Why Indian Economy is slowing down?

Aug 20

Indian-EconomyIndia has massive potential, and in the early part of the century was identified as one of the strongest among BRICs. So what explains the persistently mediocre performance? At the moment there are certain cyclical issues, but big picture, the country suffers from corruption, horrible infrastructure, and protectionism

On the cyclical front we have problems like declining consumer confidence, declining industrial output, poor monsoons, and weakness in the rupee.

Let’s look at some of the deeper rooted issues like the nation’s current account deficit woes, slow pace of economic reforms, and decline in investment because of corruption.

The Current Account Deficit Problem

Current account deficit (when the value of imports exceeds that of exports) fears have been central to India’s economic slump.

The current account deficit reached a record high of 6.7% of GDP in the last quarter and has been blamed for weakening the Indian rupee. Remember, India isn’t a heavily export dependent nation — exports account for about 25% of GDP in India, compared with about 31% in China.

Gold and oil imports have been blamed for rise in current account deficit. And after raising import duties on gold twice in 2012, India is again mulling curbs on gold imports.

India’s central bank governor Duvvuri Subbarao has said that inflation and the current account deficit have limited the monetary policy tools available to the central bank. But cooling inflation has eased some pressure.

And India is also struggling to curb its fiscal deficit. “While there was justification for running a high fiscal deficit for a short period of a year or so after the credit crisis to support confidence in growth, continuing with it for four consecutive years has hurt the economy,” write Morgan Stanley analysts Chetan Ahya and Upasana Chacra.

Slow pace of economic reforms weighing on growth

The slump in investment in the past few years has highlighted the need for economic reform aimed at drawing in foreign investment. The measures rolled out in the FY13-14 budget disappointed markets on this front. One of the biggest disappointments at the time was the failure to deliver on bigger issues like a cut on withholding taxes on debt investments.

In May, the government finally gave markets what they wanted. It announced that foreign institutional investors (FIIs) and qualified foreign investors (QFIs) would be subject to a withholding rate of 5%, down from 20% on income from government and corporate bonds, from June 1 to May 31, 2015.

But India is still considered very protectionist. The back-and-forth on allowing 51% foreign direct investment in multi-brand retail that impacts retailers like Walmart is probably the most well known. That had an unhappy resolution with the central government approving the measure but putting the onus on state governments by allowing them to decide whether they would let foreign retailers set up shop.

More recently, pharma giant Pfizer criticized India for its “protectionist intellectual property regime” to the U.S. House Committee, according to the Financial Times. At the same hearing, a lobby of U.S. tech companies criticized India for its “preferential market access policy.

There are also calls for reform around other bills like the Direct Taxes Code (DTC), the Land Acquisition Bill, and the Mines and Minerals Bill.

The DTC Bill would replace the existing income tax act to include many  companies and individuals that slipped through the tax net before.

The Land Acquisition Bill, one of the more controversial ones, aims to classify the manner in which the government can obtain land from farmers for infrastructure projects.

Protests over seized land have caused many projects to be stalled. And analysts say that getting these projects back on track, and getting new projects in the pipeline, are key to driving growth.

The Mines and Minerals (Development and Regulation) Bill is another important economic reform. The most controversial clause in the bill requires miners to share their profits with the community that is affected by their work, according to the The Statesman. Coal miners would be required to share 26% of their profits.

Major corruption and poor infrastructure

India’s mining sector is the perfect example of the kind of corruption that India has to crackdown on if it hopes to draw investment, increase supply, and drive growth.

The Coalgate Scandal as it is popularly known emerged from a report by India’s Comptroller and Auditor General (CAG) that accused the ruling UPA government of selling coal fields to top industrialists without using competitive bidding practices, and giving them “undue benefits.” The CAG claimed this cost the government billions of dollars in revenue.

But this isn’t the only corruption scandal that has delivered a blow to India’s economy. In recent years we saw corruption around the Commonwealth Games, the telecom scam, and most recently in cricket, with the Indian Premier League.

India ranked 94 on Transparency International’s 2012 Corruption Perceptions Index. This was below three of its BRICs counterparts, Brazil, China, and South Africa. Only Russia ranked lower at 133. Rampant corruption has been a major deterrent to foreign companies looking to invest in India.

The nation’s infrastructure problems act as another huge deterrent.

The World Economic Forum’s Global Competitiveness Report for 2012-2013 ranked India 70 out 144 for infrastructure.

“Inadequate supply of infrastructure,” “corruption,” and “inefficient government bureaucracy,” were cited as the top three most problematic factors for doing business.

The economy is bottoming out but elections still stand in the way

The one silver lining is that experts think the economy is bottoming out.

Morgan Stanley analysts Chetan Ahya and Upasana Chacra argue that the decline post the financial crisis that was due to a “bad growth mix,” of high fiscal deficit, strong growth in rural wages, and low investment, and that this is starting to reverse.

What’s more? Investor sentiment on India has picked up. Bank of America’s latest fund manager survey showed that investors were net 38% overweight in May, compared with 27% underweight in April.

While the government has been trying to push through reforms and review growth ahead of the 2014 general elections, some argue that the elections will be an obstacle to reviving economic growth.

With India set to account for one fifth of the world’s working age population, the country’s burgeoning youth can only hope that its leaders get serious about reviving and reforming the economy.

Ultimately, India is a democracy, and the government is responsible to the people. If reform does not come, the “Indian shining” story will be no more.

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About the Author

Amit is an Independent Financial Advisor, based in Dubai since 1997. He is part of the prestigious ‘Million Dollar Round Table’ (MDRT), which is an elite club of the best financial advisors worldwide.

He has authored the ‘6-Step Financial Success Guide’, and the book ‘Creating, Preserving, Distributing Wealth’.

He helps business owners and professionals ‘Create A Second Income’ through investments.

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