India's growth: build in an incompetence discount

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It had been another brutal day for the rupee on the foreign exchanges as India's economic crisis escalated and, travelling home from a visit to Myanmar last week, Prime Minister Manmohan Singh summoned journalists on his plane for a briefing.

The one statement he had prepared for the media that night, however, concerned allegations of corruption levelled against him and his cabinet ministers - not the economy.

Quizzed on the Indian currency's precipitous slide to record lows, Singh blamed the global economic slowdown and the euro zone's emergency, and he voiced hope that the G20 would sort these troubles out at a summit in Mexico later this month.

Two days later, when gross domestic product (GDP) data showed India's growth rate had plunged to its lowest level in nine years, Singh's finance minister likewise pointed a finger at 'weak global sentiments', as well as the Reserve bank of India (RBI) for its tight monetary policy.

But as warning lights flash on India's economic dashboard - with manufacturing output and consumer demand now fading as well as corporate investment, fiscal and trade deficits ballooning and inflation stubbornly high - few buy the line that it's somehow not the government's fault.

"There is so much denial, but almost all of the problems in India are self-inflicted," said Rajeev Malik, senior economist at CLSA Singapore. "The Indian situation is an outcome of policy incoherence, a government that's asleep."

Economists say New Delhi's policy inertia and the absence of significant reforms to sustain growth have now turned India's slowdown from a cyclical one to something that is structural or systemic.

The country is now stuck with lower growth than its potential: not the 'Hindu rate of growth' of about 3.5 per cent that dogged the state-stifled economy before big-bang reforms two decades ago, but a 21st-century version of that, which Malik calls 'growth with a government-incompetence discount'.

THE PROBLEMS ARE NOT IN GREECE

To be fair, the external environment does partly explain the faltering growth. However, all of Asia's emerging markets have been buffeted by chill winds from the United States and Europe, and yet India has fared worse than others, losing its ranking as the region's second-fastest growing economy.

Last week's news that GDP grew by 5.3 per cent in the first three months of 2012, a stunning tumble from 9.2 per cent in the same quarter of 2011, put India fourth among Asian emerging-market economies behind China, the Philippines and Indonesia.

For JP Morgan Chase's India chief economist, Jahangir Aziz, what the government needs to do is 'begin by admitting that the problem lies not in Greece, but at home'.

That doesn't look likely anytime soon: one day after the GDP data, the cabinet met to agree on removing restrictions on the export of skimmed milk powder and broke up without discussing the country's economic predicament.

Western nations might look with envy at a growth rate of more than 5 per cent, but not at India's inflation rate of over 7 per cent, a current account gap now at its widest since 1980 and a fiscal deficit that has been allowed to swell to 5.9 per cent of GDP thanks to a raft of crippling subsidies.

The rash of macroeconomic imbalances has raised the spectre of India's balance of payments crisis in 1991, when the central bank was forced to airlift tons of gold to Europe as collateral for a loan to avert a sovereign default.

Singh, then finance minister, rammed through deep-seated reforms that pulled India back from the brink and set it on the road for a streak of growth that came close to double digits before the global financial meltdown of 2008.

A repeat of the full-blown crisis 21 years ago would be hard to imagine now, not least because India's stock of foreign reserves is comfortable. But confidence is evaporating fast.

"Goodbye 2020, Hello 1991," the Economic Times newspaper moaned in a front page headline after the weak growth data, referring to India's goal of becoming a developed country by the end of this decade and rubbing shoulders with China.

SETTLING FOR SUB-PAR GROWTH

The trouble is that since it won a second term in 2009 the government led by Singh's Congress party has taken no major policy initiatives to further the liberalisation he pioneered.

Instead, an outcry over corruption and peevish coalition allies that block unpopular reform have frozen the government into inaction.

All this at a time when it needs to be slashing subsidies for fuel, fertiliser and food to fix the country's fiscal credibility and tackling regulatory uncertainty and the high cost of doing business to halt a slowdown in investment.

Samiran Chakraborty, chief economist at Standard Chartered in Mumbai, said one signal that the decline has become more structural than cyclical is that consumption - a driving force behind the growth spurt of recent years - has lost momentum.

"Both investment and consumption seem to be getting impacted now. Both engines are now not functioning," he said, explaining that persistently high inflation has eaten into real wages, negative business sentiment has spread to consumers and a post-boom stagnation of asset prices has hit consumption.

"I don't think the economy has spontaneous power to revive on its own," Chakraborty said. "It's contingent on the policymakers."

The government last week announced austerity measures that included some curbs on state spending, but belt-tightening in response to debt troubles will only drive growth lower.

A more concrete step to jump-start activity was Singh's announcement of a plan to fast-track delayed infrastructure projects in a country where more than 200 large state-funded road, port and oil pipeline projects are behind schedule.

But, according to an HSBC research note, what India most needs to get back on a higher growth trajectory in the medium term is deep supply-side reforms.

"With policy paralysis not likely to ease anytime soon, however, India may have to settle for sub-par growth and elevated inflation over the next couple of years," it said.