http://www.csis.org/media/csis/pubs/sam122.pdf.
September 2, 2008
Indias Economy: Slowing, But Still Delivering
Jonathan Robins
Jonathan Robins is a former research intern with the South Asia Program at the Center for Strategic
and International Studies in Washington, D.C
In recent years Indias economy has grown at breakneck speed, averaging 8.7 percent per year
since 2003. The downturn in the United States and rising oil and food prices has contributed to a
recent slowdown. GDP growth in India is projected at 7 and 8 percent for 2008/2009, the Bombay
Stock Exchange (BSE) is down, and inflation is now in double digits. Even with this turbulence, the
Indian economy retains considerable dynamism, but the crisis faced by Indias poor who have been
largely left out of its new prosperity is likely to deepen.
Highs and Lows: As late as January of this year, Indian Finance Minister P. Chidambaram was
predicting growth of nearly 9 percent for the upcoming year. The Bombay Stock Exchanges (BSE)
Sensex index, a measure of the biggest companies in India, hit a record high of over 21,000 in
January. Today the Sensex reflects a significant loss and is hovering around 15,000. Chidambaram is
projecting growth to slow to 8 percent for the current fiscal year, but numerous banks including JP
Morgan, HSBC, and Morgan Stanley project it to bottom out at 7 percent.
Inflation: India has been grappling with high inflation due in large part to the booming global
commodities marketparticularly the price spike in oil and food. Additionally, the country as a whole
is being hit hard by the global food crisis. Food prices have risen close to 15 percent over the
previous year, a devastating increase in a country where the average household spends about a
third of its income on food. While market forces have driven up prices around the globe, Indias
agricultural sector has seen a lack of investment in recent years, with growth averaging at only 2
percent per year since 2000. The size of this years crops will largely depend on the monsoon. To
make production less dependent on uncontrollable forces, India needs to invest more in agricultural
technology and irrigation.
Energy, particularly petroleum products, has been no less of a concern. Indias state-owned oil
companies are incurring massive losses due to price controls on a few sensitive products. The
government raised fuel prices by 10 percent in order to stem the bleeding, but the measure is more
of a band-aid than a solution. While international oil prices have fallen from their mid-summer peak
because of decreased demand in OECD countries, this will not solve Indias problems. The
International Energy Agency (IEA) projects Indias energy demand to grow by 4.3 percent per year
over the next two decades, magnifying the economic impact of price increases.
Fiscal And Monetary Policy: The Reserve Bank of India has made it clear that dealing with
inflation is its top priority. At its last meeting the RBI, under Governor Y.V. Reddy, took drastic
action by hiking interest rates by 50 basis points, twice the increase many Indian businessmen
expected. It remains to be seen whether this action will sacrifice growth for inflation.
As the economy has slowed down, the government is facing mounting budget deficitsless than
those recorded in the early part of this decade, but large enough to fuel inflationary pressures. The
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central government says it expects to meet its projected deficit of 2.5 percent of GDP. Other
estimates suggest that the deficit could go up as spending takes place for the pay raise of civil
servants, oil bonds, fertilizer subsidies and the debt relief program for farmers. Factoring in off-
budget expenditures could raise the deficit to 6.4 percent. When the states deficits are factored in,
the total reaches approximately 9 percent. Standard & Poors, among others, has threatened to lower
Indias credit rating from investment grade to junk status if the deficit continues to rise.
The current account deficit is expected to jump from $17 billion this fiscal year to $50 billion in
2009. A large part of the increase is due to the sharp rise in global commodity prices, particularly oil.
If oil prices fell to $100 a barrel, this would reduce the projected shortfall to only $32.6 billion. The
worsening fiscal situation has put significant pressure on the rupee, with Fitch Ratings lowering the
countrys domestic rating from stable to negative. Given that Fitch is usually the first to change its
outlook, the two other major credit rating agencies will likely follow suit in the near future.
Outlook for liberalization: There has been slow progress toward opening the market in recent
years. The insurance industry was partially liberalized in 2000 through the Insurance Regulatory and
Development Act (IRDA) under the stipulation that foreign companies could only own 26 percent of
any given entity. In the retail sector, which is partially liberalized, the government agreed in 2006 to
let foreign retailers own 51 percent of their stores so long as they were single brand. This effectively
barred big stores like Wal-Mart from owning a majority share of their Indian entities.
The exit of the communists from the UPA coalition over the nuclear deal has prompted further
discussions on increased liberalization. Finance Minister Chidambaram has said that the government
wants to raise the ceiling on foreign investment in several industries, including banking (from 10 to
25 percent), telecom (from 74 possibly to 100 percent), and insurance (from 26 to 49 percent).
However, these reforms will require action by the parliament and the government is likely to tread
very cautiously in pushing new legislation. Additionally, the Prime Minister has expressed interest in
selling a 10 percent stake in a few of Indias national champions, including Oil India and National
Hydroelectric Power Corporation (NHPC). Yet, the last time the government tried to expand private
holdings in state-owned energy companies it proved to be politically impossible.
Capital Flows: Between fiscal years 1996-97 and 2007-08, foreign direct investment in India
jumped nearly nine-fold, from $2.82 billion to $25 billion dollars. For the upcoming fiscal year, a
survey of Indian businessmen predicts that FDI will continue to grow albeit at a much slower pace
due to the economic slowdown in the United States and Europe.
Outbound Indian investment has grown at a rapid clip as well. While estimates vary, Indian Finance
Minister P. Chidambaram said that 2006-07 saw $11.9 billion move abroad. Indian firms have also
been engaged in a buying spree in recent years, particularly in the United States, which stems from
the fact that many leading Indian companies have been able to raise substantial amounts of capital
as a result of having very little debt. While there have been high profile purchases, such as Mittals
purchase of Arcleor and Tatas buying out of Jaguar and Range Rover, the sheer volume of deals is
impressive. Indian companies purchased 115 foreign companies with a value of $7.4 billion in the
first nine months of 2006 alone.
Elections: The UPA government, having just survived a vote of confidence, is likely to finish its full
five year term. National elections must occur no later than May 2009. The Indian electoral system is
hard on incumbents, and double-digit inflation will make it tough for the UPA to pick up seats let
alone remain in power. The two main national parties (BJP and Congress) both supported economic
reform and further liberalization while in office.
It seems all but certain that the next government will be a coalition, as the last three have been.
From the economic policy standpoint, the big question is what role key smaller parties will play in
the governing coalition. The Leftist party group, with over 60 members in the outgoing parliament,
has been an inhibiting factor on economic reform. Most observers expect them to lose seats in the
election but it is still possible that they could retain a critical role in a new coalition. The other key
players to watch are the regional parties, typically only active in one state. These parties as a group
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have steadily gained strength at the expense of the national parties for the past two decades,
bringing local concerns into the heart of coalition politics.
The major wild card in 2009 will be Mayawati Kumari, the dynamic Chief Minister of Uttar Pradesh,
Indias largest state and one also famous for toxic politics. Her Bahujan Sumaj Party was created to
represent the Dalits. Mayawati is an economic populist, promising to distribute jobs to poor people
via patronage and other publicly funded programs. Thus far, she has only organized in her home
province; however, she quit the governing coalition at the time of the parliamentary vote on the
nuclear program and since then has been putting together a coalition of her own, incorporating the
Leftist parties and a couple of regional parties from the south. She is a potential king-maker in the
short term and poised to be a compelling force in the years to come.
The U.S. Partnership: The U.S.-India relationship has grown rapidly since the end of the Clinton
Administration. Manmohan Singhs decision to move ahead with the nuclear deal, and the successful
vote of confidence by the Indian parliament, have given the partnership new energy. While there are
important differences between Barack Obama and John McCain, India policy is not one of them. Both
candidates, and both parties, are committed to improving ties with India.
The United States is Indias largest export market, and if one includes trade in software and
computer services, it is Indias largest trading partner. U.S. exports to India nearly tripled from 2004
to 2007, with imports rising approximately 55 percent during the same period. American firms are
bidding on major defense contracts, including a multi-role combat aircraft. With the U.S. economy
under pressure, outsourcing could pick up speed as a cost-saving agent.
The biggest frustration in the economic relationship comes from the Doha Round of trade
negotiations, which reached an impasse in July 2008. At the heart of the breakdown was the dispute
between the developed and developing world over agricultural trade. Indias Minister of Commerce
and Industry, Kamal Nath, positioned himself as the spokesman for the emerging market
economies. The United States and European Union proposed substantial cuts in agricultural support
programs, but these were insufficient to obtain agreement from the other side. India insisted on
retaining greater ability to block agricultural imports under emergency conditions, which the
developed countries would not accept.
The United States considers India responsible for the breakdown in negotiations. Nath has publicly
called for a resumption of talks, but it appears unlikely that the Indian government will make any
concessions in an election year. In general, India and the United States have a much harder time
working together in a multilateral setting than they do bilaterally.
Conclusion: Growth in the 7-8 percent range still leaves Indias economy with a considerable
increase in per capita income and deeper prosperity in its most successful sectors and regions. The
more difficult problem comes from those left behind, both the densely populated but economically
unsuccessful northern part of the country and the lack-luster agricultural sector. Both national
parties will remain cautious about economic reform and both will be vulnerable to a political backlash
from the less dynamic parts of the country, especially if regional parties continue to do well in the
coming elections. Furthermore, coalition politics will complicate economic policy-making. All in all,
India is still on pace to become a global economic power in the 21st century, but its progress will
continue to face challenges at home.
