Economic Environment and Country Analysis. Midterm. India 2014

1. How did India achieve higher growth rates after 1980, and particularly after 2000? What has been the role of the political system in this growth process?

In the first three decades after independence from the United Kingdom, India was a planned economy experiencing relatively slow growth (see exhibit 3). Import duties were high, foreign direct investments were prohibited in many sectors of the economy, inefficient public-sector companies were subsidized, and there was extensive regulation of interest rates and economic policies in general. In these ‘early years’, the Indian GDP per capita grew slowly, rather resembling low growth levels typically seen in mature and developed economies than fulfilling expectations for a dynamic development associated with emerging economies. Nevertheless, there wasn’t any urgency within the political leadership to address this sluggish growth pace by introducing dramatic changes - and consequently India was outshined by the rapid emergence of the four Asian Tigers (see exhibits 4, 5).

Socialist policies and the “license-permit-quota raj” led India to be a prime example of development strategies gone wrong. From 1947 to 1977, the Indian National Congress Party (CP), and especially the Nehru-Gandhi family, dominated the country’s politics. However, in the late 1970s and early 1980s, pressure from competing political parties was mounting and the “sick” public production units led to increased public debt, pushing Prime Minister Gandhi to fuel growth by introducing a more ‘pro-business’ political agenda coupled with fiscal expansion.

India continued its expansionary fiscal policies for several years, as witnessed by its increasing fiscal deficit, with the annual deficit peaking at -6.6% of GDP in 1991 (payments crisis). In spite of growing real GDP per capita and soaring total factor production throughout the 1980s, most analysts refer to 1991 as the political turning point (Rodrik & Subramanian, 2004), when India made a series of reforms following the country’s payments crisis. During this emergency period, India had to borrow money from the International Monetary Fund (IMF) to avoid defaulting on its payments and embrace the “Washington Consensus”. The IMF required several adjustments from India in exchange for providing funding – most profoundly, India was to further liberalize its economy.

A technocrat, Manmohan Singh, promptly strengthened the economic liberalization process, slowly moving from just ‘pro-business’ towards a more ‘pro-market’ environment. Amongst other measures, this involved welcoming foreign investment, which was unthinkable even a few years earlier. The following privatization was distinctive and targeted the steel, oil, power, mining, refining and exploration, road construction, air transport, ports, telecom, pharmaceuticals, and financial sectors. International trade barriers were lifted, the “license raj” was dismantled, and growth accelerated in many industries – not at least the services sector, with information technology and call centers leading the development.

The more depoliticized and market-oriented path has continued since, and real GDP quadrupled from 1991-2013. This has especially driven a boom in the service sector, which has gone from a contribution to GDP of 46% in 1995 to around 60% in 2013. In 2002/2003 the national deficit was -5.9% of GDP, and deficits of the states were -4.2% of GDP. The economic policy has been more stable during the recent decades and has been a major growth enabler.

The National and state deficits are the result of excessive government spending, financed by borrowing from the general public. India’s longstanding expansionary fiscal policy supported raising interest rates and crowding out of capital otherwise available for investing in the (more productive) private sector.

More recently, Indian politics appear to be adopting a more conservative attitude towards fiscal expenditures, rather aiming for healthy economic growth and effective tax collection, and to encourage loan repayments by state governments to reduce deficits.

2. What must India do to achieve double-digit GDP growth and inclusive development? Would you say that it is possible to achieve both goals?

The most recent, twelfth ‘Five-Year Plan’ (2012-2017) targets GDP growth of 8% in 2017. GDP growth slowed from 6,2% in 2011-2012, to 4,5% and 4,2% in 2012-2013 and 2013-2014, respectively. Furthermore, growth of this nature will eventually lead to other economic challenges, such as increased inflation and a widening inequality between rich and poor. As described in the answer to the previous question, India has experienced impressive GDP growth during the last 30 years, but many areas are lagging far behind western standards. Social changes are equally noteworthy, with the poverty rate dropping from 46% to 27% from 1983 to 2005. Still, hundreds of millions of Indians have been left out of this growth process and keep fighting in their struggle out of poverty.

Need for additional ‘pro-market’ measures

Growth has not come easy in India, and various governments with different political agendas have failed to reform some of the most imminent hindrances to stable, dynamic growth. Bureaucracy and wide-spread corruption are destructive for a strong business environment, and India’s government has still not removed the caps on foreign ownership in many industries. Politically, there are persistent regional differences, causing bumpy fiscal policies and periods of high inflation, reinforced by chronic underinvestment in infrastructure.

Many of India’s state-owned enterprises (SOEs) have recently been transformed to take a much more pro-market approach to their business strategy and have played a strong role in economic growth, but further reforms are needed if India were expected to reach double-digit growth rates. India’s SOEs still face productivity deficiencies due to inefficient organizational structures, technological lag, lack of competition, and conservative leadership. The OECD proposes to enable inclusive growth by further liberalizing the economy, establishing ‘special economic zones’ and ‘development banks’, and fostering public-private partnerships. (OECD 2015 b)

Accelerate infrastructure development to minimize regional disparities

India is far from having broad and inclusive development, with vast differences in economic development, growth, and political agendas between its regions (see exhibits 1, 2). Social indicators have improved since the economic reforms in 1991 for opening up the economy, with the largest gains