Articles / Rubric: Global

Indias Miracle Turned out to be a Mirage
The article is published in: July - August 2012

The concept of the BRIC block was to generate rapid economic growth in the countries in question, but the plan seems to have backfired on the authorities. By postponing urgent reforms, the countries drove themselves into a deadlock, one that is not easy or painless to get out of by any means.

When looking at the first decade of the BRIC countries, Jim O’Neill, the creator of the iconic abbreviation and the head of the Goldman Sachs, named India the biggest disappointment of the four countries. In fact, India, which was once considered as China’s strongest potential rival in the struggle for global primacy, has recently been generating much more bad news than good. The economic growth in India slowed to 5.3% in the first quarter of 2012, the slowest the country has seen in nine years. And the financial decline of the country is occurring at a frightening pace: just last year, India’s GDP grew by 9.2%. Last spring, the analysts at “Standard & Poor’s” officially changed their rating of India, as well as several of its largest banks and IT companies, from “stable” to “negative”. This is a troubling sign, especially when compounded with the fact that the world’s three largest rating agencies put India’s rating just one notch above “junk”. The state deficit ballooned to 5.9% of its GDP in the last fiscal year (the last twelve months, ending in March), overshooting the government’s forecast of 4.6%, The balance of payments is also deteriorating rapidly; the current account deficit of the country grew to 4% of its GDP, compared to the 2.6% from just a year earlier.

photo by franck-chilli

Who is to Blame?
Why has India started to show these signs of failure all of a sudden? The simplest explanation, one that local politicians often use as an excuse, is the global financial crisis. There is some small amount of truth in that – the overall instability of the global economy and the risk of a repeated recession in Europe make investors worried, and the massive deleveraging in developed countries is forcing companies and banks to sell their assets in emerging markets and to “repatriate” their capital back in their home countries. According to recent estimates by Nomura bank, several multinational companies stopped their investment projects in India, amounting to a total loss of $10.7 billion last year, as compared to $7.2 billion in 2010, and $3.1 billion. And this trend is not unusual – every country in the BRIC block is experiencing the same circumstances.

Global instability, however, is a poor excuse for a country that has an economy mired with ancient internal problems. The resolution to fix these problems, however, has been put off for many years as authorities celebrated in their pre-crisis success. Take, for example, the state financial situation. From a formal point of view, the situation is not terribly bad, especially when compared to the weaker Eurozone countries – the government debt is only at 70% of its GDP. The problem is in the structure of the country’s expenditures.

First, a large proportion goes to subsidize lower prices for fuel, electricity, and fertilizer, and to give financial aid for inefficient state companies. Just fuel subsidies in the last year cost the government 2.5% of its GDP. Secondly, by closing the budget deficit with loans from the domestic market, the country pushes private business out of the capital market, hurting potential investments. In the current fiscal year, the government plans to borrow close to $110 billion. And thirdly, this type of fiscal policy fuels inflation, which is over 7% per year currently, and this, in turn, limits the ability of the Reserve Bank of India to support the flagging economy financially.

The Indian authorities make no attempt to deny the flaws in the country’s budget. But before they can address the many financial problems, India has to deal with a political crisis. In the spring of 2012, India has scheduled a general election, while the coalition government – which currently supports the early public reforms – delays the passage of unpopular solutions.

Don’t Mess with the Capital
Another factor suppressing economic growth is the difficult and lengthy process for doing business in India. With the second largest population in the world, India has very strict restrictions for the development of its retail networks – the market, which is valued at almost $500 billion, is basically closed to foreign companies and continues to be dominated by small traders.

In any case, authorities often undermine the trust of foreign investors that are already in the country. With Vodafone, for example, the government decided to retroactively charge the company a capital gains tax. When the operator successfully challenged this decision in the Supreme Court, they made a retrospective review of the country’s tax legislation to continue fighting the mobile company. Taking the accrued interest and penalties into account, the law suit has already reached $3.7 billion.

For many years, direct foreign investments have been a key driver for economic growth in India. Last year, the country’s FDI rose to a record $36.5 billion (although a large portion of that money came from two major deals in the energy sector). The lack of reforms and the uncertainty of the rules, however, makes the attractiveness of India questionable.

With the investor’s interest weakening, India’s financial problems are only exacerbated – the most important thing the country needs now is an inflow of capital to maintain the stability of its national currency. The latter is particularly difficult, especially given the fact that the high prices of imported oil deepen the trade deficit every day. The rupee has become one of the weakest currencies in Asia in recent months, and despite the fact that the country’s central bank has $280 billion in international reserves, its efforts to support the falling national currency are slowly draining those supplies.

An outside observer may believe that the slow decline of India’s economy is an imaginary problem – even a 5-6% growth rate in GDP seems good compared to the economic state of the Western countries and Russia. But for India, the situation is much worse, especially given its social context. The country itself remains large and grows larger every day, but the population is very poor, and keeping up with the modern pace of development could deprive the Indian people from escaping poverty and improving their lives in the foreseeable future. On the other hand, creating a platform to accelerate growth over the next years can only be done with painstaking reforms and a lot of responsibility. And unfortunately, the government of India doesn’t seem to have the traits necessary to carry out that task.

Text: Anna Kim

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