Twice it experienced a downturn and twice it weathered the storm: In the years following the global financial crisis, India's economy displayed resilience as it battled challenges related to inflation, trade, consumption, investment and the deficit. But despite emerging from these downturns in 2009 and 2014 with stronger rates of growth, the country's current slowdown poses a challenge to Prime Minister Narendra Modi's administration as it seeks to revive rural demand and boost credit amid a shadow banking crisis. As the government focuses on raising consumption while fending off challenges from the opposition, the economy's long-term growth prospects will depend on its success in reviving fixed investment to over 30 percent, boosting manufacturing's share of gross domestic product and promoting labor-intensive growth to achieve Modi's vision of a $5 trillion economy by 2024.
India's central bank has downgraded its growth forecast to 6.1 percent for the fiscal year ending in March, suggesting India's current downturn is far from over. For Prime Minister Narendra Modi's government, boosting consumption and reviving investments will remain core policy objectives as it fends off challenges from a fractious opposition.
Surviving the Storm
In the years preceding the global financial crisis, India enjoyed extraordinary rates of growth. From 2005 through 2008, output expanded by an annual average rate of 9.5 percent, according to the International Monetary Fund. Crucially, investments as a share of GDP topped 30 percent for the first time in this period as private corporations drove a credit-fueled infrastructure binge. The manufacturing sector grew by an average of over 11 percent, raising hopes that India's lagging industrialization would take a great leap forward in the mold of China, whose own economic transition from agriculture to industry propelled its spectacular rise as the world's low-cost manufacturing powerhouse.
The global financial crisis, however, tempered India's soaring economic trajectory. As demand in the advanced industrial economies waned in 2008, India's exports took a battering. This contributed to a sharp slump in manufacturing growth from 10.3 percent in the 2007/08 fiscal year to 4.3 percent in 2008/09. Foreign institutional investors pulled capital from the economy, triggering volatility in the stock market and the exchange rate that resulted in the rupee tumbling against the dollar. (This, in turn, made exports cheaper, but the economy did not benefit appreciably due to low demand.) Inflation surged to nearly 13 percent by August 2008 because of rising oil and commodity prices. All told, growth in India's economy in 2008 fell from 9.8 percent to 3.9 percent over the previous year. This forced the coalition government led by the Indian National Congress party to turn to a fiscal stimulus involving tax cuts and public spending on infrastructure to create jobs, complementing the Reserve Bank of India's (RBI) monetary stimulus by slashing rates from 9 percent to 5 percent over six months. In the end, the strategy worked. Even as inflation persisted, growth in 2009 and 2010 rebounded to 8.5 percent and 10.3 percent, respectively.
Inflation Tempers a Temporary Recovery
But even if India emerged relatively unscathed from the worst financial crisis in 80 years, the RBI's easy money policy would soon unleash rampant inflation, triggering a deeper downturn. Growth in the 2011/12 and 2013/14 fiscal years averaged 6.1 percent, as rising consumption and limits on increased agricultural output drove food prices to double digits. The RBI sought to dampen demand by raising rates in March 2010; the strategy did reign in prices, but it blunted corporate investments by increasing the cost of loans. Making matters worse, outstanding investments from the boom years hit snags because of problems in land acquisition, environmental clearances and other structural constraints. Consequently, many corporations defaulted on their loans, saddling banks with a growing pile of nonperforming loans that hindered credit growth.
With the economy faltering and the ruling Indian National Congress battling a series of corruption scandals, the Bharatiya Janata Party (BJP) saw a golden opportunity in the 2014 elections. Modi — Gujarat's chief minister at the time — promised to create millions of jobs and restore the economy, ultimately propelling the BJP to a staggering victory and dealing the Congress a humiliating loss. Serendipitously for the BJP, Modi's election coincided with a slide in global oil prices that cut India's import bill and kept a lid on a major source of inflation. Growth inched upward to peak at 8.2 percent in 2016 — albeit after the BJP shifted its base year for measuring GDP from 2004/05 to 2011/12, thereby padding its figures while also attracting criticism over its statistical methodology. But even despite the BJP's changed calculations, growth has been falling in every quarter since the first quarter of 2018 in part because of Modi's demonetization drive in November 2016 and his rollout of the Goods and Services Tax (GST) in July 2017. At the same time, consumption and manufacturing have also slowed.
The patterns of India's downturns over the past decade point to where New Delhi's priorities will lie in the next few years.
The Crisis in Shadow Banking
Still, India's current slowdown differs in important ways from its previous downturn. Inflation remains under the RBI's 4 percent target, in part because a glut of crops following two bumper harvests means the market remains oversupplied. The resulting low prices, however, have hurt farmers' incomes, denting rural purchasing power in a country where nearly two-thirds of its 1.3 billion people live in the countryside and agriculture is the biggest employer. Compounding the problem is the shadow banking crisis: With mainstream banks still burdened by nonperforming loans from the infrastructure binge of the boom era, shadow banks — that is, non-banking financial companies — have emerged in recent years to offer more and more credit. But last year's default by IL&FS, a titan of the shadow banking industry, has raised borrowing costs while exposing the weaknesses of other shadow banks, hurting purchasing power, especially in the auto sector.
Slowing Revenue and Widening Deficits
A key risk stemming from the current downturn pertains to the fiscal deficit. Slowing growth means slowing revenues — indeed, GST collections have dipped beneath the monthly target of 1 trillion rupees ($14 billion) — suggesting the government could breach its deficit target of 3.3 percent when the current fiscal year ends in March 2020. This would dent India's credit profile after it pursued fiscal consolidation when its deficit reached 6.2 percent of GDP in the wake of the global financial crisis. Adding to the fiscal burden is the Finance Ministry's decision to slash the corporate tax rate from 30 percent to 22 percent as part of a move the government hopes will stimulate corporate spending through investments and, consequently, generate more tax revenue.
At present, the downturn is set to persist throughout the fiscal year, as the International Monetary Fund, the World Bank and the RBI have all cut India's growth forecast to 6.1 percent at most. Accordingly, the Indian National Congress and other opposition parties will have ample fodder to attack Modi on his economic record. In Oct. 21 elections in Maharashtra, India's biggest state economy, the BJP and a regional ally won a majority but lost 24 seats compared with the previous vote five years ago as the Congress gained 14 seats. Relatedly, in the northern state of Haryana, which has the nation's highest unemployment rate, the BJP is set to form a coalition government, yet it also lost its majority from 2014 while the Congress gained 16 seats. As a result, the ruling party's ability to emphasize non-economic issues and portray Modi as a visionary leader — in contrast to a hapless and indecisive opposition — will be key to fending off further political challenges.
More broadly, the patterns of India's downturns over the past decade point to where New Delhi's priorities will lie in the next few years. If India is to escape lower-middle-income status, its economy will need to grow by at least 8 percent for decades. In the end, its giant, next-door neighbor, China, powerfully demonstrates the importance of investments, savings and exports to maximize job gains. This explains why New Delhi's push to create manufacturing jobs — which Modi branded as the "Make in India" campaign — will remain a central priority to boost manufacturing's share of the economy from 16 percent to 25 percent. To boost private investment, the RBI will need to resolve the issue of nonperforming loans, explaining why its careful monitoring and demand that lenders clean up their balance sheets will remain key as the bank looks to play a role in credit markets and get the world's sixth-largest economy back on track.