New Delhi: India faces the danger of stagnating at current income levels because of poor infrastructure and inefficient economic institutions, exposing it to the risk of being ensnared in a so-called middle-income trap, the International Monetary Fund (IMF) has warned in an outlook report on the Asia-Pacific region released on Monday.
The Philippines and Thailand are also in a similar situation, said the report, which follows a fiscal year in which India’s economic growth is estimated to have slowed to 5%—the slowest in a decade.
The middle-income trap is a phenomenon in which hitherto rapidly growing economices start stagnating at middle-income levels and ultimately fail to rise to the ranks of advanced economices. This has often happened as the result of a sharp and persistent slowdown in economic growth.
Several Latin American economies, such as Brazil, Mexico, and Peru, entered a long period of stagnation in relative living standards after growth slowed in the late 1970s and early 1980s. By contrast, the four Asian Tigers— Hong Kong, South Korea, Singapore, and Taiwan—grew rapidly after attaining middle-income status and reached income levels comparable to those of advanced countries.
In India’s case, the risk might be one of a low-income trap rather than a middle-income trap given that India has barely stepped into the lower middle-income category, said Abheek Barua, chief economist at the HDFC Bank Ltd. India’s per capita income stood at $1,420 in 2012 while the lower middle-income category starts at $1,006, according to World Bank data.
“Unless there is a significant change in the ability to execute large infrastructure projects as well as change in institutional structure to encourage private investment, India could be stuck in a low-income trap for a very long time,” Barua said.
The IMF expects India’s gross domestic product (GDP) to grow 5.7% in 2013 and 6.2% in 2014. China’s GDP is seen growing 8% in 2013 and 8.2% in 2014. IMF pegs overall Asian economic growth at 5.7% in 2013.
In its report, the IMF said an analysis suggests that India’s trend growth peaked just before the global ﬁnancial crisis at about 8% and has recently declined to about 6-7%. For China, trend growth has declined from more than 10% before 2008 to less than 8% after the crisis.
“For China and India, the slowdown appears to have been driven largely by a decline in trend total factor productivity (TFP) growth, a crude measure of technological progress,” IMF said.
Even though physical capital, human capital, and employment are key drivers of economic growth, they matter less for sustained slowdowns in growth, which seem to coincide primarily with lower TFP growth, IMF said.
The IMF warned that in South Asia, notwithstanding a modest growth recovery in India on a more favourable external demand environment, deep-rooted structural challenges are expected to exert a substantial drag on potential growth while keeping inﬂation at elevated levels by regional standards.
Reducing government involvement in the economy and easing stringent regulations such as those relating to labour matter disproportionately once middle-income status is reached, the IMF said.
“This may be because they facilitate private sector development and encourage innovation over absorption of existing technology, both of which are key to graduating into the ranks of high-income economies. Likewise, insufficient road and telecommunication infrastructure emerges as a potential risk factor for growth, suggesting that infrastructure development matters more once the low-income stage of development has been passed,” it said.
However, the multilateral institution said India and Philippines are expected to enjoy the benefits of a demographic dividend with a rising working-age population while China and Thailand will be the hardest hit in the next decade as they cope with a bigger burden in supporting their aging populations.
Ahead of the monetary policy review this week by the Reserve Bank of India, the IMF said that for countries like India, where inﬂationary pressures have been elevated, vigilance on prices will pay dividends in terms of long-term growth. “In India, monetary policy can best support growth by putting inﬂation on a clear downward trend,” it said.
Many analysts have forecast a quarter of a percentage point cut in RBI’s policy rate on 3 May in the belief that the central bank would try and boost flagging growth, comforted by a decline in the wholesale price index to 5.96% in March, a 40-month low.