India’s economy: Headed for trouble?

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I’ve written in the past that India’s economy emerged from the Great Recession in better shape than China’s, despite its slightly lower growth rate. But now India looks like it’s running into choppy times as well, with frighteningly high inflation, big budget and trade deficits and weakening competitiveness versus China and other rivals. Here’s what Ken Courtis, an economist and founding partner of private-equity firm Themes Investment Management, had to say in a recent email:

The Indian economy has entered a period of quickly deteriorating macroeconomic conditions…Unless addressed quickly, purposefully, and systematically, left to its present course, India is headed for difficulty.

 The problems India is facing show just how divided the world economy has become. While the advanced economies have been struggling to create growth and jobs and fight deflation, the roaring emerging world is struggling with the negative spin-off effects of rapid growth and strong domestic demand, and are fighting rising inflation. Such woes might be the envy of the Americans, Spanish, Irish and others still dealing with the fallout from the Great Recession, but that doesn’t make those woes any less dangerous. Growth aside, policymakers in the emerging world are perhaps facing as tough a 2011 as their counterparts in the U.S., Europe and Japan. The issues and priorities might be different – totally opposite in many ways — but the problems are no less difficult to resolve.

Just look at the mess India finds itself in. The wholesale price index soared 8.4% in December compared to a year earlier. Prices of onions, vegetables and other staples are rising even faster. The latest read of the government food price index shows they jumped almost 17% in a year. That’s a serious, serious matter for a country with so many people still stuck in poverty – nothing eats into the food on a poor man’s dinner table like rapidly rising prices. Certain basic foods, like onions, are such a crucial ingredient in Indian cooking that people just can’t live without them, so rising prices at the local market hit hard. The government has been scrambling to contain the damage, by, for example, banning the export of onions.

Some of this food inflation could well be temporary – a result of unusual weather conditions that hurt the onion crop, for example. India is also not the only country facing escalating prices, especially of food. Prices of commodities are rising across the board, with the Food and Agriculture Organization’s food price index hitting a record in December. But India’s inflation is also its own fault. A mix of loose budgets and easy money (leftover from recession-busting efforts) with a lackluster approach towards much-needed reforms (more deregulation, for example) and investments (i.e., in infrastructure) have created bottlenecks that spawn inefficiencies and push up prices. Here’s more from Courtis:

If you have aggressive monetary and fiscal policy, together with booming
labor market expansion, you better have hugely powerful supply side
policies, or inflation can only explode… guess what, in the absence of China style aggressive supply side policies -infrastructure,
deregulation, opening of the economy, education–, inflation is
exploding… and which means quickly dropping competitiveness.

 India’s competitiveness problem is showing up in its widening current account deficit, to more than 4% of GDP in the July-September quarter, according to Goldman Sachs. That gap, warn economists, is being filled in by flows of capital from the rest of the world, and not necessarily the good kind. Here’s Courtis again:

All of this is financed increasingly with foreign capital inflows, of
which a sharply declining portion is from FDI (as competitiveness
drops), and remittances –which means balancing this untenable position is more and more dependent on hot money

 India’s predicament is somewhat symbolic of what’s happening to emerging markets overall. After splashing money around for the past two years trying to keep their economies growing as the West sank, they’re now dealing with the consequences of those policies. Part of the problem as well has been inflicted upon them by policy in the struggling West. The expansionary practices of the Federal Reserve have likely helped stoke inflation by ramping up the amount of cash in the world economy. But the troubles in India should also act as a wake-up call for New Delhi. India needs to focus more on improving its infrastructure and education systems and continuing the process of deregulation that sparked its economic miracle in the first place to ensure its growth stays healthy. Goldman Sachs economist Tushar Poddar hopes India’s policymakers will get the message. Here’s what Poddar said in a recent report:

We would stress that despite the risks mentioned above, the underlying structural growth story remains strong. If unbridled optimism about economic fundamentals gives way to an appreciation of risks which can then be meaningfully priced by markets and addressed by policymakers, we think it would lead to a more sustainable growth environment.

 The situation is also a lesson for the rest of the emerging world. Growth solves many problems but creates others, so policymakers have to do just as much to manage that growth in good times as nurture it in bad times.