With the value of the rupee plunging to new lows, the current account deficit at an all-time high and inflation running at nearly a ten-percent annual clip, India is in serious economic trouble. Indeed many are beginning to wonder whether the country is edging toward a replay of the events in the summer of 1991. Back then, an acute balance of payments crisis forced New Delhi into the indignity of pawning its gold reserves in order to secure desperately needed international financing.
At a small public event the other week, Duvvuri Subbarao, the outgoing head of the central bank, pointedly referred to a recent book, This Time is Different: Eight Centuries of Financial Folly, and conceded that policymakers rarely learn from their mistakes. He conceded that:
“… in matters of economics and finance, history repeats itself, not because it is an inherent trait of history, but because we don’t learn from history and let the repeat occur.”
This is a theme that policymakers have been pondering for a while. More than a year ago, at what was ostensibly a celebration of an updated book on the economic reforms catalyzed by the 1991 debacle, Subbarao warned that the dangers sparking that crisis – ballooning fiscal and current account deficits – were once again lurking. At the same time, a high-ranking commerce ministry official told a group of business leaders that economic indicators were provoking “a sense of déjà vu.” Worried that conditions were ripe for a replay of the 1991 crisis, he exclaimed:
“Why are we dodging these [policy challenges]? In 1991, we were candid enough to take these decisions. The quicker we take these decisions, the better it would be, instead of acting like ostriches.”
Prime Minister Manmohan Singh flatly rejects the comparison, however, stating that “There is no question of going back to 1991.” He is basically right, since the country is in a much more resilient position than two decades ago. That said, it would do wonders if the political class were once again seized with the sense of urgency that gripped New Delhi back in 1991. Perhaps then a solid determination will emerge to push forward with a new round of economic reforms that have been put off for years.
Shoddy management of the economy has been a hallmark of Singh’s second term, which is highly ironic given that he and his current economic team are widely credited with pulling the country out of the fire 22 years ago. Then serving as the newly appointed finance minister to Prime Minister P.V. Narasimha Rao, Singh famously inaugurated the reform era by quoting Victor Hugo: “No power on Earth can stop an idea whose time has come.” These days, however, he gives every sign of being trapped in Samuel Beckett’s absurdist play, Waiting for Godot.
Still, whatever Singh’s merits as a policymaker, he hardly deserves all of the criticism he receives for India’s travails. A good part of the fault lies in New Delhi’s peculiar structure of decision-making. Singh’s diarchal arrangement with Sonia Gandhi, the Congress Party’s risk-adverse, redistributionist-minded matron, has been a recipe for policy inertia and inconstancy, prompting one Western diplomat to exclaim a while back that “Even the power structures in North Korea are clearer than those in India.”
Officials also argue, with some justification, that India’s immediate problems are not of its own making and other countries are in the same leaky boat. The proximate reason for the current crisis can be traced back to three months ago when the U.S. Federal Reserve hinted that it would begin curtailing its ultra-expansionary monetary policy, which has kept global liquidity at an artificially high level in recent years. That signal caused foreign investors to begin pulling their money out of a number of emerging markets. India has been hit most severely, but the repercussions have also been felt in Indonesia and, to a lesser extent, Thailand, Malaysia, South Africa, Turkey and Brazil. Indeed, some analysts (here and here) are warning of calamity redux –something similar to the 1997-98 Asian financial crisis that triggered months of global economic distress.
It’s likewise true, as Indian leaders point out, that much of the deteriorating trade balance is due to the country’s dire energy shortages and the consequent need to import copious supplies of dollar-denominated foreign oil.
Moreover, as Singh argues, India is in a far stronger place than it was two decades ago. The economy has more than quadrupled since then and according to the World Bank the country has now overtaken Japan as the world’s third-largest economy (measured on the basis of purchasing power parity). In contrast to 1991, the Indian central bank today has a large buffer of foreign currency reserves (around $270 billion) and, since the rupee’s value is now determined by market forces, the bank does not need to deplete those holdings trying to prop up a fixed exchange rate. Nor is New Delhi today buried in external debt like it was in 1991 when the servicing of sovereign debt consumed 30 percent of export earnings.
Another key, largely unremarked difference regards political stability. India’s problem today is policy stasis, as opposed to the political turmoil raging two decades ago. As parliamentary elections approached in mid-1991, the country had seen three governments, each with a different prime minister and finance minister, in 18 months. The campaign was marred by greater violence than witnessed in previous elections. Then came the assassination of the election frontrunner, former Prime Minister Rajiv Gandhi, whose death followed by just seven years the assassination of his mother, Prime Minister Indira Gandhi. Major insurgencies in Kashmir and Punjab were also blazing. By the summer of 1991, many observers believed the country was on the brink of tragedy. The New York Times Magazine published a long article detailing “India’s descent into confusion and despair,” while the newspaper’s editorial writers advised readers to “pity India” because the country was in danger of fragmenting along sectarian lines.
Nonetheless, the echoes of 1991 are easy enough to discern. First, the trade imbalance is at a level – nearly five percent of GDP – much higher than it was two decades ago and almost twice what the central bank says is sustainable. And while the government itself is not encumbered by external debt, this is not the case for the corporate sector (see here and here). India Inc. carries a relatively high level of non-rupee-denominated debt and its capacity for repayment on foreign obligations coming due is obviously abraded by the rupee’s precipitous decline. Private-sector strains also could easily spill over into a state-run banking system already burdened by a rising share of non-performing loans. Finally, there is talk (here and here) of New Delhi needing to take out a loan from the International Monetary Fund, just like in 1991.
Adding to the sense of déjà vu is that, in an attempt to stanch the outflow of money, the government is reverting to actions reminiscent of an earlier era. A case in point is the controls that have suddenly been instituted on domestic capital. Overseas investments by Indian businesses are now face new restrictions, as do outward remittances by households; personal investments in foreign real estate are now prohibited. The central bank says it is willing to grant waivers for legitimate personal outflows that exceed the new caps, but this mechanism bears an unfavorable comparison to the license raj that was supposedly laid to rest two decades ago.
Higher duties have also been slapped on gold imports, which drain the economy of foreign currency. Singh chides Indians for “investing in unproductive assets,” even though one reason they import so much gold is to hedge against the high inflation rate. The higher duties are also spurring increased levels of gold smuggling, an activity that led to the expansion of criminal networks in Mumbai in the 1970s.
But the most basic similarity to 1991 is, as The Economist noted last year, the “Brezhnev-grade complacency” that afflicts New Delhi, especially the top ranks of the Congress Party. The problem is that, since economic reforms were born in the crucible of intense crisis two decades ago, there exists no intellectual tradition underpinning them nor has a political champion emerged to galvanize public opinion. As one commentator argues:
“the ‘original sin’ of 1991 is the fact that reform was pursued in crisis mode, with the underlying rationale never fleshed out or articulated once the moment of immediate crisis had passed.”
Both Gurcharan Das, business leader turned public intellectual, and Nandan Nilekani, one of the famed co-founders of Infosys, observe that reforms have been pushed more by technocrats like Singh than by political leaders, a condition that ensures narrow and limited support. The word “reform,” Nilekani notes, remains “conspicuously absent from the election manifestos of India’s parties.” Singh flagged the consequences in a newspaper interview last year:
“[T]he logic of an open economy and its benefits are still not widely understood among the general public. Public discourse still sees markets as anti-public welfare. The instinctive reactions of many, both in the political class and in the public at large, is to revert to a state controlled system. There is no realisation that a reversal to an earlier era is neither possible nor desirable. Even a neighbour like China has understood the logic of an open economy and is developing the institutional framework which is required for this.”
This broad ambivalence, if not hostility, accounts for a great deal, including the perceived necessity in New Delhi of “reform by stealth,” a mode that one observer describes this way:
“Faced with politically unpalatable proposals, Indian politicians and bureaucrats often go quiet, enact reforms in the dead of the night and then pray that the opposition is either too lazy or preoccupied to react.”
The difference also explains the glaring silence in New Delhi two summers ago at the twentieth anniversary of the 1991 reforms – even Singh himself remained mute – as well as Narasimha Rao’s erasure from the Congress Party’s institutional memory. Ironically, the economic transformations that Singh set in motion two decades ago have only reinforced the status-quo orientation of his party colleagues. As a result, Congress has spent much of its time in power instituting expensive, market-distorting social welfare schemes instead of productivity-enhancing measures. This attitude tolerated Pranab Mukherjee’s disastrous stint as finance minister in the critical years of 2009-12. Even now, party leaders are ambivalent about the modest reforms that Singh and his new finance minister Palaniappan Chidambaram are championing.
Some contend that the upside of the rupee’s rapid depreciation will be a large export surge. But the undersized manufacturing sector, along with the country’s decrepit infrastructure and the alienation of multi-national corporations, put strong limits on whatever bounce can be expected. India’s famed information technology sector will benefit from the lower rupee but, with an employment base of just two million, it is much too small by itself to lift India onto a higher economic trajectory. And as a new report by the Asian Development Bank makes clear, no emerging market can transform itself without developing a significant industrial base. Indeed, the report highlights India as a prime example of an agriculture-based economy that bypasses the industrialization process and tries to leap-frog into a services-oriented economy. Such a strategy, the ADB warns, generates only “low-quality service sector jobs.”
So, let’s hope that the specter of 1991 lingers long enough to galvanize New Delhi elites – especially Congress Party leaders who are now in populist election mode – with the courage to implement game-changing reforms. Taking a cue from the ADB, they can start by dismantling the anarchic laws governing labor markets and the acquisition of land for industrial projects which have stifled the growth of labor-intensive manufacturing. This should be a huge comparative advantage, though worrying signs are emerging of Indian manufacturers shifting to other countries. But until some hard measures are enacted, all of New Delhi’s talk about building the country into a global manufacturing hub will continue to ring hollow.
David J. Karl is president of the Asia Strategy Initiative, an analysis and advisory firm, and heads its practice on South Asia. He can be reached via Twitter @DavidJKarl.