For reasons ranging from geopolitics to poverty alleviation, a strong India is good for the US. India’s strength will depend in great measure on the vibrancy of its economy. A complete picture of how the Indian economy is faring is therefore indispensable. It turns out India’s recovery from the crisis is partly illusory - its growth is not sustainable and is not creating broad prosperity.
India’s GDP growth weakened immediately after the 2008 global financial crisis but was nonetheless one of the world’s best performances. It has now returned to the pre-shock 8-9 per cent and remains one of the world’s best performances. For the April-June quarter, India just reported that real GDP growth (using factor costs) was 8.8 per cent.
There is discussion now of growth accelerating further to 10 per cent. Domestically, rapid economic growth is supposed to be the cure for widespread poverty, among other things. Internationally, such growth is to herald India as the next global growth story. It will likely do neither.
Indian growth, driven for more than a decade by market reform initiated in 1991, is now being achieved the old fashioned, unsustainable way: through intense fiscal and monetary stimulus. Growth thus stems in part from New Delhi deliberately choosing to risk high inflation. Inflation is a tax that erases apparent wealth gains and redistributes income, hurting the poor in particular.
Growth anywhere in the 8-11 per cent range is fast but unsurprising for India at the moment. This is not because of India’s genuinely high growth potential, which features demographic expansion and strong consumer demand. Rather, the fast growth is unsurprising because it is the result of both fiscal and monetary hyper-stimulus.
Fiscal stimulus gets the attention. Last fiscal year, the federal deficit was close to 7 per cent of GDP. It is projected to fall under 6 per cent this fiscal year and will do so due to one-time gains. There is no indication of spending restraint; in fact, quite the opposite. Long-overdue reform of the direct tax code was gutted in large part to support continued increases in federal spending.
In the same way, critical changes to the goods-and-services tax have been delayed and limited due to the desire of state governments to spend more. State government deficits pushed the consolidated national deficit past 11 per cent of GDP last fiscal year and will push this year’s deficit close to 9 per cent of GDP. The level may rise again next year. It is not surprising, nor sustainable, that government spending far outstripped private consumption April-June.
Monetary policy is worse. There is an ongoing debate over whether interest rate increases are coming too fast. This borders on ludicrous. India has large negative real interest rates, a terrible financial distortion by any standard. The Reserve Bank of India’s (RBI) August hike brought the rate at which the central bank lends to banks to 5.75 per cent. This left the real price of loans, after inflation, over negative 4 per cent, a perverse incentive to borrow as much as possible.
Yet government and businesses complain that RBI is being too aggressive by modestly raising the world’s lowest real borrowing costs. Because RBI is not fully independent, negative real rates should be expected to persist - the federal government needs low interest rates to keep its own borrowing costs low. With this amount of combined stimulus, it is no wonder growth is rapid and likely to remain rapid for several more quarters.
As it stands, though, rapid GDP growth will not last. RBI documents large productivity gains in the initial reform period (1992-1997) but weaker gains since. The results are declining returns to investment and a blunting of benefits of demographic expansion. Lack of reform ensures more such weakness, and the ruling Congress Party has chosen to emphasise liquidity and spending rather than reform. For a while, quantity can replace quantity, but economic performance must eventually suffer.
The government tries to stimulate the economy through spending but undercuts that through inflation. Inflation is an unfair tax. Among other things, it punishes those who put money away for the future by eroding their savings. More broadly, it harms certain asset holders and sectors of the economy and (comparatively) rewards others without any connection to behavior or scarcity. It thus undermines efficiency, inhibiting long-term growth.
In India, the primary impact of recent high prices has been to harm the poor, whose income largely goes to necessities. Food inflation stood at 14.6 per cent at the end of the April-June quarter. While this has eased into the 10-11 per cent range, fuel and power inflation was 14.3 per cent at the end of June and may be accelerating. Asset prices are also rising because the cost of holding cash is so high. And the Ministry of Commerce continues to revise all old inflation figures higher so that previous harm was repeatedly understated.
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