in the 1980s. The critics vowed they would reverse the reforms when they came to power.

The pessimism proved misplaced, as the country’s finances were restored within two years of the reforms, and the annual rate of GDP increase accelerated to a new record of 7.5 per cent from 1994 to 1997. The outward-looking, market-friendly policies proved too successful to be reversed, and reform continued even when other political combinations came to power.