The Rupp Report: Will India Recover Now?

What’s wrong with India? With millions of cheap workers and a huge domestic market, the country should be as successful as China, but it is not. The industry is underdeveloped and unproductive, and it contributes only some 16 percent to the gross domestic product (GDP). Responsible for this misery are the excessive bureaucracy, endemic corruption, poor infrastructure, permanent energy shortages and excessive taxes as well as outdated property rights and restrictive labor laws.
India is no longer a land of masters and servants. There is a growing middle class of people who behave as self-confident and self-reliant citizens. According to a survey by the Pew Research Center, 70 percent of Indians are unhappy with the current situation in their country. High food prices, unemployment and inequality are seen as the biggest problems. The great corruption also worries a majority of the respondents.
Feudal And Caste Regime
Indian politics still operate as a feudal system. The state and the parties operate under a patronage or clientele system under which a few families and a clique have virtually unlimited power, but they “owe” on the other hand care and benefits to their followers and voters. So while some enrich themselves in the underbrush of nepotism and corruption, the others expect always greater gifts — for example, in the form of government nutrition and employment programs, or cheaper electricity. But many funds never reach the poor, and due to high liability, the state budget and many state-owned companies are close to bankruptcy. The system is no longer sustainable.
Weak Industry
At the beginning of the last legislative period, India recorded a nearly double-digit growth and its economic potential was often compared with that of the great rival China. In the fiscal year that ended in March 2014, the GDP grew by only an estimated 4.6 percent; for a developing country with a billion people, this increase is not enough. Economists assume that India should grow by some 8 percent a year to fight the widespread poverty and create enough new jobs. By 2030, an estimated 240 million new workers will enter the market: This is a ticking time bomb.
Because of the general slowdown, the industrial sector has declined in the last five quarters. In February, it shrank by 1.9 percent compared to the previous year. The manufacturing sector dropped by 3.7 percent. Under the retracement of production, exports and the service sector both suffered. According to Indian Chamber of Commerce and Industry estimates, the service sector grew by only 6 percent in 2013-14, while exports declined by 3.2 percent compared with the previous year.
Banks In Crisis
The banking sector is in a severe crisis. Between 2002 and 2007, many banks had taken advantage of the high liquidity to promote aggressive lending. However, because of the slowdown and the high interest rates, many borrowers are not able to pay back their loans. In order to control inflation, the Central Bank has raised the prime rate up to 8 percent. In the year between December 2012 and December 2013, consumer prices increased by 9.9 percent. Obviously, the high interest rates have slowed down growth and discouraged investors and consumers.
Last September, the new governor of the Reserve Bank of India (RBI), Raghuram Rajan, promised a liberalization of the banking system — with no success. Recently, the RBI submitted an action plan to bring the problem under control. First of all, there should be tougher controls on lending and the exchange of information among banks should be improved.
Only 11 percent of all industrial companies of India have more than 200 employees; in China, the number is more than 50 percent. In primary industries such as the automotive industry and its suppliers, as well as in the service sector, which accounts for 60 percent of GDP, only a few skilled workers are needed and absorbed. Therefore, India urgently needs to foster industries such as the textile industry, which provide jobs for the uneducated masses. To do so would require land reform, an overhauling of the tax system as well as labor market reform. Workers can hardly ever be fired. For this reason, many workers are only hired with short-term contracts, or work illegally.
Some Good News
However, there is good news: As imports in the last fiscal year fell by 8.1 percent, the trade deficit decreased from the equivalent of US$190 billion down to US$138 billion. The current account deficit has fallen from 4.8 percent to 2 percent of GDP. As long as the structural problems are not cleared up, it is unlikely that the government will be able to rehabilitate the budget sustainably. In 2013-14, the budget deficit could be reduced on paper to 4.6 percent of GDP. But the government held back substantial subsidy payments to improve the balance picture.
The System Is Close To Collapse
Now, the ruling Congress Party has suffered a bitter defeat. Narendra Modi, the clever man of power, has been elected prime minister by a large majority. The Indian voters hope that Modi, a member of the Bharatiya Janata Party (BJP), will deliver them from poverty. The defeat comes in the wake of of low growth and high inflation, missed reforms and countless corruption scandals. After ten years under technocrat Manmohan Singh, the Indians want a new leader who is full of energy. Entrepreneurs and investors have responded enthusiastically to the victory. The BJP is considered to be more business-friendly than the Congress party. For the first time since the 1980s, the prime minister does not depend on populist regional parties to form a coalition. The hope is that he can push through very necessary reforms alone. How he will achieve that is unknown. Nevertheless, the 67-year-old is a member of the established system with the known evils: corruption, bureaucracy, clientelism.
Tame Reforms
The Congress Party had won the 2004 elections with a promise to distribute India’s growing wealth in a fairer way. The unparalleled boom in the following years allowed it to improve the living conditions of the lower stratum of the population through poverty reduction programs and subsidies, which resulted in a growing middle class and a rising economy. In 2009, the Congress Party was reelected by a clear majority. However, Singh, who had directed the economic opening of the country as finance minister in 1991, was a disappointing prime minister in the last ten years with no will for true reforms.
There is a crucial need for reforms in the state bureaucracy, especially in the legal system. The Indian bureaucracy has a lousy reputation. The general complaint is that there are too many regulations and bans, high taxes, infinite official channels in intertwined corridors, but no service — unless you shmeer someone. In the extended black economy, there are no controls and no taxes, but also no legal certainty. Modi must act immediately, if he doesn’t want to lose his “advance credit.” Meanwhile, Standard & Poor’s has downgraded India’s creditworthiness to BBB-. There is no doubt that in the coming months, the new government’s reform initiatives and fiscal policy will be observed with a sharp eye.
No Alternative
There is no alternative to reforms. Industrial production declined by 0.5 percent in March, and inflation was at 8.6 percent in April. The RBI will therefore have no room for interest rate cuts, and a comprehensive stimulus package from the government is missing because of the high budget deficit. According to experts, to reduce poverty sustainably and create jobs for young people, the country must establish a million new jobs every month. Without a strong industry, this goal is simply unthinkable. Will India now recover?
May 20, 2014