INDIA: Waking the giant

For India to join the league of developed nations, it will have to grow at a breakneck pace over the next 10 years. But failure to hit growth targets could push the country’s development back years, if not decades

  • By Jeremy Kahn
  • 04 May 2010
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The old joke about Brazil – that it is the country of the future, and always will be – could once have applied equally well to India. The country was a sleeping giant, a potential powerhouse that never seemed able to shake off its “potential” prefix.

That is no longer the case: the structural reforms and economic liberalization the country has implemented over the past two decades have awoken this colossus.

In terms of sheer size, India, the world’s fourth largest economy, is already a force to be reckoned with. The country is now a valued member of the G20, and it played a key role in formulating the global response to the worldwide economic slump and pushing for reforms to international economic institutions.

But India is still home to an outsize share of the world’s poorest people. It continues to lag in indicators of health, education and social welfare.

For the country to join the league of developed nations, its economy needs to grow at a breakneck pace – 9–10% per year over the next decade – and it will have to ensure that its poorest citizens benefit from that growth. Any stumbles along the way can mean that millions of its citizens won’t make it into the middle class.

And while nothing is likely to derail India’s eventual rise, failing to hit its growth targets could push the country’s development back by years, if not decades.

During the recent economic slump, India’s annual average GDP growth fell from about 9% to just under 7%. In the third quarter of 2009, it was as low as 5.3%. That may not sound like a big deal – it doesn’t even come close to meeting the technical definition of a recession – but “the loss of two to three percentage points in GDP growth is a traumatic thing for an economy like India,” Subir Gokarn, deputy governor of the Reserve Bank of India (RBI), the country’s central bank, tells Emerging Markets in an interview.

In other words, it may not have been a crisis – but it certainly felt like one.

Foreign investors, desperate to repatriate cash to cover losses elsewhere, fled. Credit became scarce. Businesses deferred investments and hiring. Consumers pulled back on spending. The RBI responded by cutting rates and pumping loads of liquidity into the system, and the government helped out with a large dose of fiscal stimulus as well.

Now, India’s economy is rebounding sharply. Conventional wisdom suggests the country is poised to return to the 9–10% GDP growth trajectory that is its ticket to becoming a middle-income nation. The country’s fundamentals remain strong: India’s growth has been domestically led, not based on exports, and the country has a domestic savings rate of 35% and an investment rate of 37% – numbers that would be the envy of many developed nations and quite a few emerging markets too.


But a litany of potential obstacles is beginning to surface – from the uneven nature of the recovery to surging inflation and large-scale structural problems in sectors from energy to agriculture – that may make it difficult for India to realize this growth or sustain it over the long term.

The first question vexing policy-makers is how strong and widespread is India’s recovery? “The rebound is robust from all the indications that we are getting,” says RBI’s Gokarn.

Saumitra Chaudhuri, a member of India’s Planning Commission, says that, while the slowdown played out over 18 months, the recovery has been sharp, taking place in just two quarters. “The economy is close to where it was before,” Chaudhuri tells Emerging Markets.

The Planning Commission estimates that the economy will expand 7.2% in the current, 2009–10, fiscal year and grow 8.5% in the coming fiscal year, assuming a normal monsoon. The monsoon is always a big unknown in India, where agriculture represents 18% of GDP, employs nearly half the country, and where the monsoon delivers the vast majority of the country’s annual rainfall. Last year, an extremely weak monsoon led to record droughts and food inflation that battered an already weakened economy.

Weather forecasters say the monsoon this year is likely to be normal (although they’ve been wrong before). Still, the Planning Commission’s assessment of India’s headline growth rate is echoed by many private-sector economists as well. “The strong rebound in consumption and investment along with the government’s initiatives on inclusive growth make us confident of strong macroeconomic performance by India,” says Nandkumar Surti, the chief investment officer of JP Morgan Asset Management in India. He sees India growing at 9–10% over the next two to three years, an assessment that is in line with a recent pronouncement by Indian prime minister Manmohan Singh, who is an economist by training.

But if the recovery has been rapid, it has also been uneven. Amit Mitra, secretary-general of the Federation of Indian Chambers of Commerce & Industry (FICCI), says some sectors, such as manufacturing – which in February, the latest month for which data is available, registered a nearly 16% bump in output from the same period a year ago – have done very well. So too have consumer durables – sales of which are up 25% year over year – and the automobile industry, which in February broke all-time records for new vehicle sales on top of 11 months of solid growth.

These sectors have been aided by a hike in public-sector salaries instituted by the government in October 2008, a move which was unrelated to the financial crisis, but provided a lucky fiscal stimulus just as the brunt of the worldwide downturn hit. Other areas, such as textiles, gemstones and food processing, however, remain weak, as do many small and medium-sized businesses. These segments employ a lot of people, so lethargy here undercuts consumer demand.


Exports, which account for nearly 40% of India’s GDP, have also been slow to recover. Chaudhuri, from the government’s Planning Commission, says that “export weakness may last for a couple of years”, due to the slow pace of recovery in the developed world. He says the government hopes to offset that through investment in domestic infrastructure.

“More power, more water, more roads,” he says. “These things are necessary in any case to sustain higher growth, but now these efforts should be redoubled to offset the weakness in export-oriented sectors.”

Because of this weakness and India’s on-going hunger for imported oil, which has been rising in price, India’s current account deficit is now the highest ever recorded – 4.1% of GDP. While that might normally depress the value of the rupee, in this case one of the factors hurting exports has been an unusual appreciation of the rupee as investment and capital inflows have picked up. The strengthening currency and the large current account deficit further complicate matters for the RBI. While there is no risk of a balance of payments crisis – the central bank is sitting on more than $280 billion in foreign exchange reserves – many believe the RBI should use exchange rate adjustments to tamp down the rupee’s rise.

The currency stands at about Rp44/$ and Rp60/E, compared to approximately Rp50/$ and Rp65/E one year ago. This has been tough for smaller exporters who are less likely to have hedged their exchange rate exposure. “Exporters will take a beating,” says Ashok Kajaria, the president of the PHD Chamber of Commerce and Industry, which represents companies in India’s vast middle market. “And imports will go up, which is more trouble for the domestic market.”

Kajaria is among those who would like to see the RBI move to reverse the rupee’s rise. But that is unlikely to happen immediately. The level of capital and investment inflows, while high, does not seem to have reached pre-crisis levels, and foreign investment – to the extent it is helping finance infrastructure development – is important for India’s long-term growth. A number of analysts think the unspoken reason behind the RBI’s reluctance to temper the rupee’s rise is that the bank has been trying to facilitate the government’s large-scale borrowing campaign, and exchange rate adjustments would inevitably increase the government’s borrowing costs.

The RBI has a policy of only intervening to smooth out unusual volatility, not to keep the rupee trading within a fixed band, Gokarn says. But he adds that, should India be faced with a sudden tidal wave of foreign capital flows, as some analysts predict given the weakness of the recovery in other once-promising investment venues worldwide, the RBI would consider “policies of active capital account management” or exchange rate intervention. “We will not take any instrument or action off the table,” he says. “If the pressure gets severe enough, nothing prevents us from acting.” Among the options that many analysts think India should consider is a policy Brazil recently implemented: a tax on portfolio investment.


For now, the RBI has more pressing worries. Inflation is perhaps the biggest concern for Indian businessmen, central bankers and civil servants alike. Wholesale inflation has been rising steadily throughout the year and is presently hovering just below 10%, a psychologically important threshold. Resurgent industrial production combined with a global increase in the cost of commodities and rising oil prices seem to be the culprit.

Meanwhile, inflation in consumer prices is already running at close to 15%, among the highest of any major economy. Food inflation, in part due to last year’s poor monsoon, is a large component of this increase, but there are signs that inflation is becoming more widespread. “We typically do not see a monetary response as the right instrument to fight food inflation,” Gokarn says. “But the problem is that food inflation can spill over into more generalized inflation.”

Coming so early in the recovery, the inflation numbers alarm economists, business leaders and politicians. They say inflation is surging even though worldwide demand for many basic industrial inputs – and, perhaps most importantly, for oil – has not recovered to pre-crisis levels. Indian economic experts generally agree that if the economy is growing at its targeted rate of 9–10%, it can withstand an inflation rate of between 4% and 5%.

But current numbers are well beyond that range.

“If there is any immediate threat to being able to sustain this revival, it’s the fact that there is going to be inflation that the government will have to respond to with a good deal of fiscal contraction,” says CP Chandrasekhar, an economist at Jawaharlal Nehru University in New Delhi. After finance minister Pranab Mukherjee claimed that none of the stimulus the government injected into the economy through tax cuts and subsidy hikes last year would be withdrawn, the government did begin to pull back, hiking fuel and fertilizer prices and increasing excise duties by 2%. Mukherjee has hinted in a recent speech that further tax increases may be likely in the near future.

On the monetary side, the RBI in late April hiked its key interest rate benchmarks and its cash reserve ratio by 25 basis points. (The reserve ratio hike is designed to take an estimated 125 billion rupees, or $2.8 billion, out of the economy almost immediately.) These moves followed a surprise 25 basis point rate rise in mid-March and another 75 basis point increase in the cash reserve ratio in January. Still, some analysts feel that the bank has acted too slowly. “They seem to be a little behind in raising rates,” says Nilesh Shah, chief investment officer of ICICI Prudential Asset Management.

Gokarn disagrees. He says the data the RBI had last autumn indicated that a recovery was underway but that it was fragile. The bank did not want to move too precipitously and risk derailing renewed growth. “This judgment of being behind the curve is a hindsight judgment,” he says.

He says that the bank now has more confidence in the economy’s rebound and is more focused on the risk of inflation. “We don’t want to disrupt the recovery, but we can’t ignore inflationary pressures that are building up,” he says.

This requires skilful judgement by the RBI. If it raises rates too quickly, it could still kill off the recovery. Higher interest rates could also wind up attracting a greater influx of foreign investment, leading to further upward pressure on the rupee and potentially setting the stage for bubbles in sectors popular with foreign investors, such as real estate.

Given this, many analysts believe the RBI is more likely to use instruments – such as upping its cash reserve ratio for banks – that take liquidity out of the system without directly raising short-term interest rates. Undershoot, however, and inflation might get out of hand, hurting the poor and possibly leading to social unrest. Keeping too much liquidity in the system could also permit asset price bubbles to build, potentially triggering a domestic financial crisis when they pop. If the RBI and the government get the balance right, India seems poised to return to a growth rate of 9% or more. But sustaining that pace of growth for five years or more, which is what India must do to become a developed nation, will require significant structural reforms.

The most obvious is infrastructure. The country is desperately short of adequate power, water and roads. The government has made a significant investment in these areas, but more is needed – and fast. The government announced in April that it will likely fall more than 20% short of its five-year goal of adding an additional 78,000 megawatts of power generation by 2012.


Another area in need of a major overhaul is agriculture. Even without the weak monsoon, farm productivity, yields and incomes have all stagnated. The Planning Commission’s Chaudhuri says the government is putting a special emphasis on reforming the sector, particularly improving efficiencies in crop storage and in transporting food to market. At present between 30% and 40% of all produce harvested rots before it reaches the market. The government believes these improvements will boost supply, tame food inflation, and that rising farm incomes will aid price stability.

The government has also pushed on with a programme of privatization, selling off government-owned corporations and assets. These sales are providing a one-time boost to government revenues, helping it cover its fiscal deficit, which stands at 5.5% of GDP, down from 6.7% the year before. The government has pledged to bring it down to 4.8% next year and eventually get it below 3%.

But doing so will require the government to do more to balance expenditures and revenues over the long term. The government has instituted a number of popular, but costly, social programmes – including a rural employment guarantee scheme – that are now permanent fixtures.

“Cutting the expenditure side further doesn’t wash politically,” says Rajiv Kumar, director of the Indian Council for Research in International Economic Relations (ICRIER), a New Delhi think-tank. So the bulk of deficit reduction will have to come from enhanced revenues. “They need to unify tax rates, make compliance even better and institute a service tax,” Kumar says.

The country will take a step in that direction when it institutes a uniform Goods and Services Tax (GST), a move expected for the 2011–12 financial year.

The good news is that the government seems to have a handle on what it should be doing to create long-term, sustainable high growth. But, as always, having the right ideas is one thing, delivering on them is quite another. Given the range of potential hurdles – including the vagaries of a global economic recovery, strong inflationary pressures and large structural reforms – Indian policy-makers will have to be more than just skilful: they will have to be lucky, if the country is to realize its dream of sustainable, double-digit GDP growth.

  • By Jeremy Kahn
  • 04 May 2010

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 Citi 244,235.70 910 8.87%
2 JPMorgan 223,767.95 1021 8.13%
3 Bank of America Merrill Lynch 211,276.97 750 7.68%
4 Barclays 166,062.82 634 6.03%
5 Goldman Sachs 162,877.27 537 5.92%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 HSBC 25,202.67 100 7.14%
2 Deutsche Bank 25,125.19 81 7.12%
3 Bank of America Merrill Lynch 21,836.07 58 6.18%
4 BNP Paribas 18,395.95 105 5.21%
5 Credit Agricole CIB 18,048.72 104 5.11%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Jul 2017
1 JPMorgan 12,578.87 55 8.17%
2 Citi 11,338.07 71 7.36%
3 UBS 10,682.06 44 6.93%
4 Goldman Sachs 10,419.53 53 6.76%
5 Morgan Stanley 10,194.88 57 6.62%