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.

The Indian economy has continued to move forward at a robust pace, and weathered numerous tests of its resilience relatively well. Economic growth slipped to 5.5 per cent a year from 1997 to 2002, a favourable outcome given that the Asian financial crisis, two severe droughts, and a global recession all struck over this period.

The economy’s performance improved sharply after 2003, and annual growth accelerated sharply to an average of almost 9.5 per cent in the three years that preceded the global financial crisis. The “Great Recession” took its toll on the economy, but growth was still almost 7 per cent in 2008, and rapidly recovered to an average of more than 8 per cent a year in 2009 and 2010.

The recent growth performance, however, was propped up by unsustainable aggregate demand policies. The overall fiscal deficit has averaged close to 10 per cent of GDP over the past three years, and the budget released in February does not display any serious ambition to restrain public spending. The government’s profligacy has been driven primarily by populist spending policies, and with national elections due by 2014, next year’s budget is unlikely to be much better.

The public debt-to-GDP ratio is already close to 70 per cent or 30 percentage points higher than similarly-rated sovereigns, and further increases in the ratio are virtually certain to lead to rating downgrades. Further, current fiscal policy has contributed to a widening current account deficit and rising net external indebtedness.

The level of net external debt to GDP is already above 10 per cent or three times greater than similarly rated peers, and the more than 10 per cent drop in foreign exchange reserves since last autumn limits its ability to absorb sustained capital outflows.

The profligate public spending policies helped push the rate of headline inflation up to the 8-10 per cent range over the past two years, and though the inflation rate has since decelerated to 7 per cent, it remains above the central bank’s comfort zone. The stubbornly high rate combined with a sharp drop in the Rupee, limits the central bank’s ability to stimulate the economy, which has seen its quarterly growth rate plunge to the lowest level in seven years.

India is rapidly losing its lure as emerging market darling. Persistently large fiscal deficits, a deteriorating external position and stubbornly high inflation have seen foreign investors look elsewhere for growth opportunities. The lumbering elephant stands at a crossroads.

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