Will India be able to achieve and sustain high growth rates? Richa Sekhani and Geethanjali Nataraj are Researchers at the Observer Research Foundation, New Delhi Introduction The Indian economy is in the midst of turbulent times. While on the one hand the global trading pattern and rules are on the course of a major shift in coming years, on the other India’s four vital engines that enable economic growth, including demand, investments, production and exports, are performing poorly and are in an adverse state at present. An unfavourable external situation, falling commodity prices, currency fluctuation and sluggish growth potential in major export markets, especially in China, are also an obstacle to India’s growth story. As a result the government in the recent mid-year review of the economy had to downgrade the growth numbers from 7.5 per cent (projected in the annual Economic Survey of February 2015) to 7.2 per cent. With the revised estimates by the Central Statistics office (CSO), the India economy is now expected to grow at a 5-year high of 7.6 per cent in the current fiscal. However, taking into consideration the key parameters and the pillars of economic growth and the weak cycles reflected by the frequency indicators and factors such as industrial production (IP), Purchasing Manager Index (PMI), business and employment surveys showing poor performance, it is difficult and unlikely that India will maintain high and sustained growth rates of 7.5-8 percent. Moreover, lack of domestic reforms due to consensus, low utilization rate of free trade agreements with major trading partners, land acquisition, environmental clearances and infrastructure building and infrastructure financing are continuing to be major obstacles to achieve and sustain high growth rates. Factors driving GDP growth Economic growth of any country is dependent on both aggregate demand and supply side factors. An analysis into both factors reveals that the state of the Indian economy is not depicting a promising scenario and is in fact struggling to revive from the downslide. Indian economic growth has remained flat in the past 20 months and has grown at 7.3 percent in the entire financial year of 2014-15. Despite improved macroeconomic fundamentals and resilience compared to its peers, demand at both domestic and global level in the Indian economy is not picking up. Consumption, investments and exports in India have been in a troubled state for over a year now and require necessary reforms such that the estimated growth of 7.6 percent for this financial year is achieved. Declining exports India’s share of world exports has remained stagnant at 1.5 per cent for quite a few years now. Despite several policy announcements by the government of India, including the new foreign trade policy (2015-2020), exports have not been able to revive. In fact, one of the major causes of concern for the government of India, who are keen to achieve a growth rate of 7.5-8 per cent, is the continuous decline in exports. India’s annual merchandise exports stood at US $320 billion in May 2014 and have seen a free fall for 13 continuous months and have contracted by more than 18 per cent during April-December 2015. While the imports too have contracted over the same period, their decline has not been as steep as that of exports, resulting in a widening trade gap, despite a downward shift in the overall trade. The fall of exports in India has seen a progressive pattern and has finally set an alarm bell ringing, as the exporters are now demanding the intervention both by the government and the commerce ministry to step in to help and prop up the sector. The sluggishness in exports has hit almost all the industries, including leather and leather goods, iron ore and electronics. It is expected that India’s exports will decline by 13 per cent to $270 billion in the current fiscal year. Currently the impact of poor merchandise exports has been visible in the manufacturing segment, where capacity utilization levels have steadily dipped each quarter. According to the reports released last year, the slack in manufacturing is reaching out to labour resources as well. Exporters were forced to shut their manufacturing units, the impact of which was felt in the job market as well. According to the survey conducted by the Labour Ministry for the period April-June 2015, the net job creation declined by 43,000 people, of which export-oriented companies accounted for 26,000 of the net fall. During the same period, merchandise exports in India declined by 16.75%. A significant decline was observed in the cotton yarn industry, which saw a job loss of a staggering 3.5 lakhs people in last one year. Similarly, in the metals sector, severely hit by the global deflationary forces, layoffs or retrenchments rose. A slowdown in employment will further hit the income growth, affecting the aggregate consumption in turn, to the extent that it will offset or subdue the boost that private consumer spending is otherwise obtaining from lower fuel and other prices. The decline in exports is also seen from the special economic zones in the country. The recent CAG report of 2014 has raised serious issues and concerns on the performance, monitoring and evaluation of SEZ’s. They have not been able to achieve the objectives for which they were set up. Sluggish global demand A large chunk of India’s exports goes to OECD countries, in particular to the United States, the EU and Japan. However, the continuing impact of the global financial crisis, as indicated by the constant downward revision in the International Monetary Fund (IMF) global growth figures since 2011, means that demand stimulus from India’s traditional trading partners will remain muted and may not be able to pull back India’s export growth. The last financial year was one of the worst years for the global economy since the global financial crisis of 2008, with global trade growth collapsing to almost 0 per cent in 2015. In fact, over the years, the share of traditional partners such as the EU and India in India’s total exports has been consistently declining. Similarly, while South-South trade has continued to increase as a percentage of global trade, India cannot hope to counter the depression of demand from the global North by rebalancing trade relations with the global south. This is because emerging markets, in particular the BRICS nations, responsible for a large part of the growth in South-South trade, are now themselves struggling with the consequences of the Chinese economic slowdown and devaluation of the yuan. For India, 50 per cent of its exports go to the developing countries. While income of the developing countries has been affected by the low exports to China, it has led to reduction in imports from India as well. The yuan devaluation has made Chinese exports more competitive and they continue to flood world markets and India, in particular. Further, appreciation in the ‘real effective exchange rate’ of the rupee, when China, Russia and Brazil have either devalued or allowed a big depreciation of their respective currencies, has increased the woes for India. Rural and agrarian distress India’s agricultural sector is also facing a slowdown. Agricultures contribution to GDP has declined by 1 per cent in the last year, down from 17.2 percent in 2014 to 16.1 percent in 2015. The latest data from the Labour Bureau shows that rural wages have registered an average annual growth of 3.8 percent last year, the lowest since July 2005. Further, the downward trend in Minimum Support Price (MSPs) of major crops is hurting the farmers and a large number of them have recently committed suicide. Moreover, lack of good quality seeds, especially by small and marginal farmers, lack of mechanisation, poor agriculture marketing facilities, poor storage facilities, lack of irrigation and small and fragmented land holding along with lack of reforms in the sector have led to the inadequate growth of the agricultural sector in India. Stagflation in industrial production On account of the weakness in domestic and external demand, manufacturing growth as indicated by the index of industrial production (IIP) growth has been tepid and the capacity utilization in the Indian manufacturing sector has largely seen declining trends. India’s IIP contracted in November 2015; its worst performance in more than four years. Industrial output declined by 3.2 percent as only 5 out of 22 manufacturing sectors registered a positive growth rate. See Table 1 for details. Further as per the Table 2, the index of eight core sector industries; coal, crude oil, natural gas, refinery products, fertilizers, cement, steel and electricity has slowed down to 0.9 per cent in December 2015, with cumulative growth for April-December down to 1.9 per cent in 2015 as compared to 5.7 per cent in 2014. Similarly, Manufacturing PMI in India saw its first contraction of 49.10 in December from 50.30 in November of 2015, since 2013. Painting an even gloomier picture, the monthly PMI survey showed that the rate of contraction was sharpest in almost seven years since the global financial crisis. Non-creation of capital assets and poor investment sentiments The Gross Fixed Capital Formation (GFCF), another major driver of GDP, has hardly observed any increment in the last four quarters. On the contrary, it has declined to 30.8 percent in 2015 from 34.3 percent in the financial year 2012. Similarly, Gross capital formation which is the summation of GFCF, change in stock and valuables also showed a declining trend from 39 percent of GDP in 2012 to 24.2 percent in 2015. Gross Domestic Investment (GDI) has reached at an all-time low of 24 percent down from 29 percent in 2012. The decline in domestic investments is also underscored by low credit off take which has touched a 20-year low. Deceleration in credit growth to industry is observed in all major sub-sectors. As a result, the corporate sectors in India have been facing stressed balance sheets for a while, given that many investments made during the boom period have not yielded the expected results. It is a bit worrying that the level of non-performing assets as a percentage of bank’s gross advanced have started creeping up and touched a high of 5.1 percent in September 2015. In such a situation private sector investments are not likely to pick up and it is imperative that the government step up its public sector investments to fill the gap. From Figure 2 it is apparent that even as private sector capital formation has remained subdued, public investment has picked up to take up the slack. However, the growth in overall capital formation continues to remain at a low level. Further, investors are losing confidence in Indian markets. Estimates have suggested that Rs 25,000 crore has been taken out form the Indian stock market in the financial year 2014-15. Worse is the amount taken out in the first two weeks of 2016 which stood nearly at $700 million, lowest ever since SEBI started publishing data in mid-1999. Savings of middle class families and retirement funds of professionals have taken a serious hit and savings to GDP ratio has declined to 32.9 percent in financial year 2015. Consequently, the Sensex (India’s major stock index) has tumbled below its lowest level of 24,000 marks in 21 months, leading to outflow of money. The sustained foreign capital outflow is affecting the market sentiments adversely as demand continues for US currency from banks and importers. Additionally, India’s top 500 companies experienced zero revenue growth in 2015. The profits of Sensex companies rose by only 1 per cent during the April—June quarter, compared with 24 per cent growth in the same period a year earlier. Profit growth in 2016, as forecasted by Morgan Stanley Investment Management, is likely to be negative for the financial year. Net sales began falling since the third quarter of FY2015 and have continued to dwindle for the fourth consecutive quarter, falling 5.5 per cent y-o-y in the second quarter of the current financial year. Considering these indicators, India’s prospects of achieving the predicted growth rate seem very grim indeed. Supply side factors Beyond depressed demand factors, it is really supply–side constraints that have impacted India’s ability to expand trade into newer products and service areas and thereby strengthening its growth and development. The infrastructure sector is too big a sector and has the potential to turn around the economy. However, India is facing crippling infrastructure shortages which include power, roads, finances etc. due to low investment in infrastructure development. Investment through the public-private partnership (PPP) mode has also not come through as expected, leaving the government with few options. In fact, the PPP model, barring a few instances, has failed to take off in India and is still in its nascent stage. As per the data compiled by McKinsey & Company, the average infrastructure investment in India during the period 1992-2010 constituted 4.7 per cent of the GDP as against 7.3 per cent across countries like China, Indonesia and Vietnam. Reaching a peak of 24 per cent in the last quarter of 2009-10, the rate of gross capital formation has plummeted to zero in the third quarter of 2014-15. As a result of which the World Economic Forum Global Competitiveness Report of 2014 ranked India 85 out of the 144 countries in terms of infrastructure quality with ‘inadequate supply of infrastructure’, and infrastructure was also listed as the most difficult factor in doing business. This internal supply side constraint is actually containing India’s exports growth. The inefficiency in logistics compounded by a weak trade facilitation regime is another factor that needs to be carefully looked at as India’s manufacturing exports are losing price competitiveness. India’s over-dependence on road freight means that the cost of logistics as a percentage of GDP remains as high as 13-14 per cent, compared with 7-8 per cent in developed countries. India can easily be compensated by the export incentives of 2-3 per cent of the export value, if additional cost incurred on account of an inefficient trade infrastructure is avoided with necessary policy intervention. Another area of concern impeding manufacturing output is India’s outdated labour laws. These have consistently come in the way of enhancing manufacturing. India’s labour laws are hazardous for businesses that face seasonality in their demand to set up mass production facilities. A firm cannot retrench a part of the workforce in accordance with depression of demand. While the Ministry of Labour has brought some reform proposals in recent months, the Government needs to ensure that it is going ahead with these much needed reforms. Slow implementation of policies has done more to dissuade investment than the extant labour laws. The Government needs to continue its thrust on addressing challenges in these areas. This includes lack of access to credit, inadequate infrastructure and high transport costs, low availability and high cost of inputs, and difficult and limited access to land. India is also becoming one of the most protectionist countries in the world. According to the Centre for Economic Policy Research, the United States, India and Russia have imposed the most ‘trade distorting’ measures since 2008. India, like Russia, has hit nine of the other top 20 global economies with protectionist measures more than 150 times since November 2008. India imposed 504 protectionist measures between 2008 and 2015. This surge in protectionist measures saps trade, hampering India’s economic growth. It needs to be rectified urgently Lastly, the country’s exporters continue to face non-tariff measures and procedural obstacles, especially relating to licensing, permits to export, inspections, certificates and taxes in almost all of India’s exporting markets. Obstacles from the importing country include standards and conformity assessments, rules of origin and pre-shipment inspections; all of which are hurdle to the Micro, Small and Medium Enterprises (MSME) export community in particular. Despite being part of the trade pacts and having signed free trade agreements both on bilateral and multilateral level, India has failed to negotiate to get improved market access for the country’s exports. Most of the trade pacts that India has signed are more for geo-political reasons than commercial ones. Further India’s preferential trade agreements are shallow in terms of product coverage, implying that India has failed to utilize PTAs for export promotion. Hence, fixing the trade regime and bringing about efficiency of trade policy should be a priority for the government. Focus areas for intervention: the way forward India’s macro-economic fundamentals driving the growth of the economy have remained subdued in the financial year 2015 and the GDP growth has been almost flat. For a country keen on achieving and sustaining the high growth rates of 7.5-8 percent in an environment where China is slowing progressively and the rest of the world is also in a sluggish state (except the USA), domestic and structural reforms are the only way ahead for India. Currently, an export-push strategy for growth would be ineffective when the industrial world has stagnated and emerging markets are rethinking on the exports-led growth model. China has also has shifted focus from an export led growth strategy to domestic demand led growth strategy. Looking to 2016-17, it is the regional and domestic demand that could give spurt to the growth in India. This requires examining each of the components of demand and addressing the supply side bottlenecks through reforms and policies such that India can sustain its growth. Integrating into Global Value Chains (GVCs) At this moment sustaining domestic demand is crucial for India. India needs to stimulate the demand and create demand within, by encouraging the agricultural and manufacturing sector. Indian firms need to recalibrate their production strategies to become a part of GVCs of production. With globalization, corporations expanded their manufacturing activities across the globe, and created global supply chains to integrate their manufacturing. However, Indian firms are not integrated into the global production of intermediate goods, which today form the bulk of trade across GVCs. Further, the weak intellectual property regime (IPR) in India has also acted as an obstacle for technology transfer from foreign firms to India. In order to become a part of GVCs, India needs to establish a better IPR regime and create supply-chain efficiencies. As part of the push to increase manufacturing output, the government needs to take substantive steps towards establishing a strong defence industrial base in the country, with world class manufacturing capabilities leading to strong export possibilities. This requires continued actions to release capacity and informational bottlenecks that restrict the participation of the private sector in defence manufacturing. India is one the largest importers of arms and defence equipment in the world and that needs to change. Encouraging the private sector in defence is a key to step up defence manufacturing within the country. Reviving exports To encourage exports, particularly when China is devaluing its currency and exporting deflation to the world, India needs to improve competitiveness of its industries. Even after years of reforms, India is still exporting the same products to largely the same markets and as a result the trade has not seen a lateral or horizontal shift. Moreover, manufacturing, which constitutes more than 60 per cent of India’s merchandise exports, its composition has not undergone much change. Despite having several advantages in high-value added manufacturing, including engineering skills, a growing domestic market, a raw material base and a large pool of skilled labour, India’s share in exporting high-value added manufacturing products is still very low. Gems & jewellery, textiles & clothing, chemicals & related products still have more than 50 per cent share in overall manufacturing exports which have seen a falling trend recently. Hence, the situation needs to be rectified, especially as India is keen to promote itself as a hub of global manufacturing through its flagship ‘Make in India’ scheme. Policies supporting export-oriented manufacturing zones and the new coastal economic zones need to be relooked at. Further, norms on FDI can also be differentiated so as to have schemes that incentivize investments geared towards generating exportable goods and services. The Government of India, and in particular the Ministry of Commerce and its affiliate bodies, need to enhance interaction with State Governments, with a view to building an understanding of the comparative advantages states enjoy in the production of certain goods and services. Every State government must be mandated to come out with its own ‘Export Strategy’ document. The central government also needs to educate the state government about enhancing trade facilitation infrastructure, while concurrently improving the ease of doing business norms so that entrepreneurs and business can focus on improving products and services instead of focusing on compliance and administration. Address supply side bottlenecks Infrastructure financing is a major constraint that government also needs to look at. Development of financial sector market and institutions for infrastructure sectors is much needed to encourage private sector participation. Overall demand from rural economy is slow due to farm distress and therefore investment in rural/agricultural infrastructure like irrigation, storage etc. is needed. India should also design policies to attract money that is lying in pensions, provident funds etc. in developed countries like Japan and East Asia. A quick rollout of the Goods and Services Tax (GST), amendment of land acquisition bill and removal of all impediments to banks’ recovery of stressed loans are necessary steps. According to the central bank of India, a well-designed GST bill, by reducing state border taxes, would have the important consequence of creating a truly national market for goods and services, which would be critical for the country’s growth in years to come. Given the adverse external environment, India would need to focus on its internal market and work towards creating a sustainable unified market which requires a reduction in the transaction costs of buying and selling throughout the country. Fixing the trade regime through FTAs conclusion Fixing India’s trade regime should be a top priority for the government. India’s ill-conceived trade pacts have resulted in inverted duty structures that discourage the production and exports of value added items such as apparel and finished products like laptops or cell phone. Further, India needs to negotiate on the market access and tariff and non-tariff barriers issues with its Asian partners including China, Korea, Japan and Indonesia to penetrate their markets more easily. Also, India is presently going slow on trade pacts like the one with European Union that could be immensely beneficial, considering that the Trans-Pacific Partnership (TPP) has been signed by 12 member countries and the process of ratification is ongoing. TPP could hamper India’s exports and, particularly, the textile industry. Hence India needs to be strategic and play a more judicious role in negotiating FTAs with its trading partners. This would further encourage exports from our country. Conclusion The fundamentals of the Indian economy are depicting a fragile picture. Investments, manufacturing and exports are sliding and showing a declining trend. According to the research by Duestsche Bank, India's growth is well below trend, irrespective of the over 7 per cent growth reported as per the national accounts data, and hence the government’s claim of India as the fastest growing large economy based on GDP numbers needs careful analysis. Despite the slowdown, China’s exports declined by only 2.5 percent compared to 18.08 percent fall in India, and the yuan depreciated by only 6 percent compared to rupee depreciation of 9 percent in 2015. China on the one hand has a trade surplus of US $595 billion and India on the contrary has a deficit estimated at US $35 billion in 2015. Though the sharp fall in prices of crude oil in the international markets from US $111 per barrel in 2014 to approximately US $30 a barrel in February 2016 has provided the much needed cushion in managing the current account deficit, India has not made an optimum utilization of the windfall savings of US $47 billion from the petroleum product pricing. The ‘Make in India’ policy which aimed at creating productive jobs for rapidly expanding workforce in India’s organised manufacturing sector by enhancing exports has undoubtedly sent signals of vigour and enthusiasm. However, India should be conscious of the fact that the window of growth through export led manufacturing is limited and hence should not miss the opportunity presented to it, as the costs of failure now are greater than ever. Building productive capacities to enhance competitiveness, market linkages and enhancing investment attractiveness in selected sectors will have a strong impact on the export capacity of Indian business and will improve the country’s trade balance. In sum, export revival is one of the keys to sustaining and achieving high growth rates. But exports have shown a negative trend for the last year. The prime reasons for India’s exports contraction are a slowdown of demand in global markets and moderation in commodity prices. India’s export markets, mainly the US, China, the euro area, Singapore and Japan, are still going through either a slow revival or a decline. Prices have tanked and the impact is being felt through decline in the value of exports, particularly in top exports such as petroleum products, gems and jewellery, textiles, iron ore and so on. An uncertain global economic outlook has only added to the problem. Sustaining the growth rate requires India to take necessary steps to address both supply and demand side bottlenecks. Supply side reforms will help restart the private investment cycle, notably through recognition and resolution of the balance sheet problems of firms and banks as well as creating a clean and favourable tax environment through implementation of the GST and planned corporate tax reforms. On aggregate demand, both fiscal and monetary policy stances will need to be carefully re-assessed, to ensure they strike the appropriate balance between the short-term need to spur demand, especially private investment and exports, and the longer-term needs of preserving fundamental macroeconomic stability. In sum, taking forward and implementing key domestic reforms would help India attain a high growth trajectory and meet the aspirations of the teeming middle class 
population. Sustaining the growth rate requires India to take necessary steps to address both supply and demand side bottlenecks