Home >Opinion >Online Views >India’s growth slowdown rooted in structural issues

There are no easy exits for the Indian economy as it struggles to regain its lost momentum.

The government said on Thursday that the economy is likely to grow at just 5% in fiscal 2013— lower than what most economists expect. The data also shows that the slowdown is generalized rather than being restricted to some parts of the economy. All major components of gross domestic product (GDP) will grow at a slower pace this fiscal compared with the previous year. The only exception is “community, social and personal services", which is a proxy for public spending. This could come under pressure in the coming quarters as the government tries to put its fiscal house in order.

It is quite likely that growth has hit a bottom, but that does not necessarily mean a quick recovery is on the cards. The reason: the Indian economy has run into deep structural problems because of policy uncertainty and the lack of adequate economic reforms since 2004.

The depth of the problem is evident in the report on the Indian economy released by the International Monetary Fund (IMF) on Wednesday, based on its annual consultation with the government.

A few issues stand out:

First, the main reason the Indian economy has lost momentum is the slowdown in corporate investment and infrastructure building. Other factors such as global problems are relatively less important. But what began as an investment slowdown has now become a generalized slowdown.

Second, interest rate reductions alone will not help bring investment on track. It is not high real interest rates, but other impediments such as policy uncertainty, delayed project approvals, slow project implementation and electricity shortages that are holding back investment activity.

Third, external vulnerability is rising due to the record current account deficit. Foreign debt is up 53% in the past three years, much of it is concentrated in companies. The external debt-GDP ratio is still comfortable compared with other emerging markets. The overall external situation is still manageable, but the importance of debt in capital flows is rising and the adequacy of foreign exchange reserves is falling.

Fourth, lowering the fiscal deficit is an urgent task. The recent attempts to rein in the fiscal deficit are encouraging. However, how this is done is important. The thrust of the strategy to reduce the fiscal deficit should be on subsidy reforms, as the Kelkar committee also pointed out. An alternative strategy of fiscal discipline led by lower public investment will harm growth.

Fifth, the Indian corporate sector is looking more vulnerable, further harming the investment outlook. Its median leverage is far higher than what it is in companies in similar emerging markets and more than what it was before the crisis. The rise of unhedged foreign exchange loans is also a worry.

Sixth, bad loans in the banking sector are rising, as is usual at the end of a credit boom like the one India experienced. Bank capital ratios have fallen only slightly. Weaker credit quality has contributed to the slowing of non-food credit growth. Bad loans and debt restructuring will continue to increase in the banking sector.

Seventh, the recovery will be a slow one. India’s potential growth rate has fallen in recent years, and is now estimated at around
6-7%, lower than the pre-crisis estimate of 7.5-8%. The authorities have limited policy space because of a high fiscal deficit and entrenched inflation.

Eighth, a sustained slowdown will have social implications. “Lower medium-term growth might not generate sufficient jobs to absorb labour market entrants. Weaker growth also entails a slower reduction in poverty. IMF research suggests that 35 million more people would remain below the $1.25/day line compared to a scenario in which growth returns to the 2004–09 average," says the IMF.

It is the political risks that should eventually force the political system to act decisively—even though a general election could be around the corner.

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