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India's Economy: Stamina Is The Name Of The Game

So far 2013 has been a breath of fresh air in terms of economic news: financial markets have rallied and economic indicators have started to surprise on the upside. In India, the rupee has strengthened and the Bombay Stock Exchange index (Sensex) crossed the 20,000 mark for the first time in two years.  Industrial production has started picking up.

So is India’s growth about to go back to 8-9 percent? The short answer is no. But we need to look back to understand why India’s growth has decelerated to a decade low and why the slump, which has hit investment particularly hard, has persisted for over a year. As structural problems are at the root of the slowdown, so structural reforms must be at the core of the solution.

In the IMF’s annual check-up of India’s economy, we attribute the slowdown mainly to structural factors.  These include supply bottlenecks, but also uncertainty about policies, and lengthy delays in investment project approvals and implementation. Of course, subdued global growth and higher real interest rates have also contributed, but were not the main culprits.

Our report also points out that India has one of the highest fiscal deficits and inflation among emerging markets.  Also, India’s external position has weakened, and banks’ and corporates’ balance sheets have deteriorated.  This analysis implies that there is no quick fix. Getting investment going again is not a matter of lowering interest rates or raising government spending. Structural measures that help lift obstacles to investments are vital.  At the same time, lowering the fiscal deficit and inflation are necessary to ensure investment revives. Strengthening bank and corporate balance sheets is also important so that, once conditions are favorable to investment, firms will find adequate financing.

Keenly aware of these challenges, the Indian authorities have started to act in recent months. Addressing the nation on September 21, 2012, the Prime Minister said, “We need a revival in investor confidence, domestically and globally… the time has come for hard decisions.” Speaking at the Economic Editors’ Conference on October 9, 2012, the Finance Minister P. Chidambaram cautioned, “Without reforms, we risk a sharp and continuing slowdown of the economy which we cannot afford…”

Indian officials have taken steps to restructure the debts and reduce the losses of state power distribution companies, to facilitate large investment projects with the Cabinet Committee on Investment, to liberalize Foreign Direct Investment, and reduce uncertainty in tax policy.  The Finance Minister presented a roadmap to reduce government deficits. Buttressing this commitment, the government has started to contain fuel subsidy spending and to roll out cash transfers, which could improve spending efficiency considerably over time.

Are these measures enough? They have definitely boosted financial markets and economic confidence, but the impact will depend on successful implementation and follow-up.  Negative growth in mining and low electricity output growth suggest that supply-side bottlenecks persist, and investment continues to be weak.

Addressing long standing and complex structural issues holds the key to reviving growth.

For example, resolving problems in the power sector—from fuel linkages to pricing and the financial health of distribution companies—is essential. We also see progress on inflation and the reduction of government debt and deficits as required to boost investment.  The Planning Commission in the Draft 12th Plan has also presented growth scenarios contingent on the progress on reforms:  they range from 8 percent growth with strong and wide-reaching policy implementation to 5-5.5 percent growth with policy logjam. Given the complexity of the issues, reviving investment in India is going to be a marathon not a sprint.

That’s the reason why we expect the recovery to be gradual and inflation and the current account deficit to remain elevated for some time.  We project real GDP growth of 6 percent for the 2013-2014 fiscal year, gradually increasing to about 6.5-7 percent over the next 5 years. And because elevated inflation and a sizable current account deficit are also partly symptoms of supply bottlenecks, combined with persistent high inflation and a gradual reduction of government deficits, we expect modest progress on these variables too.

However, more important than the exact numbers is progress on addressing the current impediments to investment.  This will create a recovery that can be sustained and lay the foundations for faster growth. Stamina to carry out the reforms is required.

*Rahul Anand is an Economist in the IMF's Asia Pacific Department.