Can India be the first ‘fallen angel’ to fly again?

Over the past few months, one crisis after the other has gripped India. The problems of coalition politics have paralysed the reforms process. A campaign against rampant corruption in the government and bureaucracy has brought decision-making in New Delhi to a standstill. Ministers are worried that anything they do – even a minor policy change produces winners and losers – will be given the colour of corruption later.

The fiscal numbers signal trouble. The GDP growth rate in the January-March quarter has slipped to 5.3%; the earlier expectation was around 8%. The growth in the index of industrial production in April was just 0.1%. Interest rates remain too high, choking investment and growth. Rating agencies are taking notice: Standard & Poor’s warns that India could become the first “fallen angel” among the BRICS countries (Brazil, Russia, India, China and South Africa) and Fitch has cut India’s rating outlook to negative. All indicators of business confidence reflect the growing gloom. Dilip Gadkar, editor of Macro Viewpoints and CEO of G-Square Capital Management, a hedge fund advisory firm in New York, argues in this opinion piece that these problems are the result of populist politics combined with unsound economics – but India could bounce back faster than the pessimists fear.

India’s perplexingly sudden fall from its growth pedestal is the topic du jour among analysts and reporters. The unkindest cut came from the ratings agency Standard & Poor’s (S&P) which warned that India could be the first BRIC country to be downgraded to “junk.” The S&P report was direct in placing the blame: “The division of roles between a politically-powerful Congress party president [Sonia Gandhi], who can take credit for the party’s two recent national election victories, and an appointed prime minister [Manmohan Singh] has weakened the framework for making economic policy, in our view.”

We say “perplexingly” because analysts and reporters seem surprised by the fall. Frankly, in our opinion, it was guaranteed. The reality is that the story of today’s fall of the Indian economy was written in 2009 and it so happened.

The May 2009 election

The 2009 election was a huge victory for Sonia Gandhi, president of India’s Congress Party. For the first time since 1972, the incumbent party and prime minister were re-elected. This election delivered absolute power to Sonia Gandhi. She reappointed Prime Minister Manmohan Singh but restructured the rest of the cabinet. Most analysts missed the message that the policies of India would now be Sonia Gandhi’s policies and not those of Manmohan Singh. And Sonia Gandhi’s policies were a modern version of Indira Gandhi’s economic policy after her huge election victory in 1971.

Yet, analysts and observers kept waiting for Prime Minister Singh to introduce economic reforms that would free up the private sector. They are still waiting. They should have remembered the 1971 campaign slogan of Indira Gandhi – “Garibi Hatao” (Remove Poverty). That is exactly what Sonia Gandhi set out to do.

Noble aims and the credit boom of 2009-2010

Recently, Alan Greenspan, the former chairman of the US Federal Reserve, described the euro as a “noble but failed experiment.” These words could just as easily be used for Sonia Gandhi’s policies. Supported by her shadow cabinet of social activists, she launched programs that guaranteed monthly cash payments to hundreds of millions of India’s poor. These programs did not create jobs or much-needed infrastructure. They simply delivered cash.

This was easy to do in 2009 and 2010. The global rally in risk assets and the lure of secular high growth drove a flood of foreign capital into India. The distribution of free money worked well in the short term. Indians love to spend and rural spending drove up India’s growth rate. The uniqueness of the rural growth story drove more capital into India.