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Indian Economy Faces Crisis: From Boom To Bust ?

September 4th, 2013

Only a few years ago, India was, along with China, viewed as a sleeping giant that had awoken, at least as far as economic development was concerned. Until recently, annual GDP growth rates were just below double digit level; those rates have now been halved, as investors turn bearish on the Indian economy. In a self-perpetuating cycle of gloom, lack of confidence has led to capital flight, sparking a market-induced devaluation of India’s currency, the rupee. The  collapse of the rupee has in turn sparked a large increase in the country’s energy imports, especially oil.  All those factors have further degraded the Indian economy.

Raghuram Rajan, the new governor of the Reserve Bank of India, is doing what other central bankers have done in the wake of national economic difficulties; he’s attempting to reverse the trends through sweet-talk and optimism. In truth, it is not an option for him to say anything that would further erode confidence by global investors in the Indian economy. However, India faces structural problems that neither monetary policy nor sweet-talk can cope with. Compared with economic rival China, India’s infrastructure is sub-standard, having suffered through chronic underinvestment. It’s manufacturing base lacks the scale and size of China’s plants, being more reliant on smaller industrial establishments that lack competitiveness.

The problem with India’s economy, however, is not only structural; there are profound political obstacles that inhibit growth and scare off investors.  For much of its history following national independence in 1947, India’s political elite, particularly from the dominating Congress Party, have weighed heavily on a socialist model of economic development. Despite reforms that have strengthened the private sector in recent years, old political habits die hard. Such measures as the recent approval in India’s parliament of an expansion of the food subsidy program, which seems like laudable public policy, are actually  counter-intuitive when it comes to arousing confidence among international investors. India’s growing current account deficit is leading to a moratorium on new investment from overseas, which in turn has facilitated the drop in value of the rupee by 20 percent  during the previous two month period.

The combination of the factors outlined above, which interact and exacerbate each other, are creating growing doubts on the future economic potential of the world’s second most populous nation. And it is not only India. All four member nations of the so-called BRIC countries, that artful creation of Goldman Sachs, are to varying degrees stumbling in the performance of their economies.  Yet, it seems only yesterday that the pundits predicted that these four emerging economies would save the world after the onset of the global economic crisis of 2008. Now, as in the early stages of the Eurozone debt crisis, whispers are beginning to be overhead about how it may be necessary for the International Monetary Fund to come to the rescue of the Indian economy.

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