India is in the news of late for the wrong reason. The growth in Gross Domestic Product (GDP) slipped to 4.5 percent in July-September, a six-year low, compared with 7 percent in the corresponding quarter the previous year, according to official data. The previous low was 4.3 percent in January-March 2012-13. GDP growth has receded for six consecutive quarters. Not too long ago, 7 - 8 percent growth was considered the floor below which GDP growth would not drop in India unless there was a global crisis.
Although not yet in a crisis, the global economy is in a synchronized slowdown. Economic activity is softening in the US, Japan and the eurozone. Apart from India, the slowdown is sharper in other emerging markets such as Brazil. China's accelerated growth is experiencing a deceleration. Trade disputes, such as the tariff war between Washington and Beijing, and geopolitical tensions, such as Brexit, have spawned uncertainty.
According to the International Monetary Fund's World Trade Uncertainty index, the trade policy uncertainty is rising sharply, having been stable at low levels for about 20 years. The increase in trade uncertainty observed in the first quarter of 2019 could be enough to reduce global growth by up to 0.75 percentage point in 2019.
The decline in Indian growth does not fit the official definition of a recession. The US National Bureau of Economic Research (NBER) defines a recession as "a period of falling economic activity spread across the economy, lasting more than a few months." There is no decline in India yet. However, with weak growth, rising unemployment, and incomes taking a hit, conditions appear similar to a recession.
Economist Solomon Fabricant, a professor at New York University, coined the term "growth recession" to describe an economy that is growing at such a slow pace that more jobs are lost than added. A growth recession does not necessarily reach the severity of a true recession, but involves a rise in unemployment. Unemployment rate in India increased to 8.5 percent in October from 7.2 percent in September 2019. Unemployment averaged 5.16 percent from 1983 until 2019 and reached a record low of 3.53 percent in December 2011. Unemployment is at a 45-year high currently.
India is indeed in a growth recession. Alan Greenspan, former Chairman of the US Federal Reserve, often looked at sales of men's underwear as a guide to know where the economy was headed. He believed that when times were tough, men would stop replacing worn-out underwear before cutting other purchases. By that measure, India is in a major slump with underwear sales down 50 percent. Other indicators tell the same story. Car sales plunged 32 percent in August, the largest drop in two decades, rural consumption has plummeted and exports have been flat.
India's economic headwind owes to a combination of cyclical and structural factors. The 2019 Nobel laureate in economics Abhijit Banerjee points out that household consumption has fallen since 2014, something that hasn't happened in "many, many, many, many years." The immediate cause of the demand slowdown may have been the twin blows of demonetization and the new indirect tax regime as well as the collapse of shadow banking credit last year. Raghuram Rajan, the former chief of India's central bank, also singled out the first two as "the straw that seems to have broken the Indian economy's back". However, the slowdown in the pace of investment since the 2007-08 Global Financial Crisis and lack of economic reform suggest the problem is more structural than cyclical.
India did not focus enough on boosting private investment. This reflects a broader unwillingness to confront the structural problems. State-owned companies monopolize the lion's share of household financial savings and deploy them wastefully. Government-owned banks, comprising over 70 percent of India's banking system, continue to misallocate capital because of priorities imposed on them by politicians. Public companies are supported by the federal budget for years while making losses, making it difficult for private players in their sector to survive. The government has backed the insolvent state monopolies with renewed vigor.
Global integration without domestic reforms cannot take an economy too far. It has been almost three decades since India liberalized and integrated with the global economy. It was the seventh largest economy in the world by GDP in 2018. While India has been able to benefit from globalization, there is a common view that in a regulated market like India foreign players "have a disadvantage because the insiders know how to play the game", according to Nobel Laureate Joseph Stiglitz. Most observers agree India remains a difficult place to make things because of lack of infrastructure and an excess of regulatory red tape.
Investors do not flock to places when they are worried about regulatory and administrative uncertainty. Earlier this year, those who had invested billions in Indian e-commerce discovered the rules of the game were being changed to protect local players. Two big telecom companies were ordered by the Supreme Court to pay $13 billion in dues to the government. The markets suspect this will drive at least one of them out of business as they were already debt-ridden because of exorbitant spectrum fees.
India's recession can hurt Bangladesh. There are broadly four modes of economic engagement between countries: trade, cross-border production, investment and aid.
- Bilateral trade between India and Bangladesh stood at $9.85 billion in FY19. The World Bank estimates that bilateral trade potential between the two nations is actually $16.4 billion. Recession in India is likely to induce increased trade protectionism to keep imports low. Bangladesh has a significant market in India, especially in the northeastern parts, for bricks, cement, processed food and agro-based products, toiletries and cosmetics. Indian businesses are likely to lobby for more non-tariff barriers against Bangladeshi imports to limit competition, especially if Bangladeshi products are cheaper. There is also the possibility of "dumping" by India.
- Existing and emerging production networks between India and Bangladesh are at an early stage. The India-Bangladesh trade can be increased manifold through strengthening production networks, provided appropriate investments are made on two sides of the border on projects that give rise to trade complementarities. A weak Indian economy cannot help this move forward.
- Although still small, net FDI inflows from India increased from nearly $40 million in 2009-10 to about $115 million this year. Recession, through credit constraints, could make the Indian investors more selective on their international endeavors.
- India is not a very large donor to begin with, but a recession can slow disbursement from the $8 billion of Indian aid commitments in the pipeline.
A worry not just for India. McKinsey Global Institute in 2018 looked at over 70 emerging economies seeking to find which economies have delivered sustained per capita GDP growth over long periods of time. Over 50 years China, South Korea, Hong Kong, Singapore, Malaysia, Indonesia, and Thailand a sustained 3.5 percent annual GDP growth per capita. There is another set of 11, which delivered 5 percent GDP per capita growth over a shorter period of about 20 years. India is in this list. There are strong advantages of having growth taking off in an economy that leads in a region. Having an anchor economy close by is helpful. From this perspective, growth recession is a worry not just for the Indian policy makers but also for its next-door neighbors such as Bangladesh, Nepal and Bhutan. There are no quick fixes but addressing the sources of softening private consumption and the structural factors behind weak investment appear to be the main policy challenges for India.
It was argued for years that political stability at the top would enable essential administrative changes nudging Indian growth to race into double digits. But even a Prime Minister with strong political capital and a parliamentary majority cannot seem to reduce the enormous risks associated with investing in India. India has a leader with major political clout but not the policies the economy needs.
There are allegations of data suppression. Once that starts happening, you cannot precisely know what the state of the economy is. Last March, a group of 108 Indian and foreign economists and social scientists raised concerns over "political interference" in statistical data, saying that any numbers that cast doubt on the government's achievements seem to get "revised or suppressed". Indian economic statistics has often been criticized, but political interference was never the reason. Governments usually suppress data when they are on shaky grounds.
The author is an economist.