India has been a beacon to the world on how a thriving and vibrant democracy can transform itself into an economic powerhouse. The metamorphosis that took place in the Indian economy after the reforms of the early 1990s is nothing short of spectacular. The Indian economy was transformed into a dynamo of innovation and diversification. This fundamental transformation unlocked two decades of explosive growth in which poverty rates fell by nearly 20 percent, exports as a share of GDP increased nearly five-fold, and standards of living increased by a factor of almost four. This trajectory received but a glancing blow from the 2008 global financial crisis—this resilience was a testimonial to the benefits of the economic reforms of the previous 15 years.
Challenges to India’s Growth
But now, India’s economy once again faces formidable challenges and the fear is that it is considerably less well placed to deal with these challenges than at any time over the past two decades. The global economy is facing a new phase of the crisis characterized by an extreme bout of uncertainty, risk aversion and volatility, this time originating in the Euro Area. Some skeptics have recently questioned: Will India weather this storm as well as it did in 2008-09 and will the story of “Incredible India” remain credible? The Bank has been a firm believer that India can weather this storm and that its amazing success is not just a pipe dream. But the country cannot be a passive observer of global events, nor can it be complacent that long term growth and progress on poverty reduction will take care of themselves. Building a renewed broad consensus on critical structural reforms and polices within India’s vibrant democracy is key for its ongoing success.
While nearly all the large emerging economies (including Brazil, China, India, Indonesia, Mexico, Russia, and South Africa) have experienced a slowdown since June last year, India’s growth performance deteriorated the fastest, as have investor perceptions (as measured by downward revisions in consensus forecasts for 2012 growth). Moreover, India’s inflation (7.4 percent) and fiscal deficit as a share of GDP (8.3 percent) are the highest of these countries. Perhaps most disconcerting is the slump in investment and growth in industrial production, despite historically low (negative) real interest rates. Investment in infrastructure has slowed for a variety of reasons—including bureaucratic entanglements and slow decision making—and has had a significant adverse impact on development and growth.
What can India do to lessen the impact of the storm and bolster growth performance and confidence? Tomorrow, I will discuss solutions and policy suggestions to stem the slowdown.