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KWR Special Report

India's Big Fizzle
By Dr. Scott B. MacDonald

NEW YORK, NY (KWR) April 3, 2012 - Over the past several years, writing about India's sweeping economic transformation has become a cottage industry. We have been blessed with such titles as "Dancing with Giants: China, India and the Global Economy", "In Spite of the Gods: the Rise of Modern India", and "India: the Emerging Giant". These books are generally laudatory, though they acknowledge the "Indian miracle" has its fair share of problems. Those problems are now overshadowing the hard-earned gains India has made in recent years. In particular, India suffers from a growing lack of leadership and the pressing need for new reforms. Without a greater degree of decisiveness, the country runs the risk of falling back into a slow pace of growth, which will only aggravate unaddressed structural weaknesses.

Through the 1990s and into the 2000s, India made substantial progress in moving away from an inward-driven, highly-statist managed economy into a more open and globally-integrated economic machine, pumping out its own set of multinational corporations. Today, India has a growing middle class, a falling number of people who are "desperately needy" and a number of competitive businesses of global stature. According to an Indian government report (released in March 2012), the desperately needy are defined as rural-dwellers who earn less than 22 rupees ($0.44) daily or those in the cities earning less than 29 rupees and they have declined from 407 million in 2004 to 355 million in 2009.

Yet as India moves deeper into the second decade of the 21st century, the dynamism of the past decade is fizzling and the country's direction is becoming more uncertain. Over 2011 and 2012 the Indian economy has slowed, there are ongoing concerns about the direction of policymaking, and the related reform process seems to be stuck in neutral. This, in turn, is putting strong economic growth at risk and making fiscal management an increasing risk.

What ails India? Indian politics have entered a twilight zone as the ruling Congress Party-led coalition has run out of gas and the opposition is currently unable to assume control. The Congress Party is in trouble. In March it suffered significant losses in state elections, reflecting increasing public discontent. The party lost in Punjab and Goa, won in Manipur and Uttarakhand and came in a dismal fourth place in Uttar Pradesh. The last was important in a number of ways. Uttar Pradesh has a population of 200 million people, is the size of Brazil and is an important component of the national economy. It can be said that so goes Uttar Pradesh, so go the fortunes of the ruling party. What made the defeat in this state such a blow to Congress was that the party's aspiring leader, Rahul Gandhi spent a considerable amount of time there. Out of 403 possible seats, Congress came away with a painfully meager 23 seats. For all of Rahul's time and effort, the result was a blow to his claim to party leadership. As The Economist dryly noted (March 24th, 2012): "Long touted as Congress' next leader, he risks becoming India's answer to Britain's Prince Charles: stuck in a dynastic holding pattern behind his powerful mother, Sonia."

Matters for Congress and Rahul have not been made any better by the reports that Sonia Gandhi has been ill. Moreover, Prime Minister Manmohan Singh is close to 80 years of age and has been in office as Prime Minister since May 2004, having won re-election in 2009. His government's tenure is scheduled to end in 2014, but elections can be called before then. The question looming over the Indian landscape and Congress, in particular, is political succession. As Singh is getting older and tired from his lengthy tenure at the top and Sonia's health has been questionable, the failure of Rahul to stir the Congress faithful and other voters casts a shadow over the political landscape. Who will lead the ruling party in 2014 still remains a question mark.

Another problem on the political front is the unwieldy nature of the Congress-led coalition. The Congress Party holds a little over 200 seats in the Parliament out of 543 total. This means that Congress rules with the support of other parties directly in the United Progressive Alliance (UPA) as well as with the support of non-coalition parties. While the latter can be fickle in terms of dependability, Congress' closest ally in the UPA, the Trinamool Congress (19 seats), has functioned as a brake to fiscal and other reforms. Mamata Banerjee, Trinamool's leader, is opposed to any taxing of the people, the entry of foreign retailers like WalMart and Target into the country, a water-sharing deal with Bangladesh, a government-sponsored anti-corruption bill and raising rates on trains for the first time in nine years. She was a major force in driving out of office one of the government's more reformist ministers, Dinesh Trivedi, who handled the rails and was a member of her own party. While Banerjee probably does not have the ability to become the country's next prime minister, she can bring down the government and is clearly an impediment to reforms.

Banerjee has also made fiscal consolidation impossible. Out-of-control spending on food, fertilizer and fuel subsidies blew up last year's (2011-12) central government deficit target of 4.6% of GDP, leading to a result of 5.9% of GDP. On March 19, 2012, Moody's stated that the new budget for 2012-13 – heavy on subsidies, was a credit negative for the sovereign's rating (Baa3 stable), that it "lacks new solutions to address sovereign fiscal constraints" and is vulnerable to commodity prices, exchange rates (which are high) and the level of corporate tax revenue. Accordingly, the rating agency observed: "And the fiscal 2012-2013 budget's lack of specific policies to address these weaknesses is credit negative. Absent new policy initiatives during the year, it will take a combination of improved GDP growth and corporate profitability, lower global commodity prices, as well as exchange rate stability to improve fiscal performance and meet the fiscal 2012-13 deficit target of 5.1% of GDP.

Political succession and weak coalition politics have taken away from a needed focus on the budget deficits. The Congress Party's Finance Minister, the 76-year old Pranab Mukherjee faces a "mission impossible" task considering the political environment. Under his tenure welfare (including subsidies), military and infrastructure spending (a $1 trillion, six-year plan) is going up.

The fiscal situation is not good and it does not look to get any better anytime soon. Real GDP growth will be around 7.0% this year and hopefully back up to 7.5% next year. The fiscal drag is not just limited to central government books – according to a Morgan Stanley report, if one adds state deficits and off-balance-sheet items, the number goes up to 8.5%, which is not a healthy level. To bring the fiscal situation under control, the most obvious item to cut is subsidies. Yet, the fragile political situation precludes that option. Moreover, India remains vulnerable to higher oil prices. An oil shock would be a major blow to the Indian economy. There could also be problems should the monsoon not deliver its badly-needed rains.

India in 2012 has lost its fizzle. High oil prices are hurting growth prospects, while industrial investment is disappointing, inflation remains high as are interest rates which hurts corporate borrowing. At the same time, the fiscal deficit means high government borrowing, which is crowding out private sector borrowers. All of this is a turnoff for investors. Gross fixed capital formation has plunged since 2010.

India is now in a waiting mode – waiting for a new leader to emerge, waiting for the next national elections and waiting for momentum for the next round of economic reforms. As India is often compared to an elephant, it has gone from a healthy trot to a slower, lumbering pace. The risk is that India's politicians continue to put off the tough decisions and let the country drift into the somnolent pace of the 1980s just before its 1991-92 balance of payments crisis. India, as a high-flying BRIC has lost its fizzle; what it takes to get the fizz back does not appear to be available in the short-term, but surprises do occur.

This article originally appeared in The Global Economic Reports, MC Asset Management Holdings, LLC

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KWR International Advisor

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Publisher: Keith W. Rabin, President

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