When Narendra Modi was re-elected, optimists expected GDP growth to accelerate to 8%. Alas, it is plummeting towards 4%, having fallen steadily in the last four quarters — 7%, 6.8%, 5.6% and 5%.
Expect a further fall to almost 4% when the July-September figures come out. The Index of Industrial production was minus 4.3% in September, the worst in a decade, with 17 of 23 industrial categories recording declines. Capital goods output (representing fresh investment) declined 20.7%. GDP growth is approaching the 3.9% low of the Great Recession of 2008-09.
One reason is cyclical. The slowing world economy is pulling India down too.
But India also has serious structural flaws that will not mend easily. Unless mended, the new growth normal for India may be closer to 5% than the “miracle economy” benchmark of 7%. Former chief economic adviser Arvind Subramanian once theorised that statistical flaws were inflating official GDP growth by 2.5%. He said the distinct slowdown after 2011 in four indicators — exports, imports, electricity and credit growth — suggested GDP growth was between 3.5% and 5.5%, far lower than the official 7%.
I attacked this analysis saying no country derives growth estimates from just four indicators. He was right to raise doubts about 7% growth, but his estimate of 3.5-5.5 was too low. However, even the official data has now fallen to this range. The problem is not fudged data. India’s momentum sustained 7% growth for several years despite poor performance in the four measures because of the gains of internal trade. India failed to reap the gains of international trade, but a big expansion of roads, electricity and telecom to rural areas boosted internal trade between states, producing the economic gains that small countries can gain only from international trade. This sustained 7% growth for some years. But now over 90% of the country has roads, electricity and telecom, so further gains are tapering off. That, combined with global headwinds, has caused a plunge.
In the 2000s, India produced three world-class industries — software, automobiles and pharmaceuticals. In the 2010s, it hasn’t produced a single new world-class industry, mainly because of India’s lousy educational system. This produces a veneer of excellent graduates along with an army of unemployable semi-literates. The thin veneer was sufficient to create three champion industries in the 2000s, but it cannot create any more. The Economic Survey cried out for educational reform. But nothing has happened since the Budget.
Pending legal cases exceed 35 million, and cases go on forever, so law-breakers have an advantage over law abiders. This flawed judicial system kills honesty and efficiency. Enforcement of contract is critical to market economics but is wrecked by legal delays. The Economic Survey estimated that adding just 2,279 judges in the lower courts, 93 in high courts and one in the Supreme Court would suffice for a 100% case clearance rate. Why has nothing been done about this after the Budget?
India is uncompetitive in most economic inputs. Compared to competitors, India has higher costs of land, labour, capital, electricity, tax rates, rail and air freight. Only one of these — high corporate tax rates — has been tackled so far. Reportedly, the government plans to make larger land banks with environmental clearance available for major foreign investors. This is a partial solution. India needs more liberal land acquisition laws.
The RBI cut interest rates, but this has not transmitted to borrowers. One reason is high interest rates for small savings which seem politically sacrosanct. This must end. High rates for industrial power subsidise farmers and towns. This must end. Besides, discoms are bankrupt in all but name — one reason why the plant load factor of thermal plants has crashed to 48%. Electricity may be the next sector to default massively, extending the banking crisis. Power reforms are a must.
Railway freight rates have historically been kept high to subsidise passenger fares. That hits transport costs and hence exports. This too must stop. So must sky-high state taxes on aviation spirits that make our air cargo rates among the highest in the world.
In the short run, there is a case for fiscal stimulus. The fiscal deficit can be allowed to rise to anything up to 4% for this year. But history shows how difficult it is to end a stimulus, so caution is needed on this front. In any event we need to focus more on the long-term than short-term issues. Otherwise the days of miracle 7% growth will be over.