The Growth Story That Wasn't

It was the year 2011. The Indian economy had grown an astounding 9.3% in terms of GDP; almost a double digit figure. India had rarely seen such high growth rates since independence. Investor sentiment was high; markets were bullish and the economy was booming.
The much criticized Indian Prime Minister
Manmohan Singh
Fast forward to 2013. GDP growth rate falls to a low of 5%; dangerously close to the dreaded growth rates of 3-4% of the pre-liberalisation era. Inflation remains to be high. Markets are down; investor sentiment negative and the economy is sagging.

What went wrong? How was it that a country which was growing at such high rates for the past decade now has a measly growth rate of 5% ?

Most economists and analysts would blame the government for this. My take is different. The Government could have at the most slowed the fall. The basic problem is that the Indian growth model was not sustainable for the long-term.

To understand the reason for the downfall of the Indian economy we need to first analyze the reasons for the India story.

India has never exactly been a export or manufacturing hub. Our economy has been consumption-driven which in essence means that we grew because our large population consumed a lot. When our economy flourished, the reason was that people were consuming more. And people only consume more when they earn more. The question that remains to be answered is that why were the Indian people earning more than before?

For the answer we have to go back into the history of modern India. The Atal Behari Vajpayee Government was remarkable for two achievements on the growth front - continuing the economic reforms of 1991 and building roads throughout India.

With more economic reforms pouring in, a country of 1.2 billion people became an open market for foreign investors. Investments flowed like water. Better roads and infrastructure helped attract more investments. Thus, the economy did quite well.

In 2004, the government was replaced and Manmohan Singh, the very person who introduced economic reforms in 1991, became the Prime Minister. Due to coliation pressures, economic reforms stopped abruptly but the economy continued it's growth due to welfare schemes introduced by the Government.

The most prominent of these welfare schemes was the MGNREGA, the Mahatma Gandhi National Rural Employment Guarantee Act which promised money in exchange for some minor work. Farm laborers who now had the MGNREGA to support them if they quit farming, began asking for higher farm wages. 

Thus, with more money in their hands, they started consuming more. The poor farmers of rural India, now began to look forward to objects like mobile phones, which were earlier considered to be a luxury of the rich. This also explains the telecom boom we have seen in India.

Throughout this period, investors continued to remain actively interested in India. Thus, with increased consumption and more investment, the economy reached the heights of it's glory. Near double-digit figures of GDP growth were obtained. Everyone was upbeat; no one realized then that the economy was silently overheating.

The Bombay Stock Exchange
With such increased consumption and with almost the same rate of supply, inflation began to raise it's ugly head. Buoyed by the increase in money, India began to import more while exports remained virtually the same. The Current Account Deficit (CAD) began to widen.
With the rise in inflation and CAD, the Reserve Bank of India (RBI) decided to step in and act. 

It began to raise interest rates steadily, under the impression that if the easy flow of money from the banks to the borrower was stemmed, the borrower would be less likely to import and consume more.

This move by the RBI didn't have any short term impact on inflation. Instead until 2013, inflation was mostly on the rise. The only short term impact of the rise in interest rates was a body blow to the manufacturing industry.

Forced to pay more to the banks on a loan, setting up industries and factories became a costly affair. Local entrepreneurs became reluctant to set up factories. The manufacturing sector declined and so did exports. The CAD widened even more.

Meanwhile, in the Western World a crippling recession struck in 2008. India remained largely unscathed, thanks to the consumption nature of it's economy and due to three successive stimulation packages to the economy by the Union Government. But foreign investors in the USA and Eurozone, facing recession at home stopped investing in India.

Thus, faced with a disastrous manufacturing sector, rising inflation and CAD and a reduced flow of investments, the economy began it's slow decline. But that's not it. Thanks to cash-eating schemes like MGNREGA and a farmer loan bailout and the three economy stimulating packages, the Government's fiscal deficit reached historical levels.

With a high fiscal deficit, rising inflation, a high CAD, increasing interest rates and no new economic reforms, investor confidence declined. The already reduced flow of investments to India narrowed even further. Thus, India clocked a miserable 5% rate of GDP growth in financial year 2012-2103.

Looking back, it is plain to everyone now that the reason for India's economic decline is it's consumption nature, which was what drove our economy in the first place. Thankfully, a few green shoots are now visible. The Government has now began to take measures to reduce it's fiscal deficit and has began reintroducing reforms. Inflation has fallen and the RBI has reduced interest rates.

Yet, the road to recovery is still a long, winding path. A lot needs to be done yet, the first and foremost being a concentrated effort to change the basis of India's growth model - consumption. The Indian growth story, highly publicized as it is, is actually unsustainable.

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