In the aftermath of the global financial crisis, optimists hoped that the BRIC (Brazil, Russia, India, China) countries would drive the world’s economic engine. But those hopes have sputtered.
China’s economic growth has slowed to its lowest rate in three years. Brazil’s economic growth has fallen to under 3% from around 7.5%. Russia’s economy is heavily dependent on oil and energy prices. And India? It seems destined to never fulfill its economic potential.
In the 30 years following independence in 1947, India achieved a modest rate of economic growth of 3-4% per annum. The “Hindu rate of growth” was a derogatory term coined by economist Raj Krishna to draw attention to India’s poor performance compared to other Asian economies.
Reforms in the 1990s paved the way for a period of expansion and relative prosperity for India — exemplified by the marketing slogan “India Shining,” which was first popularized by the then-ruling Bharatiya Janata Party for the 2004 Indian general elections.
Over the last two decades, India’s economy has almost quadrupled in size, growing at an average rate of about 7% per annum. India’s GDP rose by 43% between 2007 and 2012, slightly less than China’s, which increased by 56%, but much faster than developed economies that grew only 2%.
In late 2011, the Indian government’s 12th five-year plan forecast growth of 9% between 2012 and 2017. Yet by early 2012, India’s growth had slowed to around 6%, high by the standards of developed countries but well below the levels required to maintain economic momentum and improve the living standards of its citizens.
Internal fissures
Increasingly, India’s problems — poor public finances, weak international position, structurally flawed businesses, poor infrastructure, corruption and political atrophy — threaten to overwhelm its potential.
In recent years, India has consistently run a public sector deficit of 9%-10% of GDP, including the state governments and off-balance-sheet items. The problem of large budget deficits is compounded by one major cause — poorly targeted subsidies for fertilizer, food and petroleum which may amount to as much as 9% of GDP.
In March 2012, India brought down a budget that forecasted a fiscal deficit of 5.9%, well above its previous fiscal deficit target of 4.6%. India’s strong rate of recent growth (an average rate of 14% between 2004-05 and 2009-10) made large deficits, on the order of 10 % of GDP, relatively sustainable. Slowing growth will increasingly constrain India’s ability to run continuing large deficits.
India’s government debt is around 70% of GDP. As its debt is denominated in rupees and sold domestically, India faces no immediate financing difficulty. Instead, the government’s heavy borrowing requirements crowds out private business.
But India is running a current account deficit of over 3% of GDP, and trending higher — among the highest in the G-20. The cause is slowing exports as a result of weakness in India’s trading partners, while imports, mainly non-discretionary purchases of commodities and oil, have increased. India imports around 75% of its crude oil.
India’s weak external position has manifested itself in the volatility of the rupee, which was one of the worst performers among Asian currencies in 2011. Indian businesses, which have unhedged foreign currency borrowings, have incurred significant losses as the value of their debt rises as the rupee falls. Indian companies face large debt maturities in the coming year. The ability to refinance the debt coming due remains uncertain in an environment of a weakening economy as well weakening company outlooks.
India has more than US$300 billion in currency reserves. Foreign debts that must be repaid in the current year are around 40%-45% of this amount, which if deducted highlights the increasing weakness in India’s external position.
Crisis brewing
Slowing growth, tighter credit and other economic problems have increased corporate defaults to the highest level in 10 years. Non-performing loans are now around 2.5%-3% of bank assets. Analysts estimate that the major banks have around $25 billion in bad loans, an amount which is increasing.
The Indian government has already moved to recapitalize state-owned banks to ensure their capital position. In the process, the budget deficit and the government borrowing requirements have come under increasing pressure.
India is plagued by inadequate infrastructure. In critical sectors like power, transport and utilities, there are significant shortages. Yet political pressure to keep utility costs low has impeded investment.
In the electricity sector, for example, state-owned utilities that purchase power from producers and sell to residential users have incurred large losses. State governments are unwilling to raise retail consumer rates despite increases in the price that power producers charge the utilities. Attempts to increase rail ticket prices have failed. The Railways Minister’s own party opposed the proposal and demanded he be removed from his job.
Increasingly, the structural problems and poor history of projects has made foreign investors cautious, creating a shortage of foreign capital for investment in infrastructure.
While its workforce is young and growing, there is a dearth of skills. The shortage has led to large increases in salaries for skilled workers. Higher wages increase the cost of Indian businesses, making them internationally less competitive and fueling domestic inflation.
Still, the key drivers of growth remain intact, including a large population, a substantial domestic market, high savings rates that have financed investment and an educated, English-speaking workforce which is under employed. But the question is whether India has the collective will and ability to overcome this sea of troubles.
Source: marketwatch.com
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