From 2003 to 2007,India experienced heady growth,averaging over 9 per cent a year. When the global economy threatened to melt down in 2008,the Indian slowdown was mild and the bounce back was rapid. These years came on the heels of nearly 15 prior years of dynamism. India had seemingly broken out of its low growth trap. The only competitor in the growth sweepstakes was China. Many predicted that China was bound to slow and India was likely to further accelerate,spurred by a deep well of entrepreneurial energies.
Instead,Indias GDP growth has decreased to about 5.5 per cent a year. True,other countries,including China,have also decelerated. But the Indian data shows a deeper malaise. The manufacturing sector has barely grown in recent months. If,as is likely,the double digit growth in construction and finance proves unsustainable,a further drop in growth may be imminent. Aggregate investment spending has been virtually stagnant over the past year and inventories of durable goods,notably cars,are piling up as the Indian consumer takes a deep breath.
Some argue that short-term growth numbers are fickle and could quickly reverse. But the Indian problem is more structurally embedded. Accompanying the slowdown has been persistently high inflation and a rising current account deficit. Inflation has remained among the highest in emerging economies,near or above double digit rates. The current account,which was close to balance in the early 2000s,has turned into a deficit of over four per cent of GDP,an unusually high level for India. Indeed,the trade deficit is eight per cent of GDP. Together,these are signs that India is constrained by supply bottlenecks and is losing international competitiveness.
Some suggest that easier monetary policy will kick-start the Indian economy and a high growth trajectory will re-emerge if a range of reforms are undertaken. Others are even more optimistic,arguing that the reform momentum is irreversible,as the electorate increasingly rewards politicians who deliver results.
We believe that a more sceptical view is warranted. Indias two-decades-long growth was due to a favourable confluence a sweet spot created by four factors. First,the reforms,especially those that released restrictions and encouraged new entry,unleashed pent-up entrepreneurship. Second,the global economy enjoyed prolonged prosperity from the early 1990s through to the start of the Great Recession in 2008. Third,domestic politics and governance did not impose heavy costs in this period. Fourth,growth and development fostered rising aspirations,which generated more insistent demand for education,housing,durable goods,and for more and better public services.
These factors generated a virtuous cycle. Reduced internal restrictions,buoyant external trade,and the growth dynamic itself made discovery and investment highly attractive. As we have documented in our earlier research,the Indian corporate sector was kept vigilant by new domestic entrants and international competition,with profits by and large reflecting efficiency rather than entrenched advantages. Growth also produced buoyant government revenues,allowing an expansion of public services without having to tackle deep-rooted problems of low quality and vested interests.
The Information Technology (IT) sector symbolised these developments. New firms,large and small,drew on a history of public sector investments and an unanticipated pool of talents,often with little background in business but with good engineering degrees. The world was experiencing an IT boom and outsourcing was the global growth industry. The regulatory framework on IT enterprises was particularly light once entry barriers had been lifted. Links with the state were initially pragmatic around land and tax benefits rather than payoffs. Large parts of the Indian population benefitted from the access to cell phones and jobs based on IT-related vocational training.
But the favourable conditions have mainly reversed. The global economy has barely regained the lost ground from the crash in 2008-09 and growth prospects for advanced economies the US,the eurozone and Japan remain dim. Global trade is almost at a standstill and international competition is,therefore,more severe. Domestically,the deepening connection between business and politics is making annuity-like returns from government contracts more attractive than risky productive activities. A striking development has been the sharp drop in new firms from about 2003. Either the much-vaunted entrepreneurial pool was not as deep as presumed or rent-extraction offers much higher returns.
We may be witnessing the onset of a vicious cycle. With lower growth comes lower investment,weaker government revenues,greater political competition for scarce budgetary resources to satisfy special constituencies and hence higher deficits and greater uncertainty in policymaking which reinforce lower growth and investment. Aspirations may still be strong,but are insufficient to sustain momentum. Corruption in the state-business nexus and the daily humiliation are intensifying the cynicism; lower growth and high inflation are dampening consumer sentiment.
The international experience forewarns that sharp and persistent decelerations follow growth accelerations. The reason for this outcome is not a mystery. Initial growth accelerations arise from modest policy initiatives,but extending the growth spell requires deeper institutional transitions. The east Asian economies that achieved virtually uninterrupted growth undertook forward-looking change. In India,institutional reform has lagged in infrastructure,education,government performance and business-state relations. With slower growth,the needed institutional transformation will now be even harder. Indias sweet spot was wasted in the pursuit of muddled populism. The way forward requires a more transparent and accountable separation of the governments economic and social goals,not simply a tinkering with monetary policy or a sudden resumption of reforms.
Ashoka Mody is with Princeton University,US. Michael Walton is with Harvard University,US and the Centre for Policy Research,Delhi