India’s Sagging Economy – Strategic Consequences

Editor’s note: Teresita Schaffer has started work on a book called India at the International High Table. The book, co-authored with Howard Schaffer, will examine how India sees its role in the world, and how this translates into India’s negotiating style. This article discusses the strategic importance of India’s current economic slump.

Two decades of rapid economic growth and surging international trade gave India the economic and strategic heft to go with its world-wide vision and voice. The current slump threatens to bring back the lowest economic numbers in twenty years. This sagging performance will burden both India’s domestic politics and its global strategic goals. Manmohan Singh’s visit to Washington will provide some short term relief, but all India’s contenders for political power need to be thinking about how to get India’s economy humming again.

The story of the Indian economy’s fall from grace is by now familiar – almost a new cliché. After three years of 9 percent growth, India’s economy has sharply slowed. Projections for 2014 range from 4 to 5.5 percent; Paribas bank estimates growth during the April-June 2013 quarter at 3.7 percent. Manufacturing growth, which had done well during the boom years, sank to 3.5 percent in 2011 and barely topped 3 percent in 2012. Perhaps the biggest attention-getter has been the plummeting value of the rupee, down 22 percent between May and September 2013, Rs. 63 to the dollar in mid-September.

The picture is not all bleak. Services, accounting for about 59 percent of the Indian economy, grew over 7 percent – below the double digit levels of the past two decades, but still ahead of GDP, and some decline in services growth was widely expected. Domestic capital investment remains relatively high by international standards, though it did fall from a high of 38 percent of GDP in 2007/08 to 35.4 percent in 2011/12. International trade has held up better – exports and imports came close to doubling in the five years since 2007. Incoming investment has zigzagged. And undergirding all of this is the fact that private economic activity has been steadily expanding as a share of the economy for twenty years or more. 

Two decades ago, India’s economic travails would have been greeted with hand-wringing and a sense of the inevitable. Today, the reaction is different. Indian decision-makers and policy elites recognize that economic dynamism is not just a prerequisite for bringing prosperity to India’s poor, but also a strategic asset – or liability. And around the world, India’s economic performance is seen as a prime indicator of its capacity to shape regional and global events. 

The government clearly understands that it needs to turn the economy around. In the past couple of months, Finance Minister P. Chidambaram has pushed through some measures intended to bring in more foreign investment and improve relations with international business. These included the suspension of the Indian government’s policy on “preferential market access” (local content requirements) for electronic equipment purchased by the government.  The government also revised and moved to implement its decision to open single-brand retail to foreign investment. Unfortunately, to sell this measure politically, the government surrounded it with conditions that have kept investors away. None had signed on as of mid-September; the government is working hard to bring in at least one of the major retailers. 

India’s economic slowdown and pre-election introspection has probably had its most serious impact on ties with the United States.

In other indications of a push to revive the economy, the Foreign Investment Promotion Board with some fanfare cleared 8 new proposals in mid-July. The appointment of economist Raghuram Rajan as new Governor of the Reserve Bank of India, India’s central bank, normally an event confined to the fine print on the financial pages, was greeted with a full-court media press. Rajan’s initial statements emphasized the importance of growth – and of patience. He is evidently betting on the long term, and willing to take some short term heat, as witnessed by his September 20 hike in the bank’s key interest rate.

However, elections loom before May 2014. The government has turned inward; populist issues top its legislative agenda. The Food Security bill, passed during the last session of parliament, will extend food entitlement programs to up to 50 percent of the urban population and up to 75 percent of the rural population. The Land Acquisition, Resettlement and Rehabilitation Act, also passed during the last session, updates the often troublesome process of land acquisition. Legal experts familiar with the process expressed hope that the enhanced compensation levels it enacts will reduce the frequency of protracted litigation over land acquisition. Business observers fear that the requirement for administrative review of the social impact of each land transaction in which the government is involved will lead to even further delays on the creation of new industrial establishments. And the impending election has slowed progress toward the unification of India’s tax system through a nation-wide Goods and Services Tax – ironically, because the major parties agree that it would be beneficial, but the opposition does not want to give the current Congress-led government a chance to look good.

The impact of these developments goes beyond the domestic scene. For the past twenty years, India has enjoyed and nurtured a global role that goes starts with primacy in its own neighborhood but also features a dynamic new relationship with the United States, expanded trade as well as strategic competition with China, a growing role in Asian security extending from the Indian Ocean through to the Pacific, and a growing network of economic agreements, including Free Trade Agreements already concluded with Japan, Korea and ASEAN and pacts under negotiation with the EU and Canada. India has also built up its ties with the BRICS countries – Brazil, Russia, India, China and South Africa. Each of these relationships is driven in significant part by India’s economic profile. 

In each of these arenas, India’s economic slowdown will act as a drag on its strategic objectives. Take the strategic competition with China: India grew more slowly than China even during the boom years, and the present slump coincides with some speed bumps in China’s economic advancement. Nonetheless, India’s lackluster economic performance suggests that the time when India might move into the same economic league as China is not getting closer. Deepening economic engagement with Southeast and East Asia will continue – and India is fortunate to have concluded most of its trade agreements in that region before pre-election distraction set in. But security engagement to India’s east will depend in part on the budget, and at the moment, austerity is holding planned defense increases below the rate of inflation. The economic question marks that hang over some of BRICS’s more ambitious goals are bound to be intensified by India’s economic doldrums. The clearest example is the proposed BRICS development bank: unless India’s economic surge resumes, it becomes almost impossible to imagine such a bank having sufficient capital to make a difference unless its financing is turned over to China, a decision that India would probably be reluctant to accept. 

India’s economic slowdown and pre-election introspection has probably had its most serious impact on ties with the United States. Economics were the starting point for the expanded U.S.-India relationship, and economic and commercial issues have an unusually large impact on a country’s profile in Washington. In the five years since the global financial crisis started, the U.S.-India bilateral economic agenda has made relatively little progress. Long-standing issues important to U.S. business, such as the cap on foreign investment in insurance, have stalled. Recent Indian legislation, especially on land acquisition, has raised hackles among prospective investors. Compulsory licenses for pharmaceuticals in 2012 and 2013 may, as India argues, be consistent with India’s intellectual property laws and its agreements with the United States, but American businesses that went through the IP dispute in earlier years wonder whether India is moving back toward its former policy that basically disallowed foreign patents. The result is an extraordinarily sour mood among senior U.S. officials concerned with economic ties with India. 

The problems of course come from both sides. Indians are worried and frustrated over the immigration bill that passed the U.S. Senate in late June. It includes provisions that appear aimed at the heart of India’s most successful information technology companies’ business model for working with the United States, through dramatically increased visa fees and a prohibition on stationing their employees at a client’s workplace. And India’s pre-election distraction has probably met its match in the U.S. administration’s preoccupation with dysfunctional partisan warfare that threatens a government shutdown. 

The visit of Prime Minister Manmohan Singh to Washington September 27 offers the hope of some short term salve for a relationship that has always been “high maintenance.” His personal relationship with President Obama is good; both have a strong commitment to finding ways to work together. Both governments are trying to use this “action forcing event” to resolve some problems, possibly including some of the obstacles to civilian nuclear trade. 

But the longer term challenge remains, as Manmohan Singh knows only too well. India needs a thriving economy to achieve its goals, both at home and in the world. Election pressures run the risk of doing damage that may take a while to reverse.