AS ECONOMY GROWTH SLOWS..IS INDIA LOSING ITS WAY?

After a decade of rapid growth, peaking at 10%, India's economy is now growing by around 5%. Investors, both local and foreign, have become wary, frustrated by stalled reforms, huge corruption scandals and bureaucratic inaction. Foreign direct investment, in the first quarter of 2012, was down by 67% compared with last year. The rupee has slumped, a current-account deficit looms and inflation, though it has dipped a bit, remains high. The central bank refuses to cut interest rates, and public debt is high. A credit downgrade is looming, and perhaps a full-blown economic crisis. In response, in September, India's government attempted a set of reforms: cutting subsidies on diesel and gas; promising to raise funds by selling of parts of state-run firms; easing conditions for foreign investors in domestic aviation, broadcasting, electricity trading, single-brand shops (such as IKEA, a furniture-maker) and, most important, supermarkets. More reforms could follow. But the political storm, in response, has been severe. A crucial ally of the government flounced out of office. Street protests and strikes ensued. Does this mean that India is set on a path of lower economic growth than before, or that attempts to restore high growth are bound to bring intense political turmoil? The consequences of lower growth would include fewer tax revenues to spend on building infrastructure, social programmes, new cities and the country's armed forces. Less economic growth could quickly translate into less diplomatic or military clout abroad. Yet slower growth may also bring some benefits, such as lower inflation, less environmental damage and more equality. Just possibly, greater political turmoil could help India: could a new government prove more active, and more capable, than the current one? MODERATOR S REMARKS India needs a tough debate about government, policy and its future right now. For at least a couple of years its voters and its eliteparliamentarians, pundits, ministers, bureaucrats, businessmen, academics, and so onwere told by those in power that their domestic economy was doing fine, and any slowing of growth in India was caused by problems abroad. Now, at last, the script is changing. In September the government, led by Manmohan Singh, the prime minister, and Palaniappan Chidambaram, the finance minister, pushed through limited policy changes. After years of spending to the point of profligacy, India's rulers had grown worried about a big fiscal deficit and a host of troubling economic indicators. So the heavily subsidised price of diesel was lifted; plans for divesting parts of state-owned firms were announced; foreigners were told they could more easily invest in certain industries in India, such as retail and aviation. Judging by the political fuss that followed, you might think that only Mr Singh and Mr Chidambaram believed the September reforms were necessary means to help India avoid losing its way in the coming years. The furious reactions from every corner were damning. Mamata Banerjee, the chief minister of West Bengal, pulled her ministers out of the government in Delhi in protest. Other allies of the central government joined in with public marches in anger. Neither the president of Congress, Sonia Gandhi, nor her son, Rahul Gandhi, has since tried explaining in public why the reforms were worthwhile. Meanwhile the opposition, such as the Bharatiya Janata Party (which used to promote pro-growth market reforms when it was in office), also attacked the changes.

For all the political fuss, however, it is not obvious that the limited September reforms were anywhere near enough to lift investor confidence, fend off a possible credit downgrade in the coming year, get the government to hit its fiscal deficit target andultimatelyto get economic growth back up from the current 5% or so, to something nearer 7% or 8%. It is surely as likely that growth could slide down further. For anyone worried about creating the 13m additional jobs that India needs each year, or eliminating poverty as quickly as possible, or providing revenues to fund decent public services, prolonged slower growth would be bad news. Any policymaker has to worry about politics, of course. India is always, somewhere among its 1.2 billion people, in a pre-poll period. Across the many states and territories, there are always big elections looming that make it hard for politicians to take unpopular decisions. Yet in the coming year-and-a-half, with some ten important state elections and then a general election due early in 2014, the space for making more difficult policy decisions is set to shrink again. What does all thisplus continuing gloom in the world economy, domestic anger over corruption and the famously unhelpful Indian bureaucracypromise for India in the coming years? After a decade of rapid economic expansion, matched by impressive social and educational gains, India may have to brace itself for much slower growth and a more difficult, and profoundly messy, political period. It may be that promises of rising welfare for the poorin the form of rural make-work schemes, food rations, and subsidies of fertiliser and fuelwill become impossible to fund, or at least to expand. Politically, too, change may be looming. After several years when one or other of the main parties, Congress and the BJP, dominated national politics, India looks poised to enter a period of greater instability and political horse-trading, with a host of smaller, regional parties able to influence fractured national governments much more. That is likely to make it harder to get stable rule, let alone unpopular (but arguably necessary) reforms passed. Or, just possibly, one of the big old partiesperhaps invigorated by a new, younger leader might yet bounce back and take advantage. At a time of such uncertainty, commentatorswhether in the press, in politics, in social media, in universities or simply as informed individualshave a greater chance than usual to help shape a serious, enlightening and clearly directed public debate on India's prospects. Better public debate, just possibly, might also help to create conditions in which good policies can be rolled out. WITH THE MOTION A re-energised government attempting to rescue a slowing economy from policy paralysis and uncertainty hardly signals drift. But the risk, not the inevitability, that India will lose its way is real and substantial. Of course, it is true that the past three decades have been a golden age for India: rarely if ever in Indian history have so many people seen such improvements in their standards of living and in such a short span of time. Amazingly, work by Devesh Kapur and colleagues suggests that even the millennia-strong stranglehold of caste is being broken by a few decades of economic growth. And, above all, India's future seems bright. At about one-tenth of the standard of living of the richest countries, India is still so poor that the scope for growth via catching up to the economic frontier remains considerable; most of the egregious shackles on the private sector have been lifted, unleashing its innate dynamism; and demographics will reinforce this dynamism because tomorrow's India will be a very young India.

What then is the problem? In the short run the economic challenges are numerous. Inflation has been at or near double digits for nearly three years. More troubling is the lack of outrage from the public, whose demand for growth carries the risk that inflation will become entrenched in a manner eerily reminiscent of pre-hyperinflationary Latin America. Less well-recognised is that a Japan problem looms for India. The years preceding the global financial crisis saw a borrowing (and lending) binge predicated on growth being sustained indefinitely at 9%. But that rising tide is now a receding one. Overextended balance sheets make companies, especially in the infrastructure sector, look weak and incapable of supporting investment for years ahead. In turn, the banking system looks wobbly, and only the "extend and pretend" lending attitudes of the banks confer a veneer of soundness. Not just because the banks are publicly owned but also because many of the weakest companies are too big and too well-connected to fail, the brunt will be borne by, who else, India's government. Public-sector finances are a mess. A decade of high growth (nearly 8%) and low real interest rates (2%) should have yielded a fiscal bonanza and made the Indian government's balance sheet the envy of the world. Instead, India is as debt-addled as the advanced economies. And the future looks unpromising because India is in thrall to fiscal populism. Redistributive programmes are expanding, while subsidies for power, fuel, food and fertiliser are growing, with prospects for addressing them still slim. Most critically, India's development model is in danger of running out of steam. Skilled labour has been India's primary source of comparative advantage. But two decades of double-digit growth in remuneration are signalling that demand is running ahead of the ability of India's shambolic higher-education system to meet this demand for skills. Infrastructure, another key determinant of growth, has become a casualty of corruption. As I have argued, India has gone from being an import-quota-licence raj to a resource-rents raj (where the scarce resources are spectrum, coal and especially land). As the locus of the rents raj shifted to land, prices started rocketing, rendering it an increasingly scarce factor of production. And India's abundant unskilled labour is essentially not part of the equation because a panoply of regulations leads to its chronic underutilisation. In the absence of significant and structural changes, India's potential growth rate may be 67% or lower. The high growth rate preceding the crisis may have been the real puzzle rather than this lower trend. But these are all proximate manifestations of two deeper problems: an alarming decline in state capacity and in the quality of Indian democratic politics. The Indian state is increasingly unable to provide a range of basic services: health, education, physical security, rule of law, water and sanitation. The writ of the Indian state, for example, covers only about 80% of India, with the tribal belt essentially contested by Maoist insurgents. The private sector can substitute for some of these deficiencies but never completely (and because it cannot the outcome is the Annawadi slum in Mumbai vividly described in Katherine Boo's recent book). Moreover, talent is fleeing the public sector, reflected in the dramatic increase in unfilled vacancies in India's police, military, administrative services and even the elite institutes of higher education. In the long run, growth is determined by effective state capacity: that is India's weakness compared with China. Democratic politics is flawed everywhere. In India, it exacts a heavy economic toll. The consistent and widespread handouts from the government, under the guise of furthering equity, are above all a reflection of populism being perceived as an electoral winning strategy. Problems in the energy sector have less to do with insufficient resources as the

fact that people are not expected to pay fully for the power they receive. Politicians also brazenly, and without consequences at the polls, steal power or divert it to cronies. India's democratic politics has successfully provided the space to minimise the risks from some of the country's numerous social cleavages such as language and caste, but the fear is that otherssuch as religion, region and skill levelsmight be less easily managed. Will India inevitably lose its way? Not at all. Weakening state capacity and the deteriorating quality of politics are neither uniformly pervasive nor irreversible. Indeed, the hope for India is that there will be more successful experiences at the state level which can then travel either through demonstration effects or through people voting with their feet. But there is a race between rot and regeneration in these underlying institutions of the state and politics. And it is far from obvious that the forces of regeneration are winning. AGAINST THE MOTION One of the lesser-known dangers of a fixation on GDP is that, whenever the national economy hits a rough patch, detractors seemingly spring to life to take advantage of the opportunity to criticise. The list of woes is well-known: there is difficulty attracting private investment, particularly from foreign investors; domestically, there is inflation, particularly in the prices of food and fuel. And all this is apparently compounded by a "policy paralysis" that will not let the government respond adequately to these arguably pressing concerns. Let us concede, for the purposes of argument, that many of these concerns are valid, and carry much weight. Yet, those who would take this to herald the demise of the Indian miracle are guilty of an elementary mistake: they mistake diagnosis for prognosis. China and India remain the fastest growing economies in the post-recession world, and of these, India is far less vulnerable to export shocks. Historically, domestic growth, savings and investment have been the stable drivers of Indian growth. What was once derisively called "the Hindu rate of growth" of GDPabout 3%remains the unfailing contribution of the domestic sector to the Indian growth story. Consider the following: only 10% of India's growth comes from external demand, while over half of it is domestically oriented. By contrast, 65% of China's real GDP growth comes from exports, and only 25% from private consumption. Households account for 65% of India's national annual savingsour household saving rate, at 32% of disposable income, is the highest in Asiacompared with barely 40% in China. Bad loans account for only 2% of Indian banks' credit portfolios, versus 20% in China. India's economy grew by 6.5% in 2011-12. Manufacturing exports declined, which is inevitable, given that purchasers abroad must first be able to afford our products. Services exports, however, rose by 9%, accounting for 58% of India's GDP growth. Remittances from Indians overseas remain consistently strong as well, growing by over 20% to almost $60 billion. The contribution of services to our GDP growth, at over 3%, represents in itself a growth rate many Western economies would find enviable. Domestically, McKinsey & Co estimates that India's middle class will grow to 525m by 2025, 1.5 times the projected size of America's middle class. According to last year's census, the country's 247m households, two-thirds of them rural, reported a rise in the literacy rate to 74%, from 65% in 2001. In just the past two years, 51,000 schools were opened and 680,000 teachers appointed. Net enrolment ratios are over 99%. Our workforce has been growing at 2% steadily for the past decade (the comparable figure for China is 1%).

The reported slowdown in industrial production is primarily an export-oriented phenomenon. The domestic sector continues to expand apace. For instance, an impressive 63% of Indians now have phones, up from just 9% a decade ago; 100m new phone connections were established last year, including 40m in rural areas; and India now has 943.5m telephone connections. At the same time, some 20,000 MW in additional power-generation capacity was added last year, with 3.5m new electricity connections in rural India. As a result, 8,000 villages got power for the first time, and 93% of Indians in towns and cities now have at least some access to electricity. These are not the signs of an economy that is losing its way. Nor is it slowing: India is looking for $1 trillion in infrastructure development over the next five years, most of it in the form of public-private partnerships. This offers hugely exciting opportunities to investors. Reports of a flight of foreign capital in the light of a retrospective amendment to the law on taxation of capital gains also appear premature; in any case, the entrepreneurial private sector continues to successfully translate domestic savings into investment in various sectors. In this, a particular asset is our central bank, which applies intelligent regulations to permit such mobilisation while guarding against overexposure. This is not to say that we do not face challenges. There is no doubt that inflation is a concern, and not one that can be addressed purely through monetary policy. Let us not forget, though, that a high inflation rate is also a signal. It points to the fact that, in keeping with the expansion of the middle class, domestic demand has grown to outstrip supply. Industrial productivity hurt by the loss of export markets will find new customers at home. Reforms in distribution systems will make this adjustment still more efficient; recent stockmarket behaviour reveals the optimism of Indian industry towards such reforms. A vast and diverse federal polity like India may present many challenges to a policymaker, but it presents nothing but opportunity to an entrepreneur. Far from losing our way, we are rediscovering ourselves.