Why is India’s growth slowing? | CNBC Explains

India is one of the world’s fasting growing economies. It had been touted as an

economic and geopolitical counterweight to China. But recently its growth fell to its

slowest pace in six years. Investment has weakened, and unemployment has risen.

So what’s causing the slowdown, and how can it be reversed?

Since the turn of the century, India’s economy has grown at a rapid rate,

helping transform the country.

Between 2006 and 2016, rising incomes lifted 271 million people out of poverty, meaning

the proportion of Indians still living in poverty

has fallen dramatically, from around 55% to 28%.

Access to electricity has also improved. In 2007 just 70% of the population had access

to power. By 2017, that grew to nearly 93%.

More recently, the Indian government constructed around 110 million toilets -- a huge step

towards better sanitation designed to prevent the practice of open defecation. It's a signature

program of Prime Minister Narendra Modi, known as Swachh Bharat, or Clean India.

All this development has been supported by a booming economy, but as of late, that expansion

has begun to run out of steam. In the third quarter of 2019, India’s economic output

grew by 4.5% - making it the first time the country’s growth dipped below 5% since 2013.

For context, 4.5% growth is still much higher than that of developed economies like the U.S.,

But with 12 million Indians entering the workforce every year, economists say

the country needs annual growth rates to stay above nine percent

to ensure there are enough jobs.

So, what’s causing this recent slowdown?

Well, government officials argue turbulence in international financial markets is at fault.

Political uncertainty and  U.S.-China trade tensions  mean confidence levels among investors

and consumers everywhere have sunk.

The United Nations has even warned that a global recession in 2020

is now a ”clear and present danger.“

But back to India - many economists say the country's

growth problems are actually self-inflicted.

One obvious culprit is the shadow banking sector.

During the 2000s, India saw an investment boom. It was fuelled by state banks dishing

out a load of loans for big infrastructure projects. But some of the companies taking

advantage of these loans couldn’t keep up with the repayments. That meant the state

banks weren’t getting paid back and therefore struggled to give out new loans.

To keep business moving, shadow banks stepped in. These financial institutions, which operate

like ordinary commercial banks but don’t follow traditional banking rules, eventually

made up an estimated third of all new loans nationwide.

The loans played a pivotal role for the millions of small businesses and consumers who would

otherwise have no access to credit.

But in 2018, shadow banking giant Infrastructure Leasing & Financial Services, defaulted on

its debt repayments. Its collapse sent shockwaves through the economy and shook up more traditional

banks that had supported the sector.

This had a ripple effect. It became harder for people to buy expensive items like cars.

That hurt India’s automotive industry, which is one of the country’s biggest.

It employs about 35 million people and makes up about 7% of India’s GDP. Last summer,

the industry suffered its worst sales performance in nearly 19 years, and reports suggest tens

of thousands of workers have been laid off.

The agriculture and construction sectors have also been hurting, with small and medium businesses

being hit the hardest.

The country’s unemployment rate has been on an overall upward trend since July 2017,

rising several percentage points to 7.7%.

Higher unemployment means consumers are buying less, leading to the unfortunate cycle of

slower manufacturing, production, investment and job creation.

A survey from the Reserve Bank of India found consumer confidence has fallen to its lowest

level in five years. But Indians still have a positive outlook for the future, with most

consumers expecting to feel more optimistic in a year.

However, if things don’t improve, debt could become another issue. Expecting better days

ahead, many households have continued to spend, by taking out loans and dipping into savings.

Household savings as a proportion of GDP has fallen from 23.6% to 17.2%. Meanwhile, household

debt has surged to 10.9% during the same period.

Critics say the government in New Delhi has failed to spot these risks and hasn’t done

enough to get the economy moving again.

The Reserve Bank of India's former governor Raghuram Rajan recently blamed the lack of

significant reforms and a slowdown in investments since the global financial crisis.

Even the country’s chief economic advisor recently admitted

reforms are needed to make India more friendly to investors. India has cut its corporate tax rate,

but labor and land laws are still extremely strict. He also says the country

needs to become pro-market, rather than just pro-business,

to avoid costly government bailouts of failing sectors.

But not all reforms have been good to the economy.

In 2016, Prime Minister Modi tried to clamp down on corruption, counterfeits and tax evasion

by banning high value bank notes. In one night, the cash ban made 86% of all hard currency

invalid. Three years later, many analysts say the policy disrupted the economy and failed

to achieve many of its original goals.

In 2017, a new sales tax placed small businesses

under pressure and some of them were forced to close.

In mid-2019, India's government introduced a controversial new tax on foreign investors.

Consequently, India’s stock market suffered its worst July performance in 17 years.

Just one month later, the measure was scrapped.

The government has now refocused its efforts on international trade and investment,

and the recent changes to the corporate tax rate could indeed

help attract businesses and investors to India.

But if the country wants to be part of the world's largest supply chains, it will need

low and consistent tariff levels to encourage outsiders to invest for the long term.

The country's shifting export policy has harmed

several of its largest industries, particularly clothing.

India's share of the global apparel market has increased only slightly in the past 20 years.

And though the Indian workforce is vast, both Bangladesh and Vietnam now export more.

On top of that, the country’s import tariffs on average are much higher than the world’s

biggest economies. They’re also among the highest of the world’s emerging economies.

Even U.S. President Donald Trump has called for the country to bring down its duties.

But let’s take a step back. Has India’s growth actually slowed as much as we think?

The government’s former chief economic advisor Arvind Subramanian

caused a fair bit of controversy in June 2019, when he claimed the country’s official stats

probably overstated GDP growth by 2.5% from 2011-2012 to 2016-2017. He says the bottom

line is that India never recovered from the global financial crisis.

The government denies this.

But none of this has hurt Prime Minister Modi at the polls -

he won by a landslide in the most recent election.

So how will he keep his promise and double the size of the economy by 2025?

Many economists insist a well-explained economic vision would help. As would more

long-term investment, better skilled workers and improvements to infrastructure.

It may not matter who or what is to blame for India's recent economic challenges,

but bottom line - India's economic growth needs to bounce back, and fast.

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