No 215 INDIA'S ECONOMIC HURDLES TO SUCCESS

By: Cheng Yi Xuan

THE GLOBAL ECONOMIC RECESSION of 2008 has affected the economic growth of many countries around the world. The United States for instance faced a maximum negative GDP growth of 8.9% in 2009 and in the same year, the GDP growth rate for the United Kingdom was at negative 2%. The global economic recession also affected fast growing developing economies such as India with a GDP growth rate drop of 3.9% between 2008 and 2009. In 2010, the Indian economy seemed to have recovered from its lower GDP growth rate with a peak of 9.4% growth in that period. However between India's peak GDP growth in 2010 and the present year of 2012, we can see a trend similar to that of the 2008 economic recession, in contrast to IMF's projections of GDP growth of 8.7% for 2011. In this post, we are going to look at the cause recent decline of the Indian economy.

Recently several news articles reporting on the rapid decline of the Indian economy has surfaced on the Internet. A report published by the AFP on 6 June 2012 states that India's prime minister, Manmohan Singh, admitted that the Indian domestic economy is heading into 'turbulent weather'. In the report, the prime minister indicated that the economic slow down in India is mostly due to the eurozone debt crisis and the rising international petroleum and commodity prices. (Article:Put cap on public debt, RBI tells Government)On the other hand, an article published on The Economist magazine blamed India's economic slowdown on problems within the country. It states, "The state is borrowing too much, crowding out private firms and keeping inflation high. It has not passed a big reform for years. Graft, confusion and red tape have infuriated domestic businesses and harmed investment. A high-handed view of foreign investors has made a big current-account deficit harder to finance, and the rupee has plunged."(Article:Farewell to Incredible India).

First we are going to look at how the eurozone debt problem could affect the Indian economy. Firstly the eurozone debt problem was the result of countries like Greece having too much government spending. Before the financial crisis of 2008 which started in the United States, they were able to sustain their spending. However, past the 2008 crisis, people started questioning some of Europe's economies. When people lost confidence in the Greece economy, other European countries like Spain and Italy also saw more people being cautious in spending.

At the present stage amid government bailouts, government spending cuts and increased taxation, the many of those European economies currently affected by the crisis are seeing little or no growth in their economy. As such, import growth rate in to the European union faced a steep decline in import growth, falling from about 32% in January 2011 to 0% in December 2011. With imports into the European Union being so severely affected by the eurozone debt crisis, India's export industries are likely to be affected as well. With exports declining, India will ultimately see a decline in growth of its economy.Another problem that might cause a decline in growth for India's economy would be the rising commodity prices between the period of December 2011 and March 2012.

 



 Indicated by the graph above showing an index of commodity prices. Rising commodity fuel prices meant that firms would face increased productions costs and thus their profits is reduced. Hackett's research conducted a survey among firms affected by the rising commodities and fuel prices and respondents reported that they will pass half of the costs to their buyers while the other half is absorbed by their individual firms. Either way, we can see that quantity in the market will be reduced. Firms will reduce the supplied quantity when there is less profit to be made by supplying at the current quantity. On the other hand, some buyers will choose buy the products at a higher price while others leave the market. It is possible to visualise this situation by having the supply curve shifting inwards in a supply and demand graph. Thus the overall reduced quantity will affect the growth of the GDP.

Another problem that could affect India's GDP growth is the large public debt to GDP ratio. According to an article on The Economist website, India's public debt currently stands at about 60%(using data from the IMF) and its fiscal budget deficit is currently standing at 5.9% up from 4.8% a year ago. At the second search conference held in Mumbai in February, Dr. Subbarao governor of the Royal Bank of India stated that excessive deficit will militate against growth and that government debts should be capped at a percentage of GDP. At the conference, Dr. Subbarao also mentioned that the government should improve the quality of government expenditure, such as spendings on merit and public goods that will improve social and human capital and also physical infrastructure.

Furthermore if India's government keeps spending on things that will not benefit long term growth, such as on loss making state owned enterprises, then we can only see an increasing misallocation of scarce resources and thus will not facilitate the growth of the Indian economy. Since the Indian government have been accumulating more debts to fund its revenue shortfall, a side effect of such an action would be the crowding out of private sector credit. Since there is a likelihood that private sector borrowing rates will increase as the result of the government borrowing, we might also see businesses choosing to look overseas to fund their operation where the borrowing rates are more favourable and thus exposing them to the volatile rupee.

However, in my opinion, the problems that India is currently facing whether internal or external should only affect India's economy in the short term. If India's government could streamline their spending and introduce new measures to make more efficient use of their human capital and natural resources, there is a good chance India's economy can match or exceed its previous high.