Paralysis exacts a heavy economic, political toll

As Indias economy slows and inflation grows, reforms take a back seat

India’s coalition government just celebrated the third anniversary of its tenure with a self-congratulatory banquet that could not have been more poorly timed: India’s currency, the rupee, is falling; investment is down; inflation is rising; and deficits are eating away at government coffers.

While short-term growth has slowed but not ground to a halt, India’s problems have dampened hopes that it, along with China and other non-western economies, might help revive the global economy, as happened after the 2008 financial crisis. Instead, India is now facing a political reckoning, as the country’s elected leaders must address difficult, politically unpopular decisions – or risk even deeper problems.

“When India was being run comparatively well in 2008, they seemed to cope with these external shocks, at least from a financial perspective,” said Glenn Levine, a senior economist at Moody’s Analytics in Sydney, Australia. “I think people are starting to question the long-term Indian story. That is the difference now.”

India’s difficulties come as the global economy is wobbling once again. Europe is grappling with a sovereign debt crisis that could shatter the continent’s economic and political union.

The United States is still not producing enough new jobs. China’s growth has weakened, with a real estate downturn and stalling exports, while important emerging economies like Brazil are slowing down, adding to pessimism about the world economy at a critical time. India is often viewed as a rising global powerhouse and, not too long ago, Indian officials were predicting growth rates of 9 per cent or higher. The Obama administration, eager to tap into such a booming market and envisioning India as a regional counterweight to China, trumpeted the US-India partnership.

Some analysts even saw the global downturn as an opportunity for India, making it more attractive for foreign investors wary of putting money into declining advanced industrial countries. Today, India’s economy is still expanding, with growth projected between 6-7 per cent this year. And analysts say India’s long-term strengths remain significant. It has one of the world’s youngest populations and polls consistently show they are overwhelmingly optimistic about their future. Meanwhile, India’s businesses are competing more aggressively on the global stage.

But the slowdown has punctured the once-bubbly mood in the business and political classes and brought sharp criticism of the government. Indian business leaders, foreign investors and analysts say India’s strengths are being undermined by growing political dysfunction: the populist tendencies of Indian politicians, a lack of action by top leaders and allegations of corruption that have undermined the authority of policymakers.

India is desperate for investment in mining, roads, ports, urban housing and other areas, but Indian businesses and foreign investors are starting to shy away. Indian corporations, unable to obtain governmental licences or permissions for projects, are investing overseas instead.

Crisis of confidence

Foreigners also are pulling back; their investment in Indian stocks and bonds totaled only $16 billion in the last fiscal year, compared with $30 billion the year before. The trend accelerated in recent months after the finance ministry, trying to stem a rising budget deficit, proposed a raft of new taxes on foreign institutions doing business in India. “A quiet crisis of confidence is building up,” said Pratap Bhanu Mehta, president of the Centre for Policy Research in New Delhi. “There is no certainty over the regulatory regime. There is no certainty over the tax regime.”

Indians have long thrived amid adversity, often by creatively – at times, illegally – subverting onerous regulations with a workaround ethos that has spurred economic activity. Even today, industries like pharmaceuticals, information technology and consumer goods, which do not need many licences and official approvals, are prospering. But those sectors tied to the government, including mining, construction and manufacturing, are struggling.

At the core of the political uncertainties is the weakened status of the Congress party, which leads the UPA coalition government. Since 2004, the government has operated under an unorthodox partnership between Sonia Gandhi, president of the Congress party and the governing coalition, and Manmohan Singh, her handpicked prime minister.

In 2009, voters returned the coalition to power amid expectations that India, having shrugged off the 2008 global recession, was on an inevitably upward growth track. But analysts say the contradictions in the Singh-Gandhi partnership have since been exposed.

Singh holds the most politically powerful job in the country, yet is seemingly reluctant to wield power and often must seek approval on policy questions from Sonia Gandhi. She oversees an advisory panel largely consisting of social activists that her critics regard as a shadow government.

The result, especially during the past 18 months, has been a lack of a clear political agenda emanating from the top, analysts and business leaders say, allowing the bureaucracy to fall back into its traditional resistance to making decisions. When officials do act, they often change course after encountering political opposition.

“The last year was wasted,” said Sanjaya Baru, a former spokesman for the prime minister who is now at a research institute. “We’ve had a crisis of leadership on the economic side.” Moreover, the government has been on the defensive since a series of corruption scandals, dormant for several years, exploded into public view.

In December, Singh’s Cabinet announced that foreign retailers like Wal-Mart would be allowed for the first time to open stores in the country with local partners. But Singh was forced to reverse course after a crucial coalition ally, Mamata Banerjee, the chief minister of West Bengal, balked and threatened to bring down the government.

Then in March, facing pressures to raise revenues and stem the rising fiscal deficit, finance minister Pranab Mukherjee, released a budget that proposed new taxes on foreign entities in India, including levies on past deals that the Supreme Court had ruled were not taxable in the country. Foreign investors were stunned, and analysts say the outflow of capital is one reason the rupee has tumbled 13 per cent since the end of February.

“We are fed up and our investors are not keen to even talk about India,” said a senior executive at a US bank in Mumbai, asking not to be identified so he could speak bluntly. “They are sick and tired.”

Kaushik Basu, the government’s chief economic adviser, acknowledged that the government had made mistakes and had missed opportunities to better position India as the global economic landscape is shifting.

Yet he said that the rising pessimism was unwarranted and that India was still growing, still had high investment and savings rates, and should take advantage of the depreciation of the rupee to push exports. He said India’s problems were no worse than those in emerging economies like Brazil, South Africa, Argentina and China. “It is a difficult stage,” Basu said in an interview. “But I do remain very, very optimistic. Six months and we will pull up.”

In the meantime, the immediate challenges are piling up. This month, in a move to raise revenues, the government raised petrol prices, drawing public fury. Now the question, analysts say, is whether the administration can muster the political courage to trim the bigger subsidies affecting diesel fuel and cooking gas.

Singh last week warned that the government would have to make some unpopular decisions. Many experts, however, say they expect more stalemate. “It has always been tough,” said Levine, the Moody’s economist, “but there is a sense, at the moment, that it’s too difficult. For the time being people are just giving up on it.”