The Challenges Facing India's Economy

Hello, and welcome to the World Economics section of Teen Political News. I’ll start off by saying that I don’t have any experience whatsoever in the art of writing blogs, which probably isn’t a great sign for you the reader. But I’ve taken on this challenge to put across my views on the emerging economies, the India’s, China’s and the Middle-East of this world, to try to get to the root of what drives these economic powerhouses, and to gain an understanding of what problems they are facing in their effort to sustain this purple patch. You may not agree with everything I say, but as far as I know, by creating debate and opinion, my job as a blog writer will have been a success.

So where do I begin? Let’s start off with India. The so-called superpower of the millennium, India was growing at over a staggering 9% over the last 3 years (just to put this into perspective, the trend rate of growth in the UK is 2.75%). Overseas investment was at an all-time high, $20billion was poured into the Sensex (Indian stock exchange) as investors rode on the crest of the economic wave. India was benefiting from a period of liberalisation in the early 1990’s carried out by the current Prime Minister, then finance minister Manmohan Singh. These reforms greatly lowered barriers to trade and liberalised capital markets, resulting in trade accounting for 45% of GDP in 2008 and huge levels of foreign direct investment. Even the cricket team was doing well for once, as we won our first World Cup for 24 years in 2007. The cricket-mad nation was on a high, and was loving it.

So was I. Despite living in England for the best part of my life, India has always held a special place in my heart, I support India as vociferously and devotedly as any cricket fan out there (I think my throat was sore for about a month following the World Cup triumph), and I always make it a point to go to India at least once a year. I could see the changes taking place and to be a part of it was a special feeling.

Yet, at the same time, I felt on more than one occasion that too much was happening too quickly - surely the reforms of the 1990’s could not be replicated to allow for current high levels of growth to continue. Make no mistake, the sustainable rate (trend rate) is growing very quickly, and the significant gap between actual level of growth and sustainable level of growth is being reduced, mainly due to a boom in manufacturing and technology. The efforts by the government to increase the quality of the infrastructure in order to support this are there for all to see. In the major cities, electrical supply is no longer a problem, public transport networks are sprouting all around the country, and almost every Indian you see in a city will now own a mobile phone. For this, the government must be applauded as the multipliers caused from their spending have played their part in the surge of the economy.

However, the economy is still stubbornly growing well above the trend rate, and this has created that menace for every economy, inflation. Although I agree that some inflation is necessary for an economy to function smoothly, the large level of inflation currently being experienced by the global economy (due to rising commodity, oil and food prices) has some very significant drawbacks, especially in India’s case.
It can be said that India has created its own troubles with its obstinate pursuit of high economic growth, yet I feel that in many ways it has been the victim of its own success.

With investment constantly rising and the housing market booming, employment was at an all time high and a real positive wealth effect was being felt in the nation. This increase in prosperity created more effective disposable income and increases in purchasing power, and rapidly rising demand is a definitive cause of inflation. Although the Reserve Bank of India (RBI) could be blamed for not foreseeing this, the chances are that they realised that high inflation was a good enough price to pay in order to maintain the 9% levels of growth being witnessed at that time.

An ever increasing population, as well as a rising standard of living and greater distribution of wealth are other reasons for rapidly rising demand. High demand has not been the sole cause of inflation however. As we all know, over the last year rising commodity, food and oil prices have created inflationary pressure on the global economy. India has also felt the effects. Higher costs of production for manufacturing firms have led to rising prices in the domestic markets. What’s the result? An astounding 12.4% inflation - a twenty year high. Worrying? Definitely. But damaging in the long-term? Well that depends…

Recent inflation has reduced the competitiveness of Indian exports, has further served to widen the wage inequality gap (middle-class workers in India are in extremely weak bargaining positions and so have suffered cuts in real wages), has resulted in many policy changes (mainly related to the banning of the exports of raw materials to reduce demand), and has caused the RBI to become ‘bearish’ and raise its lending rate to 9.0%, a seven year high. Growth is going to suffer in the short-term. There is absolutely no doubt about that, and we can see the signs of it already with growth of 7.75% in the financial year ending in 2008, down already from years before. High interest rates will ensure that growth will stay low in the near future as well, as the RBI tries to rein in inflation to a target of 7.0% by next year. I feel that this is beneficial. India needs to cool down and grow below the trend rate during this period of global instability. The economy was in danger of overheating, but now has a chance to regroup, rethink its policies and economic strategies and then push on to greater heights once this global slowdown is over.

There are many things in its favour.

The culture of India is one factor that has, in my opinion, been one of the founding and uncelebrated factors of the resurgence of its economy over the last 15 years. The increased work-ethic, the ambition to succeed, and most importantly the falling levels of corruption (for this, the government must be given a hearty slap on the back), have been essential in not only creating but maintaining the high growth rates. I have witnessed this first hand, and I can say that the competition for success and the astounding amount of hard work that people are putting in to achieve their dreams is something I have not seen anywhere else in the world. People from underprivileged backgrounds are now daring to dream, and are also reaching those dizzying heights. Laxmi Mittal started off with nothing, and is now one of the richest men in the world. This is perhaps one of the major benefits that India is experiencing from having a large population, and long may it continue.

Another factor is the very strong housing market in India. Although investment has tailed off in recent months, this is as a result of the higher interest rates implemented by the RBI to control inflation. There is no denying that the housing market has very far to go, and I think this has a lot to do with the fact that until recently it was not based on the ‘credit’ culture. To own a house in India, you had to pay the full value upfront, and no loans were given. This is probably one of the reasons for apartments being the main form of dwelling. Only after retirement did people buy or build their own houses. This meant that the people of India built up very little debt, and thus were able to spend freely and without concern after retirement. My grandfather earned and saved for 25 years before he owned his first house. Although recently the trend of mortgages is hitting India, these are very low risk as a large upfront payment is still required, and as a result India has hardly felt the effects of the global credit crunch. The housing market will be a backbone for the Indian economy in the future, and I think that foreign investors will be lining up to get onto the Indian property ladder.

Finally, India has benefited from a great deal of investment in the past (as mentioned earlier) and will continue to do so due to its unique opportunities and high growth. This is beneficial to both the investor and the economy. The cheap, skilled labour, low rent and access to a high quality and improving infrastructure will ensure that investment remains attractive. The investor gets the returns from his investment that he is looking for, while the economy benefits from the rising levels of technology, capital and skills – all leading to increasing efficiency. This will help the trend rate of growth to continue rising, and will serve to dampen inflationary pressures in the future.

On this note, however, a word of warning. The right balance must be found between domestic investment and foreign input. India must not get too reliant on investors from abroad to keep investing in order to be able to sustain its success, but must develop its own firm foundations from which to build on. There are a lot of resources in India that are currently not being fully exploited, such as agriculture. As long as these are built on and expanded, India will be able to keep developing and going from strength to strength.

India will turn into an economic powerhouse, simply because it is in too strong a position at the moment to be thrown off course by a temporary global slowdown. True, it is not all rosy - there are challenges that must be faced and overcome. There would be no satisfaction in success if there were no difficulties to be dealt with along the way. The foundations have very nearly been laid, & for sure the potential is there. It is now up to the government, and more importantly the people of India, to make sure it does not go to waste. China's in its sights, and India is going places. Watch this space.


By Kunal Gupta, TPN's Emerging Economies & International Economics