India’s Economy Is Slowing Down. What Happens Next?

What will it take for the Indian economy to keep up the growth pace it has set over the last five years?

In September, 2019, the Kellogg School’s Public–Private Interface and the Indian School of Business hosted a discussion between Krishnamurthy Subramanian, chief economic advisor to the government of India, and Benjamin Jones, a professor of strategy at the Kellogg School, to examine India’s economic outlook, how the boom of the last three decades will shape its future, and what structural changes can keep it growing.

This discussion has been edited for length and clarity.

Jones: India has had an extremely impressive run of economic growth. Income per capita today in India is about four times what it was back in 1992. But now people are talking about some headwinds and the possibility of slower growth.

Thinking about the next few years, do you see a slowdown coming? If so, is it just a blip? What concerns you and what do you think India needs most to resolve?

Subramanian: Let me start on a positive note. Just to give you a sense of this five-trillion-dollar economy: In the first 55 years of India’s existence, we added one trillion dollars in GDP. In the last five years, 2014 to 2019, we added another trillion. And given the changes to the exchange rate, it’s even more impressive. We added about 25 trillion Rupees in 55 years, then about 65 trillion rupees in the space of five years. In about one-eleventh of the period, we have accomplished two and a half times as much.

But in order to hit our goals, we need to be growing at 7.5 percent plus. In the last two quarters, growth has dropped to 5.8 percent and 5 percent. So there’s been a slowdown. The slowdown is partly cyclical, having to do with the global economy. But it is also partly structural.

We had three governments in a 15-year period, 10 years under the previous political party and then five years under the current one. Before 2004, we were really focusing a lot on structural reforms, but then we took our eye off of them. In the period from 2004 to 2009, we focused a lot more on welfare, so that era was about distribution rather than about growth. The period 2009–2014 was—and I say this without any political affiliation—a period where there was a lot of corruption and scandals leading to a misallocation of resources and lots of nonperforming assets. And then 2014–2019 has been about the cleanup: winding down of the overleveraging and dealing with bad balance sheets.

As a result, the investment-to-GDP ratio, which peaked in 2008–2009 at close to 40 percent of GDP, is now at 29 percent. And this is important because if you look at the advanced economies when they were at a stage that we’re in today—whether it is China, other East Asian economies, or other advanced economies—they all grew on the basis of investment, and especially private investment.

Jones: That puts India into interesting historical context. The U.S. would be quite pleased to have 5 percent growth, so one should always keep things in perspective, but India is indeed reminiscent of Singapore, China, and other countries we’ve seen that have achieved high investment rates and rapid growth.

So investment as a share of GDP is a ratio you want to improve. Some part of that is about credit, banking, and corporate income taxes. But another part is understanding what bottlenecks you hope to resolve that will increase productivity in the economy.

Take China. Investors really like the reliability of infrastructure, transportation, and electricity in China. We know that India has challenges in these areas and that the Modi government has big, ambitious plans for progress. What’s next?

Subramanian: So labor reforms, land reforms, and sorting out power are the three key areas that we need to work on to grow investment, especially private investment.

Our labor laws are still very stringent and unfriendly to investors. We conducted an economic survey of reforms to the labor laws in one of the states in Rajasthan. See, in India, if you’re a firm above a certain size, aspects of the labor law are applicable to you. What Rajasthan did was they increased the threshold size from 100 employees to 300 employees. We showed that as a result, the cumulative annual growth of labor, of capital, and levels of productivity all increased.

Land is similar. In order for us to actually build factories or roads, land acquisition is very important, but some laws make land acquisition extremely difficult. For example, to acquire land you have to get the approval of two-thirds of all the people who have a part of the land, which is a very high threshold. That imposes some difficulties on infrastructure.

Jones: So that’s really slowing you down?

Subramanian: Yes, it is, actually. Also, the government has certainly pushed the envelope in bringing electricity to a lot more people, but there’s work that still needs to be done in terms of appropriate pricing and making people pay. Right now, power is free for many farmers, so they have incentives to use it excessively, which depletes the water table, among other things.

Jones: I’ve been interested to see that the Modi government has announced extremely ambitious electricity plans, not just in terms of total energy supply, but also in the share that will be renewables. Solar and wind are meant to be 40 percent of the supply by 2030.

One of the challenges of renewables is that they’re intermittent, so they’re hard to rely on. How is India thinking about balancing this desire to go in the renewable direction with the challenge of being able to provide reliable electricity supply?

Subramanian: India is a coal-rich country, and the fact remains that we still need to bring power to a large mass of people at reasonably low rates. So we really need to walk this tightrope between ensuring development while also setting an ambitious benchmark for renewable energy. India is taking the leading steps here in target-setting. And that comes from our ethos. In India for instance, just about everything is worshiped. Rivers are worshipped, animals are worshipped, nature is worshiped. So, increasing the share of renewables in our energy is consistent with our ethos, while also recognizing that we cannot go all in immediately.

Jones: If you’re thinking about advising Modi and other policymakers about governance reform—rule changes that can help unleash organic investment in the private sector—what kinds of reforms do you encourage?

Subramanian: The key change that needs to happen in India is understanding the difference between pro-market versus pro-business. Somehow, in India, they are taken to be the same.

Let me use a recent example: the clamor for the bailout of the automobile sector, which occupies about 14 percent of Indian of manufacturing. Automobile companies’ sales have dipped about 25 percent this year, but that is on the back of profits that they’ve made for the last six or seven years.

The narrative that’s been created is that auto sales falling is symptomatic of the economy doing poorly, when the fact remains that there are a lot of other factors at play that are hurting the automobile sector: electric cars, Uber, millennials not valuing assets like cars.

I bring this up because in a market economy we have to recognize that firms will sometimes make profits and sometimes make losses. But every time a firm makes a loss, they can’t keep coming back to the government saying, “okay now bail us out,” because that creates the moral hazard of profits being private and losses being socialized by the taxpayer. This is an extremely important behavioral change that needs to happen. Sure, no country has been able to completely avoid that moral hazard, especially in the financial sector. But that moral hazard can’t be allowed to creep into other sectors.

So we’re transitioning. I made this comment, and it was flashed in all of the newspapers: I said, “We liberalized in 1991, and it’s been almost 30 years now. At this point, the private sector should be behaving like a 30-year-old adult, not running back to his or her father saying, ‘Dad save me.’”

We basically need to recognize all the important principles of a market economy, reduce the presence of the public sector, and bring in a much better credit culture through bankruptcy court.

Jones: Trump has created a trade war, largely with China, but not exclusively. What are the challenges that this brings to India? And as supply chains in East Asia get disrupted, is this an opportunity to grow substantially?

Subramanian: You know, this question gets asked often. The fact remains that India’s share of global trade is less than 2 percent. So even in a shrinking economy, we can still expand our share. So, I don’t think that India is so much at the receiving end of trade wars. It is an opportunity.

Now what we need to do really is to set our own house in order. We need to identify those parts of the value chain where we can really plug in. For instance, in the last few years, India’s share of assembling mobile phones has increased significantly, because we are now importing all of the components, assembling them here, and shipping them back. And this is possible because tariffs were reduced, and the mobile-phone assemblers could actually get these components at reasonable prices.

I’ll give you another example. When I was here in the United States, I used to drive a Toyota Camry, which is not a luxury car here. But in India, a Camry is a luxury vehicle. Why? Because duties and tariffs are just humongous. That fact enables many of our less productive automobile firms to continue to survive and remain immune to competition.

So we need to be reducing some of those barriers and really enabling trade and joining trade agreements. I’m glad to say that at the highest level of our government, there is clear recognition that we cannot grow by remaining insular, that we have to compete with the best in the business and only then can we grow beyond that 5-trillion-dollar economy.

Jones: India is a robust democracy, large, and highly diverse: different languages, different ethnicities, religious views, et cetera.

There’s a lot of GDP weight in the world right now moving in an authoritarian direction, and I think historians are looking at this period and wondering, “Is this a blip in authoritarianism, or is democracy in reversal?” And it strikes me that India has an incredibly important role to play. So I am curious about how robust you see India’s democracy as being, and whether you think India is going to increasingly take a role as a leader pushing democracy around the world.

Subramanian: That’s a very nice question. My answer has two parts. One: I think as a democracy we’re clearly very robust. The elections that happened just a few months back had the maximum number of voters ever voting. We are also clearly an exception because we are a democracy at the level of per capita GDP that we have.

Two: there are some principles that define India. For instance, historically we’ve never ever gone and attacked a country. Similarly, in our existence, we have never ever defaulted on any obligation. And these are not economic arguments, but spiritual ones. And therefore, when we think about India’s role, especially in today’s world, it involves some of these principles that are just nonnegotiable. Not reneging at all, even if it is economically optimal. Playing the game actually in a fair way.

India is going to be the president of the G-20 in 2022. We can show how cooperation can be based on principles. I think India understands its soft power very well and is very happy to put that soft power to good use in leading what we view to be an uncertain world.