By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011). Jointly posted with Roubini Global Economics
In the aftermath of the global financial crisis, optimists hoped that the BRIC (Brazil Russia India China) would drive the global economic engine. But China’s economic growth has slowed to its lowest rate in three years. Brazil’s economic growth has fallen from around 7.5% to under 3%. Russia’s economy is heavily dependent on oil and energy prices. India also has stalled. This 3-part paper looks at the development and future trajectory of the “I” in the “BRIC”. The first part looks at the background to India’s recent rise.
Despite the world and its citizens earnest desires, India seems destined to never fulfil its economic potential.
In the 30 years following independence, India achieved a modest rate of economic growth of 3-4% per annum and incomes improved by 1-2% each year. This was the “Hindu rate of growth”; a derogatory term coined by economist Raj Krishna to draw attention to India’s poor performance compared to other Asian economies.
India’s poor economic performance was not driven by religious factors but the half-baked socialist policies of its leaders. India’s first Prime Minister Jawaharlal Nehru admired the Soviet Union, becoming one of the few followers of its ultimately unsuccessful economic policies.
The economy was administered by a central Planning Commission, through a series of 5 year plans, modelled on a similar process used in the Soviet system. Major businesses were State owned and operated. Private firms required official licenses, their operations being strictly controlled by the regulatory regime, rather than free-market demand.
The Indian economy was closed to the world. The principal policy was import substitution and a reliance on internal markets for development. India’s currency, the rupee, was inconvertible. A system of high tariffs and import licensing restricted foreign imports.
This was the era of the “License Raj”, a reference to the elaborate licenses, regulations and stultifying red tape required to operate businesses in India. Consents from up to 80 government agencies were required before private companies could produce goods and services. Under the terms of a license, the government regulated all aspects of operations, including production levels, prices, investment policy and financing. The government restricted businesses from laying off workers or closing factories.
At the time of its independence, India was a stable relatively open economy with high rates of economic growth and significant international trade and investment. By the 1980s, three decades of poor economic management meant India had low growth rates, was closed to trade and investment and prone to instability.
In the 1980s, India made tepid efforts at reform. By the early 1990s, the country was in dire straits. A combination of international factors (high oil prices) and domestic failures (public finance problems and political turmoil) left the nation effectively bankrupt. Remaining foreign exchange reserves were only sufficient to cover payments for less than 2 weeks. The Reserve Bank of India (“RBI”), the country’s central bank, was forced to airlift 47 tonnes of gold to the Bank of England as humiliating collateral for a loan, while it waited for assistance from the International Monetary Fund.
On 24 July 1991, Manmohan Singh, the current Prime Minister and then Minister of Finance, told the Indian parliament that “the room for manoeuvre, to live on borrowed money or time, does not exist any more. ” Mr. Singh succeeded in passing a reformist budget, devalued the rupee and opened the door to foreign investment in certain industries. He also reduced the tariffs and eased the system of licenses.
Mr. Singh ended his speech to parliament quoting French author Victor Hugo: “No power on earth can stop an idea whose time has come.” Within the next decade, the idea of India as a “major economic power in the world” seemed within reach.
The actions of 1991 paved the way for a period of expansion and relative prosperity for India. Over the last two decades, India’s economy has almost quadrupled in size, growing at an average rate of about 7% per annum and over 9% from 2005 to 2007 – Chinese rates of growth.
The key drivers of growth included a large population which created a substantial domestic market, high savings rates which financed investment and an educated, English speaking workforce which was under employed. De-regulation allowed a latent commercialism, suppressed during the license raj days, to prosper.
While the reforms of 1991 and the nation’s natural resources were crucial, India was lucky. The opening up of India coincided with the rise of business process outsourcing (“BPO”). Developed nations commenced outsourcing basic support services and information technology (“IT”) to cheaper foreign providers. The need to re-code computer software to avoid the Y2K or Millennium Bug and support the Internet boom provided a significant boost to the India IT industry.
The external environment was favourable, characterised by strong global growth underpinned by the “peace dividend” from the end of the Cold War. The rise of emerging markets, especially the BRIC (Brazil, Russia, India, and China) nations, helped sustain a flow of investment into India. A weak Indian Rupee assisted growth, allowing Indian exporters to compete and encouraged foreign capital.
India also avoided the worst of the 1997/ 1998 Asian monetary crisis and the 2007/ 2008 global financial crisis. The high level of regulation of the financial system, including extensive capital controls, and domestic focus of the banking system protected the Indian economy.
The last factor which assisted growth was the large Indian Diaspora. The lost decades had resulted in a flight of human capital to developed economies. Beginning in the 1990s, there was a steady flow back of these skills, augmented by overseas education and experience, into the Indian economy.
Non-resident Indians (“NRIs”) were important in supplying capital. Indians working overseas, both in technical or more modest positions especially in the Middle East remitted more than $20 billion a year to India, the most of any country in the world. Successful expatriate Indian businessmen and professionals provided business connections which helped Indian business.
India and Indian had arrived on the global economic stage. Activist Arundhuti Roy satirised President George Bush’s favourable view of “Innians”: “…I like rish Innians…they are obedient and brainy…they provide additional brainpower to help solve problems… Innia is important as a market for US products…one billion people to exploit…” Domestic Innians now shared the success of their immigrant countrymen.
India’s GDP rose by 43% between 2007 and 2012, slightly less that China which increased by 56% but much fast than developed economies which grew only 2%.
Economists rushed to out do each other in spruiking the India story. Forecasts of growth rates of 8.5% per annum or even higher became commonplace. Morgan Stanley, the US investment bank, predicted that India’s growth would reach 9-10%, outpacing China’s pedestrian 8% within three to five years. In a report titled India: Better Off Than Most Others, Macquarie Capital, argued that India’s traditional weaknesses -low exports, a predominantly state-owned financial system lightly integrated to foreign markets, sluggish export growth because of bureaucracy and the large domestic agricultural sector producing only for domestic consumption- were now strengths underpinning growth.
Indian leaders moved between international forums, basking in their new found status and power. Indian businessman made trophy purchases of business overseas, financed by debt. At the World Economic Forum at Davos, representatives of the Indian government and business announced that India could grow in its sleep.
India’s economic hubris was exemplified by a marketing slogan, first popularised by the then-ruling Bharatiya Janata Party (“BJP”) for the 2004 Indian general elections – “India Shining”.
While India’s economic progress was evident, the benefits were narrowly based. A large portion of the population continued to struggle with low living standards or poverty, lacking access to basic amenities such as sufficient nutrition, clean water, sanitation as well as basic education and health services. The basis of the growth was also not balanced.
After years without a good news story, the Indian media focused on the nation’s “greatnesses”, relying on extraneous facts. The fact that the market capitalization of State Bank of India surpassed that of Citigroup was cheered. The press celebrated the first Indian edition of Harper’s Bazaar, which featured a crystal-studded cover, the introduction by Rolls-Royce of its new Phantom Coupe in India and the opening of a new BMW showroom in Delhi.
India now had nearly 7% of the world’s 1,000 or so billionaires, despite its GDP being only 2% of world GDP. The total wealth of Indian billionaires is more than 20% of the nation’s GDP, about the same as Russia but higher than China where it was less than 3%.
Mukesh Ambani, head of Indian based petrochemical giant Reliance Industries, and the fifth richest man in the world with a net worth of around $50 billion, used his wealth to build Antilia, a $2 billion house within sight of some of Mumbai’s slums. The lavish property was dubbed India 21st century Taj Mahal.
Controversial from the outset, Mukesh Ambani and his family reportedly have not moved into their new completed home, preferring to move between Antilia and their previous residence, Sea Wind. The press speculated that the building did not comply with principle of Vaastu, an Indian tradition similar to Feng Shui, the ancient Chinese system of aesthetics. Antilia’s shape was supposed to move energy beneficially through the building to improve the wealth and well being of residents. But it may violate of a key principle of Vastu. The building’s Eastern side does not receive ample morning light. It is more open to the West, which exposes it to negative energy.
Hindus believe that living in a building not built according to Vastu principles brings bad luck. In recent times, Mukesh Ambani’s empire has been adversely affected by a bitter fight with his brother Anil as well as legal and regulatory problems with some of his businesses.
Like Ambani, India’s bad luck may be just beginning, as growth slows rapidly and her problems mount.
Prime Minister Singh recently conceded that “it would be wrong to conclude that India is now unshakeably set on a process of rapid growth.” It was a contrast to Home Minister P. Chidambaram earlier optimism: “Thanks to our domestic consumption and demand, India and a handful of other countries, despite world gloom, are a shining example of a resilient economy”.