India leaving China behind? Not so fast - FT.com http://www.ft.com/cms/s/3/71a4cad2-728e-11e5-bdb1-e6e4767162cc.h...

EM SQUARED October 15, 2015 10:43 am

Alan Beattie

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Bloomberg

he truth may finally be wearing off the old saying that India only ever compares itself with
itself. As the Indian economy has proved to be one of the least dim spots in a gloomy
emerging market landscape, boasts are multiplying that it is overtaking China as the engine of
world expansion. Jayant Sinha, Indias junior finance minister, recently laid down the bold
prediction that in coming days, India will leave China behind as far as growth and
development matter.

Not, as it were, so fast. While Indias short-term macroeconomic performance has put it at a
better place in the cycle than most big emerging markets, the longer-term structural problems
that have kept it in a lower growth class than China unfortunately persist, as do the political
elephant traps awaiting intrepid reformers.

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On the face of it, the Indian economy is performing well, and the popularity of Narendra Modi,
the prime minister elected on the promise of liberalising reform last year, is holding up.
Christine Lagarde, IMF managing director, has referred to India as a bright spot in the
slowing global economy. Growth equalled Chinas last year at 7.3 per cent, and the IMF predicts
India will be the fastest-growing large economy in the world this year.

The reality is less encouraging. For one, the statistics may quite simply be wrong. A new data
series for GDP introduced in February did much of the work in raising Indias growth rate near
Chinas, and the numbers, with a short history and without detailed data to underpin them, sit
at odds with other indicators such as industrial production and imports.

Second, the current conjuncture has been delivered by a number of one-off factors. The falling
global oil price since late 2014 has benefited India both in holding down inflation and in
helping Mr Modi reform public finances by cutting expensive government fuel subsidies
without raising the price to consumers.

Third, substantial impediments remain to the challenge of increasing investment, particularly

in infrastructure, to unlock Indias potential for competing with east Asian countries for the
manufacturing industry currently being priced out of China by rising wages and costs. Growth
in manufacturing came to a halt between 2012 and 2014 after several years of expansion,
casting severe doubts on its underlying momentum.

Certainly, macroeconomic policy has improved compared with earlier eras. Fiscal and current
account deficits remain manageable. The Reserve Bank of India, which has traditionally
struggled with a multiplicity of targets and instruments, adopted a more conventional model,
targeting consumer price inflation using the short-term interest rate. Under Raghuram Rajan,
who took over as governor in 2013, the RBI got on top of inflation by rapidly raising rates. It has
now been able to cut them by 125 basis points to stimulate growth while other EM countries
such as Turkey and Brazil have had to tighten.

But the RBI statement accompanying its latest cut, a larger-than-expected 50 basis points on
September 29, made quite clear that the contribution of monetary policy to growth was running
out of room. Mr Rajan said: While the Reserve Banks stance will continue to be
accommodative, the focus of monetary action for the near term will shift to working with the
Government to ensure that impediments to banks passing on the bulk of the cumulative 125
basis points cut in the policy rate are removed.

Indeed, problems in the banking sector are exactly one of the problems holding back
investment. State-controlled banks have overlent, often under political inducement, to failed
infrastructure projects, and overall the accretion of bad loans in the system is blocking the
extension of fresh credit. The state banks will need new capital over the next few years, the
government wanting nearly two-thirds of it to be raised from markets, but whether that will
permit the widescale rationalisation and privatisation that many banks need remains to be seen.

There is a problem with the demand for investment lending as well as the supply. India has
always struggled to expand its industrial sector on a scale to match the fast-growing economies

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of east Asia, and the share of manufacturing in the Indian economy appears to have stalled at a
lower rate than for other emerging economies.

Alongside poor supporting infrastructure, one of the reasons has almost certainly been the
difficulty of acquiring land for industrial development, given the complexity of antiquated land
laws. Long before Mr Modi came to power, the problem was symbolised by Tata being forced to
relocate the manufacturing plant for its Nano car across India after it was driven out of its
initial site in West Bengal by angry locals, raising the cost of the project.

Reforming land acquisition laws was one of Mr Modis signature projects as prime minister. But
a change in the law, along with the introduction of a value-added Goods and Services Tax,
stalled this summer in a session of parliament dominated by corruption scandals rather than
legislative progress. Without the ability to build large-scale industrial plants near a source of
workers, any Indian push into manufacturing is likely to be dominated by capital-intensive
projects that provide fewer jobs.

Mr Modis government insists it will push on with reform but, given the snarl-ups in parliament
over the summer, his political space is shrinking. An important test of his governments political
momentum comes next month in the state elections in Bihar. The eastern state has long been
one of Indias poorest and, while it has been growing rapidly, it has struggled to expand its
manufacturing sector. If Mr Modis message of clearing away the impediments to investment
does not resonate, it does not bode well for his chances of maintaining momentum into next
year.

For the moment, it seems that India will be happy being regarded as a standout in the otherwise
disappointing emerging market class. If its cyclical advantage fades and it returns to its familiar
sub-China levels of growth, its politicians are unlikely to be so vainglorious.

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RELATED TOPICS CentralBanks,China,India Politics & Policy

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