The old joke about Brazil that it is the country of
the future, and always will be could once have applied
equally well to India. The country was a sleeping giant, a
potential powerhouse that never seemed able to shake off its
That is no longer the case: the structural reforms and
economic liberalization the country has implemented over the
past two decades have awoken this colossus.
In terms of sheer size, India, the worlds fourth
largest economy, is already a force to be reckoned with. The
country is now a valued member of the G20, and it played a key
role in formulating the global response to the worldwide
economic slump and pushing for reforms to international
But India is still home to an outsize share of the
worlds poorest people. It continues to lag in indicators
of health, education and social welfare.
For the country to join the league of developed nations, its
economy needs to grow at a breakneck pace 910% per
year over the next decade and it will have to ensure
that its poorest citizens benefit from that growth. Any
stumbles along the way can mean that millions of its citizens
wont make it into the middle class.
And while nothing is likely to derail Indias eventual
rise, failing to hit its growth targets could push the
countrys development back by years, if not decades.
During the recent economic slump, Indias annual
average GDP growth fell from about 9% to just under 7%. In the
third quarter of 2009, it was as low as 5.3%. That may not
sound like a big deal it doesnt even come close to
meeting the technical definition of a recession but
the loss of two to three percentage points in GDP growth
is a traumatic thing for an economy like India, Subir
Gokarn, deputy governor of the Reserve Bank of India (RBI), the
countrys central bank, tells Emerging Markets in
In other words, it may not have been a crisis but it
certainly felt like one.
Foreign investors, desperate to repatriate cash to cover
losses elsewhere, fled. Credit became scarce. Businesses
deferred investments and hiring. Consumers pulled back on
spending. The RBI responded by cutting rates and pumping loads
of liquidity into the system, and the government helped out
with a large dose of fiscal stimulus as well.
Now, Indias economy is rebounding sharply.
Conventional wisdom suggests the country is poised to return to
the 910% GDP growth trajectory that is its ticket to
becoming a middle-income nation. The countrys
fundamentals remain strong: Indias growth has been
domestically led, not based on exports, and the country has a
domestic savings rate of 35% and an investment rate of 37%
numbers that would be the envy of many developed nations
and quite a few emerging markets too.
But a litany of potential obstacles is beginning to surface
from the uneven nature of the recovery to surging
inflation and large-scale structural problems in sectors from
energy to agriculture that may make it difficult for
India to realize this growth or sustain it over the long
The first question vexing policy-makers is how strong and
widespread is Indias recovery? The rebound is
robust from all the indications that we are getting, says
Saumitra Chaudhuri, a member of Indias Planning
Commission, says that, while the slowdown played out over 18
months, the recovery has been sharp, taking place in just two
quarters. The economy is close to where it was
before, Chaudhuri tells Emerging Markets.
The Planning Commission estimates that the economy will
expand 7.2% in the current, 200910, fiscal year and grow
8.5% in the coming fiscal year, assuming a normal monsoon. The
monsoon is always a big unknown in India, where agriculture
represents 18% of GDP, employs nearly half the country, and
where the monsoon delivers the vast majority of the
countrys annual rainfall. Last year, an extremely weak
monsoon led to record droughts and food inflation that battered
an already weakened economy.
Weather forecasters say the monsoon this year is likely to
be normal (although theyve been wrong before). Still, the
Planning Commissions assessment of Indias headline
growth rate is echoed by many private-sector economists as
well. The strong rebound in consumption and investment
along with the governments initiatives on inclusive
growth make us confident of strong macroeconomic performance by
India, says Nandkumar Surti, the chief investment officer
of JP Morgan Asset Management in India. He sees India growing
at 910% over the next two to three years, an assessment
that is in line with a recent pronouncement by Indian prime
minister Manmohan Singh, who is an economist by training.
But if the recovery has been rapid, it has also been uneven.
Amit Mitra, secretary-general of the Federation of Indian
Chambers of Commerce & Industry (FICCI), says some sectors,
such as manufacturing which in February, the latest
month for which data is available, registered a nearly 16% bump
in output from the same period a year ago have done very
well. So too have consumer durables sales of which are
up 25% year over year and the automobile industry, which
in February broke all-time records for new vehicle sales on top
of 11 months of solid growth.
These sectors have been aided by a hike in public-sector
salaries instituted by the government in October 2008, a move
which was unrelated to the financial crisis, but provided a
lucky fiscal stimulus just as the brunt of the worldwide
downturn hit. Other areas, such as textiles, gemstones and food
processing, however, remain weak, as do many small and
medium-sized businesses. These segments employ a lot of people,
so lethargy here undercuts consumer demand.
Exports, which account for nearly 40% of Indias GDP,
have also been slow to recover. Chaudhuri, from the
governments Planning Commission, says that export
weakness may last for a couple of years, due to the slow
pace of recovery in the developed world. He says the government
hopes to offset that through investment in domestic
More power, more water, more roads, he says.
These things are necessary in any case to sustain higher
growth, but now these efforts should be redoubled to offset the
weakness in export-oriented sectors.
Because of this weakness and Indias on-going hunger
for imported oil, which has been rising in price, Indias
current account deficit is now the highest ever recorded
4.1% of GDP. While that might normally depress the value of the
rupee, in this case one of the factors hurting exports has been
an unusual appreciation of the rupee as investment and capital
inflows have picked up. The strengthening currency and the
large current account deficit further complicate matters for
the RBI. While there is no risk of a balance of payments crisis
the central bank is sitting on more than $280 billion in
foreign exchange reserves many believe the RBI should
use exchange rate adjustments to tamp down the rupees
The currency stands at about Rp44/$ and Rp60/E, compared to
approximately Rp50/$ and Rp65/E one year ago. This has been
tough for smaller exporters who are less likely to have hedged
their exchange rate exposure. Exporters will take a
beating, says Ashok Kajaria, the president of the PHD
Chamber of Commerce and Industry, which represents companies in
Indias vast middle market. And imports will go up,
which is more trouble for the domestic market.
Kajaria is among those who would like to see the RBI move to
reverse the rupees rise. But that is unlikely to happen
immediately. The level of capital and investment inflows, while
high, does not seem to have reached pre-crisis levels, and
foreign investment to the extent it is helping finance
infrastructure development is important for Indias
long-term growth. A number of analysts think the unspoken
reason behind the RBIs reluctance to temper the
rupees rise is that the bank has been trying to
facilitate the governments large-scale borrowing
campaign, and exchange rate adjustments would inevitably
increase the governments borrowing costs.
The RBI has a policy of only intervening to smooth out
unusual volatility, not to keep the rupee trading within a
fixed band, Gokarn says. But he adds that, should India be
faced with a sudden tidal wave of foreign capital flows, as
some analysts predict given the weakness of the recovery in
other once-promising investment venues worldwide, the RBI would
consider policies of active capital account
management or exchange rate intervention. We will
not take any instrument or action off the table, he says.
If the pressure gets severe enough, nothing prevents us
from acting. Among the options that many analysts think
India should consider is a policy Brazil recently implemented:
a tax on portfolio investment.
For now, the RBI has more pressing worries. Inflation is
perhaps the biggest concern for Indian businessmen, central
bankers and civil servants alike. Wholesale inflation has been
rising steadily throughout the year and is presently hovering
just below 10%, a psychologically important threshold.
Resurgent industrial production combined with a global increase
in the cost of commodities and rising oil prices seem to be the
Meanwhile, inflation in consumer prices is already running
at close to 15%, among the highest of any major economy. Food
inflation, in part due to last years poor monsoon, is a
large component of this increase, but there are signs that
inflation is becoming more widespread. We typically do
not see a monetary response as the right instrument to fight
food inflation, Gokarn says. But the problem is
that food inflation can spill over into more generalized
Coming so early in the recovery, the inflation numbers alarm
economists, business leaders and politicians. They say
inflation is surging even though worldwide demand for many
basic industrial inputs and, perhaps most importantly,
for oil has not recovered to pre-crisis levels. Indian
economic experts generally agree that if the economy is growing
at its targeted rate of 910%, it can withstand an
inflation rate of between 4% and 5%.
But current numbers are well beyond that range.
If there is any immediate threat to being able to
sustain this revival, its the fact that there is going to
be inflation that the government will have to respond to with a
good deal of fiscal contraction, says CP Chandrasekhar,
an economist at Jawaharlal Nehru University in New Delhi. After
finance minister Pranab Mukherjee claimed that none of the
stimulus the government injected into the economy through tax
cuts and subsidy hikes last year would be withdrawn, the
government did begin to pull back, hiking fuel and fertilizer
prices and increasing excise duties by 2%. Mukherjee has hinted
in a recent speech that further tax increases may be likely in
the near future.
On the monetary side, the RBI in late April hiked its key
interest rate benchmarks and its cash reserve ratio by 25 basis
points. (The reserve ratio hike is designed to take an
estimated 125 billion rupees, or $2.8 billion, out of the
economy almost immediately.) These moves followed a surprise 25
basis point rate rise in mid-March and another 75 basis point
increase in the cash reserve ratio in January. Still, some
analysts feel that the bank has acted too slowly. They
seem to be a little behind in raising rates, says Nilesh
Shah, chief investment officer of ICICI Prudential Asset
Gokarn disagrees. He says the data the RBI had last autumn
indicated that a recovery was underway but that it was fragile.
The bank did not want to move too precipitously and risk
derailing renewed growth. This judgment of being behind
the curve is a hindsight judgment, he says.
He says that the bank now has more confidence in the
economys rebound and is more focused on the risk of
inflation. We dont want to disrupt the recovery,
but we cant ignore inflationary pressures that are
building up, he says.
This requires skilful judgement by the RBI. If it raises
rates too quickly, it could still kill off the recovery. Higher
interest rates could also wind up attracting a greater influx
of foreign investment, leading to further upward pressure on
the rupee and potentially setting the stage for bubbles in
sectors popular with foreign investors, such as real
Given this, many analysts believe the RBI is more likely to
use instruments such as upping its cash reserve ratio
for banks that take liquidity out of the system without
directly raising short-term interest rates. Undershoot,
however, and inflation might get out of hand, hurting the poor
and possibly leading to social unrest. Keeping too much
liquidity in the system could also permit asset price bubbles
to build, potentially triggering a domestic financial crisis
when they pop. If the RBI and the government get the balance
right, India seems poised to return to a growth rate of 9% or
more. But sustaining that pace of growth for five years or
more, which is what India must do to become a developed nation,
will require significant structural reforms.
The most obvious is infrastructure. The country is
desperately short of adequate power, water and roads. The
government has made a significant investment in these areas,
but more is needed and fast. The government announced in
April that it will likely fall more than 20% short of its
five-year goal of adding an additional 78,000 megawatts of
power generation by 2012.
Another area in need of a major overhaul is agriculture.
Even without the weak monsoon, farm productivity, yields and
incomes have all stagnated. The Planning Commissions
Chaudhuri says the government is putting a special emphasis on
reforming the sector, particularly improving efficiencies in
crop storage and in transporting food to market. At present
between 30% and 40% of all produce harvested rots before it
reaches the market. The government believes these improvements
will boost supply, tame food inflation, and that rising farm
incomes will aid price stability.
The government has also pushed on with a programme of
privatization, selling off government-owned corporations and
assets. These sales are providing a one-time boost to
government revenues, helping it cover its fiscal deficit, which
stands at 5.5% of GDP, down from 6.7% the year before. The
government has pledged to bring it down to 4.8% next year and
eventually get it below 3%.
But doing so will require the government to do more to
balance expenditures and revenues over the long term. The
government has instituted a number of popular, but costly,
social programmes including a rural employment guarantee
scheme that are now permanent fixtures.
Cutting the expenditure side further doesnt wash
politically, says Rajiv Kumar, director of the Indian
Council for Research in International Economic Relations
(ICRIER), a New Delhi think-tank. So the bulk of deficit
reduction will have to come from enhanced revenues. They
need to unify tax rates, make compliance even better and
institute a service tax, Kumar says.
The country will take a step in that direction when it
institutes a uniform Goods and Services Tax (GST), a move
expected for the 201112 financial year.
The good news is that the government seems to have a handle
on what it should be doing to create long-term, sustainable
high growth. But, as always, having the right ideas is one
thing, delivering on them is quite another. Given the range of
potential hurdles including the vagaries of a global
economic recovery, strong inflationary pressures and large
structural reforms Indian policy-makers will have to be
more than just skilful: they will have to be lucky, if the
country is to realize its dream of sustainable, double-digit