Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site www.greatconservatives.com
The Economist’s leading article last week suggested that India’s long boom was about to end in a credit crunch. At first sight, this seems unduly pessimistic. China’s boom hasn’t yet ended in disaster, so why should India’s? However, when India’s position is examined more closely one comes to the conclusion that, while a crunch is not imminent, India’s economic miracle is a lot more vulnerable than it appears.
In the past, Indian economic expansions faltered either because its payments deficit widened, leading to foreign exchange shortages, or because public finances spiraled out of control, sucking resources from the private sector and driving up interest rates. That poor trade and fiscal performance gave India a low credit rating. However, Standard and Poor’s recently raised India’s sovereign debt rating Tuesday from BB+ to BBB-, an investment grade rating, indicating that things may have changed.
India’s current account deficit widened to $11.7 billion (3% of GDP) in April-September 2006 from $7.2 billion in April-September 2005. Indian central government revenues were up 27% in April-November 2006 from the previous year, while current expenditures were up 17%; the central budget deficit was 4.5% of GDP. The currently modest trade deficit is no threat while international liquidity remains high. Moreover India now has $178 billion of reserves, more than a year’s imports, enough to cushion it from global credit crunches. The budget deficit also appears to be under control -- the tsunami of revenue is making it shrink rather than grow.
In inflation, stocks and housing, the three traditional indicators of overheating, the record is more mixed. Inflation was 6.6% in the year to January 2007, pretty restrained, although the trend is clearly upwards. Indian bank credit grew 31% in the year to January 2007, the same rate as in the previous year. Broad money growth was 20% in the year to January 2007 compared with 16% the previous year. Both these figures would be somewhat worrying, although they can be expected to be exceptionally high in an economy enjoying such rapid growth, whose entire structure is being modernized.
The Mumbai Sensex 30 stock index closed at 14,539 Friday, up 55% since 31st December 2005. On a 23 times P/E ratio, it looks thoroughly overvalued, but that doesn’t distinguish it from most other stock markets worldwide.
Housing is likely to continue booming for some time yet. Deepak Parekh, Chairman of Housing Development Finance Corporation, said recently “There is no point building houses of a crore (10 million rupees, $225,000) and 2 crore when people don’t have the resources to pay for them.” However by Western metropolitan standards $225,000 or even $450,000 is a bargain. As economies emerge, the newly wealthy and increasing foreign residents force house prices up towards Western levels. In India, with rapid growth and inequality rising through wealth creation, house prices could rise considerably further before unaffordability chokes the market.
Thus there seem no indications of a crisis in the short term; in this respect, the Bear would for once disagree with the bearish view expressed by the Economist. In the medium term, however, the picture is much gloomier, largely because of Indian politics.
It is the repeatedly expressed belief of the Economist and the mainstream Western media that India’s current prime minister Manmohan Singh and the Congress Party have been responsible for the economically reformist steps that have allowed India to begin to achieve its economic potential. For them, the Bharatiya Janata Party government of Atal Bihari Vajpayee in 1998-2004 has been airbrushed out of Indian history, except for the occasional negative reference to its Hindu nationalist principles.
The reality is very different. Economic reform in India began, not with the first Manmohan Singh government of 1991 but earlier, when Indira Gandhi realized after her hard-fought election victory of 1979 that socialism wasn’t going to work. Indeed, the seeds had been sown earlier still, with her forced sterilization policy of the middle 1970s; this was thoroughly unpopular, as should have been expected, but it brought home to ordinary Indians for the first time the huge adverse economic consequences, personal and national, of excessive reproduction. As a result, Indian population growth began to decline, and economic growth per capita was higher in the 1980s than in the 1970s, if only because the population was increasing more slowly.
Manmohan Singh indeed introduced further economic reforms as finance minister after 1991, but in a tentative fashion, since he did not control the Congress government, which relied on left-wing allies to maintain a majority. In consequence, Indian economic growth, after a few good years, stagnated in the middle 1990s. Only after Vajpayee took firm control in 1998 did the reform process revive, with reform accelerating after 2001 as it began to show serious results. Had Vajpayee won the election of May 2004, as he expected to, economic reform and privatization would have continued at a rapid pace, and India would now be well on the way to true prosperity, without a large budget deficit, without resurgent inflation and with the country’s serious corruption problem through its overstuffed bureaucracy well on the way to being solved.
Progress under Manmohan Singh since May 2004 has been much slower, since the government relies on the anti-capitalist Left Front to maintain itself in power. Public spending has risen faster than inflation, privatizations have been postponed, and labor law flexibility (a key issue in India’s 1950s-style socialism) has been more or less abandoned. In some areas, such as caste-based reservations in educational institutions, there has even been regression. However the economy itself has continued to surge ahead, running on the reformist momentum and opening of the Vajpayee years.
Most alarming is India’s draft Five Year Plan, for 2007-12, which sets a target of 9% annual economic growth over the 5 year period – almost certainly too high, and indeed incompatible with a country still run by the absurd mechanism of a Five Year Plan. It contains such gems as “Although growth in manufacturing has accelerated compared to the 9th Plan it is unlikely to exceed 8% in the 10th Plan. This is unacceptably low. If we want our GDP to grow at 9%, we have to target a 12% growth rate for this sector.” Yes government targeting – that’ll do the trick, raising manufacturing growth rates 50% above their already exalted level! The plan also proposes a substantial increase in India’s current account deficit (in the past a sure-fire killer of its economic expansions).
However the plan’s most ambitious wish list is reserved for the public sector, which is supposed to provide simultaneously for better infrastructure, better education, more help for the poor, more programs to eliminate discrimination and better healthcare – oh, and a better savings rate for the government, not that the Indian government has ever saved anything in real terms in the 60 years since independence. Total government spending is supposed to increase by an additional 2.5% of GDP – for a government which is already running public sector deficits of 8% of GDP. This may sound modest, but it is based on the 9% economic growth assumption; when growth falters, massive public spending plans will already be in place, resulting in a huge lurch upwards in the state’s share of the economy. Needless to say such a public sector expansion would choke off economic growth altogether.
The steroid-Stalinism of the Five Year Plan is wholly incompatible with a long term increase in India’s economic growth rate, or indeed its maintenance at current exalted levels. This will probably become apparent in India’s forthcoming Budget, to appear around the end of this month. The extraordinary increase in government revenues in the year to March 2007 will be assumed to be repeatable year after year with no adverse effect on economic growth, and public spending will consequently be increased to match. Expect an increase in planned public spending in the year to March 2008 of at least 20% over the year to March 2007, and probably 25%.
What form the ending of India’s economic boom will take is as yet unclear. Probably a sharp increase in inflation will take place, accompanied by major financing difficulties in the national and state budget deficits. Even though India’s financial position is currently manageable, it seems unlikely that this denouement can be delayed beyond the end of 2007. Thus in the medium term the Bear agrees with the Economist, although from an almost contrary rationale.
Where the Bear parts company with the Economist is in the remedy recommended. Just as we disagree about the responsibility for India’s growth, so we disagree on the potential for its redemption. Manmohan Singh, to the extent he is a reformer, is a very feeble one who does not command a majority in his own party. While in the boom-time conditions of the last 3 years he has proved adequate, albeit failing to advance economic reform further, as Vajpayee would have done, he is almost certain to be overwhelmed by any economic crisis in late 2007 or 2008. For one thing, the crisis itself will remove his credibility; to the extent he is trusted by the left, it is as the architect of economic miracle. He will thus fail to bring public spending back under control and will be unable to produce remedies for the economic problems that have arisen. Instead he will probably punt the problem forward with populist public spending and “soak the rich:” emergency taxes beyond the next election, due at latest in May 2009 but probably earlier if the economy has deteriorated.
The crucial question for India’s long term future is whether at that election India’s electorate proves to be smarter than the Economist. The worst possibility would arise if the BJP and its allies, following the retirement of Vajpayee in 2005, are unable to coalesce around an economically reformist leader, choosing instead either disarray or a reversion to primitive Hindu nationalism. In that case economic reformists would effectively have been disfranchised, and India could expect many years of renewed economic decline – the “Hindu rate” of 3% economic growth would have returned, for the same reasons as in 1947-91.
Somewhat less bad would be the Economist’s preferred result of a re-election of Manmohan Singh over an economically coherent BJP alternative. At least then Congress and its allies would be blamed by the electorate for continued economic decline, and reformists in the BJP or elsewhere would be correspondingly strengthened for the following election in 2013-14. A bad decade for the Indian economy probably, but not a bad century.
Only if the BJP and its allies were to conquer the forces of reaction and the Economist and return to power on a policy of re-starting the economic reforms that were under way in 2001-04 could India return to rapid economic growth. Even then there would probably be a 2-3 year period of monetary stringency and public spending cuts before the economy righted itself.
India has a great chance to enjoy rapid economic development and take its rightful place within a couple of decades among the world’s wealthy, albeit with a substantial remaining impoverished and under-educated rural proletariat. However, the Indian electorate’s decision in 2004 to remove Vajpayee has meant that a further period of economic chaos may have to be endured before renewed progress can occur. Countries can either have Five Year Plans or economic miracles, but not in the long run both.
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