India’s lost economic opportunity and its implications

Indian GDP growth for fiscal year 2012 was just announced, at a surprisingly low 6.5 percent. Attention is focused on the present – the slow growth, still high inflation, and balance of payments instability. There is even talk of a crisis similar to that in 1991, which launched now-distant market reforms. The real danger, though, is to the future. India is early in a powerful demographic expansion, a rare opportunity for sustained, rapid growth. It is wasting that opportunity.

The waste can be traced to the past. Current difficulty should surprise no one – the mistakes being made were plain by mid-2009 at the latest. The federal government has been blinded by the belief that, because India could grow at 9-10 percent, it would. In fact, just as in 1991, the bridge from economic potential to reality is built by market reform, not state stimulus and wishful thinking.

The implications for the U.S. are unpleasant. No economy can substitute for a thriving India, for what will soon be the world’s largest workforce. America, both public and private sectors, should make the best of a deteriorating situation by working with as many economic partners as possible, starting with individual Indian states to the extent possible. The U.S. is already cultivating Indian states but the federal government’s economic failures make it a more urgent task

India’s Economy Right Now

The initial estimate for Indian fiscal 2012 GDP growth is a sharp slowdown from 8.4 percent in fiscal 2011. The performance was worst in the final, January-March quarter, where the GDP gain was only 5.3 percent. The January-March result may be revised higher in and, at first glance, 6.5 percent annual growth might still look satisfactory. However, in addition to the discouraging trend, there are three critical flaws, all of which have been building for some time.

First, the general economic trajectory is unsustainable. While Delhi can point to a double-digit rise in per capita income of around 14 percent, debt per capita rose well over 20 percent in fiscal 2012. The public contribution to this has been much discussed: while boasting of high growth, the government has failed to cut the annual fiscal deficit below five percent of GDP. Pledges that an improvement is right around the corner are based, not on budget discipline, but on higher GDP growth that never materializes.

There is another unsustainable trend that receives less attention. From April 2006 to March 2010, real GDP expanded 50 percent, an outstanding result. However, broad money M3 ballooned 150 percent. In fiscal 2011, credit growth in particular accelerated sharply past 22%. This cannot last. The fiscal and monetary stimulus India has relied upon not only is not working but it must end.

The second critical flaw is inflation. Year after year, the government insists inflation is soon to drop to 6 percent. Consumer inflation was 9.5 percent at the end of the fiscal 2012. The wholesale price index rose “only” 6.9 percent but previous readings have all been revised higher and wholesale prices now look to be accelerating again. During the two terms of the ruling United Progressive Alliance (UPA), overall prices have increased 63 percent. Food prices have doubled, overwhelming the UPA’s promise to make growth more inclusive.

Losing An Irreplaceable Opportunity

This is the context for the GDP report. Rather than spreading benefits, the UPA government spread inflation and debt. These, in turn, are now undermining growth itself.

Of course, other countries have experienced weak economies over the past five years and India has done well in some areas. But India is not other countries. It is in the midst of a demographic expansion, where the labour force gets larger. Moreover, it is early in that expansion – the labour force is still getting younger. In this situation, economic growth can be rapid for a full generation or more. If that occurred, it would transform the world.

So government officials are correct to insist double-digit growth is achievable. But this only highlights the extent of the ongoing failure. India can grow at 9-10 percent without high inflation or debt. It has the labour endowment and a demonstrated capacity to innovate, at least in some sectors. Global capital would indeed flow to a, liberalizing, price-stable, responsible India.

This India does not presently exist, and its absence is extremely costly. The country’s performance should not be compared to the rest of the world; others do not have an unparalleled opportunity to lift 1.2 billion people from $1,500 annual per capita income (in today’s terms) to $15,000. Every year wasted reduces the real income level that can be reached in the demographic expansion. Every year wasted raises the prospect of an economy near mid-century that is much older and needier but remains all too poor.

Delhi should shift from deficit spending and loose money to labour market liberalization and an investment climate that favors risk-taking over government revenue. It should do so now - waiting two more years for an election that may change nothing is two more years of lost potential that cannot be regained. If India is truly incapable of the necessary steps, there will be no demographic dividend and the India of the future will suffer greatly for it.