The writer is former chief economic adviser to the government of India
India’s economy is experiencing a sharp slowdown — to the consternation of many observers. For several years, analysts and organisations such as the IMF and World Bank have touted India as the fastest-growing major economy, with the world’s brightest medium-term outlook. But in December the Reserve Bank of India, the central bank, cut its forecast for 2019 growth in gross domestic product to 5 per cent.
That headline figure actually understates the slowdown. High-frequency indicators show that in the first eight months of the current fiscal year, non-oil exports and imports have fallen, as has production of investment goods. Production of consumer goods and real government tax receipts have both grown by only 1 per cent. And a savage credit crunch has reduced commercial lending to less than Rs1tn in the first six months of this fiscal year, one-seventh its level the previous year.
Why have analysts failed to see the severity of the problem? A key factor has been faulty measurement. Ever since a new data system was adopted several years ago, methodological problems have bedevilled GDP estimates. As a result, the official growth rates of 7-7.5 per cent since 2011/12 have overstated actual growth by a considerable margin.
At the same time, analysts have misdiagnosed the problem because this time really has been different. India has experienced standard business cycles and even macroeconomic crises. But until recently it had never suffered from a serious balance-sheet crisis.
After the global financial crisis, corporate profitability collapsed, causing the share of debt owed by companies that do not generate enough cash to service interest payments to skyrocket to 40 per cent, according to Credit Suisse. Unlike in macro crises, the impact on the economy from the balance-sheet crisis has not been dramatic. Instead, momentum has slowly ebbed from investment, export and credit growth, while India’s entrepreneurial spirit has been drained.
Consider next the outlook. The stock market seems optimistic. Similarly, the IMF and World Bank are expecting growth to rebound in the next fiscal year. To be sure, India’s future is fundamentally bright. It has cheap labour and some decent institutions, with considerable scope for growth. Even so, the outlook for the next few years is sombre.
To begin with, India does not have the macroeconomic tools to get the economy out of the slump. Monetary policy is ineffective because central bank rate cuts are not being passed on to customers by financially stressed and risk-averse banks. Fiscal policy is constrained because public-sector deficits have risen to nearly double-digit levels, while debt dynamics are adverse because primary deficits are high as are interest rates compared with growth.
More importantly, India’s main challenges are not just cyclical, but structural. Fixing the balance-sheet problem has proved difficult. Despite determined efforts by Narendra Modi’s government, including launching a new bankruptcy code and repeatedly injecting capital into banks, stress in the corporate sector and banks remains high.
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A related challenge is the fraught relationship between the state and the private sector. For the economy to recover, investment must revive, which is why the government recently announced a major infrastructure initiative. Translating these intentions into reality, however, will be difficult, because in India neither the state nor the private sector commands great legitimacy.
This problem has a long history, but intensified after the government corruption scandals of the 2000s and the lending practices of the past decade. Given this experience, bureaucrats will be reluctant to sign off on public sector projects, while the anxious private sector will continue to lack appetite for ambitious projects that demand long-term commitment.
None of this should be taken as a counsel of despair. The government can pull the economy out of the slowdown. But two ingredients are essential: recognising the true extent and nature of the problem, and instituting reliable data systems for good policy navigation. Otherwise, not just Indian policymakers, but their Washington advisers too, risk remaining in the dark.
Josh Felman, head of JH Consulting, also contributed