India’s growth doesn’t have a story


For a plan to come together there has to be one in the first place. As India finds itself grappling with a sudden fall from grace, an economic blueprint continues to elude policy makers.

World-beating growth numbers of over 7% might look good when global growth is sagging, but the underlying drivers aren’t so solid. Half of India’s gross domestic product isn’t actually improving. Meanwhile, of the other half, 15% is growing because of lower commodity prices and a third of that improvement is because of government actions, according to an HSBC analysis.

Since the government drained 86% of the cash in the Indian economy in November, economic activity has fallen sharply with no signs of recovery yet. Large swaths of the rural economy have been strangled just as consumption, a key source of growth, was gaining momentum, worsening India’s chronic problems.

India’s ad hoc reforms have led to colliding policy motives and consequences. In the most recent example, Prime Minister Modi has talked up an export-led model by endorsing the merits of his Make in India manufacturing program at a time when policy makers across the world are grappling with the rising threat of global protectionism. However, the cash-drain exercise pummeled the informal sector, home over to about a fifth of manufacturing jobs and nearly a quarter of India’s GDP. Industries like leather, a key focus of Mr. Modi’s manufacturing program, have seen production fall by 60% after the demonetization.

India continues to struggle in boosting fixed investment which continues to hover around just over a quarter of GDP, barely budging since a year ago. Meanwhile, subsidies and other expenditure make up a majority of government spending. Credit growth remains anemic because funding channels are clogged even as easy credit is extended to areas that won’t ultimately boost investment. When Mr. Modi took office he embarked on global roadshows to lure investors. Global companies, though, have either withdrawn or are second-guessing plans to break ground in India, lamenting bureaucratic red tape.

None of this is new, but, considering the reformer Mr. Modi is touted to be, it is surprising such pitfalls haven’t been made priorities. Government finances are in better shape. Fiscal discipline shouldn’t mean capital spending loses primacy, though. Going by Mr. Modi’s year-end speech, much will be spent on largely populist social spending ahead of key provincial elections. And, as the effect of low oil prices wears off, energy costs will divert cash away from investment and the recapitalization of weak public-sector banks just as nonperforming assets continue to build up.

In an ideal world, public investment could inspire confidence in the private sector and lure in long-term money rather than opportunistic investments. In India’s case, a 1 percentage point GDP increase in the government’s capital expenditure could lead to a 1.1 percentage point increase in real GDP growth over 18 months, according to HSBC analysts, pointing to the government’s key role.

Business confidence has slumped and deep-pocketed investors, while appreciating conviction, now seriously question the unskilled execution of the cash reform that sent the economy on a downward trajectory for the foreseeable future.