Behind India’s Economic and Political Woes

Declining value of the rupee and soaring prices for onions are just two of the problems plaguing India. Professor Tarun Khanna explains the political and economic causes.
by Zeenat Potia

The Indian economy has been teetering on the brink for the past few months. The most manifest of these problems has been the crash of the Indian rupee, which has shown a decline of approximately 20 percent against the US dollar in a short period of time. Tarun Khanna, Director of the South Asia Institute at Harvard University and Jorge Paulo Lemann Professor at Harvard Business School, offers some insights into the causes and conditions at play.

Zeenat Potia: Can you give some context around the downturn of the Indian economy and how it applies to other emerging markets?

Tarun Khanna: First of all, I'll say that this isn't a crisis, but a significant correction. It's the result of a general reduction in confidence in the Indian economy and, in turn, has fed further angst. The fall of the rupee comes at a time of corrections to other emerging market currencies such as the Indonesian rupiah and the Brazilian real. A common cause of these price movements is shifts, or expected shifts, in US monetary policy. The United States is still the big gorilla in the global currency field, and when policies are tightened at home, resulting in the dramatic withdrawal of money from emerging economies, the smaller economies pay the price. The problem is exacerbated by continuing structural weaknesses in developing countries where foreign investments are not necessarily anchored in long-term commitments to infrastructure or projects that require physical plant equipment, but often are more portfolio—like in nature and somewhat footloose and fancy-free.

Q: What are some of the causes of the decline that are specific to India?

A: Due to large-scale economic liberalization since 1991, India has had a nice long run of reforms that drove increased investment, both by local entities and foreign investors, but when times are good, people tend to assume that they are everlasting. Sadly, reality isn't so compliant. During flush times, people borrowed excessively beyond their capacity to repay their debts, which is a common cause of corrections in emerging markets. Now under sobering conditions, people are scrambling and realizing that it's tough to refinance their debts.

For instance, a landlord of an apartment building in Bangalore has a short -term loan in dollars that is being serviced or paid for in rupee receivables. In other words, the landlord still gets the same rent in rupees from his tenants, but that money just became 20 percent more expensive in the global currency market. So what is she to do? The options aren't appealing: Default on the loan or change the business model by possible refinancing. As you can see from this example, the current Indian economic crash has real microeconomic consequences causing consternation for companies, small businesses, and entrepreneurs.

Q:Do you think the Indian political climate has contributed to the current economic situation?

A: Absolutely. India has, sadly, become notorious for policy paralysis. Laws are often tabled in Parliament, and they get pushed from session to session, despite their urgency. There is a rampant lack of clarity and leadership from the major political parties. The main opposition party, the Bhartiya Janta Party (BJP), recently announced Narendra Modi as their candidate for Prime Minister. The party currently in power, Congress, in the form of the government of Prime Minister Manmohan Singh, does not have a clear successor PM-candidate. Parties are preoccupied with their own internal affairs and not attending to the business of governing—a state of affairs that surely deters serious longer-term investors.

“There is a rampant lack of clarity and leadership from the major political parties”

Q:Are you saying that China would be a better choice for that?

A: There is a biblical saying that advises one to use a period of feast to prepare for a famine. In the Indian context, if, as was the case in China, adequate investment had been put into roads, bridges, and power plants, I suspect that a much larger fraction of the money coming into India would have been productively deployed into longer-term fixed assets, securing it against the volatility of global currency markets, particularly the tightening supply of the US dollar. India's economy still has many strengths compared to China, especially thriving entrepreneurship at the grass-roots level, but it's been sadly overshadowed by the less-than-sterling performance of the state, to put it mildly.

Q: On a different note, any thoughts on the rising price of onions in India?

A: This is very bad news for the incumbent government, since the price of onions is a harbinger of electoral distress. It is a bellwether consumer price in India, given its status as a consumer staple, and it indicates potential economic distress for the common man and woman. The Indian government recently passed a massive food security bill, which is an attempt to provide subsidized food to the poorest of the poor and to raise their level of welfare. Nobody can disagree with the need to alleviate the suffering of the hungriest, but the issue in India is that the mechanisms to distribute food to the most vulnerable people are inept and corrupt. The most charitable estimate I've seen is that for every rupee of subsidized food, 65 paisa doesn't reach the intended recipient, and the least charitable estimate is that eighty-five paisa goes awry.

This speaks to a very large leaky pipe, into which the government is pouring more resources in the futile hope that the pipe repairs itself. The fear is that this is an election sop, before next year's national elections, in order to boost ratings. If so, it would be a poor use of resources compared to using funds to repair the broken infrastructure. Since sizeable commitments of this sort can further exacerbate the fiscal deficit, already high, it can worsen an already weak fiscal situation. As Indians say, we're on a sticky wicket, to use a cricket analogy.

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    • Amit Daga
    • Vice President, Xerox
    There are additional elements contributing to the dysfunction in India, some of which Prof. Khanna touched upon very subtly but which need to be highlighted:
    (a) The Indian political system has converted itself into a blatant kleptocracy, similar to the worst examples we know of from Africa or Haiti. Governance in India today is limited to protecting the flow of resources to those currently benefiting. At the same time, opposition to the government is driven not by the direction in which governance is headed, but a fight by those pushed aside to gorge from the same trough. When Prof. Khanna says 65-85% of the resources directed to the poor never reach the intended recipients we need to understand that there may never have been any intent for this money to flow to the poor to begin with.
    (b) The Indian populance is shockingly resilient to poor governance. The reforms of the last 2 decades have given the average Indian just enough to develop a fear of losing what they have. Demographically, a very small percentage of the educated and middle-class Indians cast votes in national elections and fewer still vote in state and regional elections. Those at the bottom of the economic spectrum with no resources and little to lose are incented to vote by the kleptocrats through meager offerings of free food backed by the threat of physical violence. Thus a small and less educated demographic define the direction of the nation for the rest who ironically have the most to lose.
    (c) The judiciary in India has not been immune from this moral and social decline either and has slowly lost significance. Like the US, India too has a Constitution which should serve as a moral guidepost for the Judiciary to align to. However the judges at all levels of judiciary themselves are corrupt and in those rare instances when a court does choose to defend a moralistic and constitutionally valid law, they are quickly shouted down and made irrelevant. Those responsible to enforce laws and court directives themselves corrupt, with no incentive to stand ground and multiple disincentives to do so, the courts in India are virtually irrelevant themselves.

    Like any situation of this magnitude, much more can be analysed and identified as contributing to the root causes, not just the ones I have opined on. No doubt multiple opinions exist as to why India is in this sorry state of decline. Sadly enough, in this situation all perspectives may be correct.
    • Thothathri Raman
    • Chairman, SEAA Trust, New Delhi
    With due respect Dr Tarun Khanna lost a wonderful opportunity for a Harvard professor of his status to give more insights into the economic crises facing India and whether or not this would have been avoided. To equate India with Brazil or Indonesia with that of India is not fair as the problems here is not due to excessive borrowing to finance development. India has had difficulties with the FII investment which necessarily or footloose and fancy free. But the FDI investments are intact. It is all about the priorities of the foreign institutional investors which have been off the mark in this economy. Onion prices may make good news within the country but it is not worth commenting about in the international forum as it is a pure aberration and possibly also in tune with overall rise in prices. Bad governance, poor fund management, lack of support from markets like America which is highly exposed to Chinese market owin
    g to extremely negative balance of payments crises with that country are reasons for our economic neglect.
    • Premanathan VK
    • Professor & Director, TIMS, Edappal, Kerala
    Prof Khanna is spot on when he cites certain typical malaises which infest the national life of India. Alas ! things are going from bad to worse with an inept bureaucracy calling the shots especially after the loss of face by the poloitical leaders of all hues. India is turning increasingly a theatre of the absurd and the TV channels seem to celebrate it.

    Lastly, there are many Indias when it comes to development and awareness. A Kerala or Goa is distinctly in another league when it comes to HDI indices compared to UP or Bihar. The developed states have started feeling that they are being penalized for their development and appeasement politics is no more applied only to religious denominations.
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) private Limited
    This brief conversation with Prof. Tarun Khanna has touched some vital and complex issues facing the Indian economy. However, we need to understand that there are various other factors involved. Lack of clear direction from the top, unchecked delays in competion of projects leading to cost over-runs, accepting corruption as something which cannot be countered, directly/indirectly shielding the corrupt, unjustified problems attributed to a coalition government, extreme concern to win the elections by hook or by crook, are some of the key factors which have led to where India stands today. Additionally, its concern for human values has had a fall with so many instances of lootings, murders and rapes. Law and order machinery is working in a lax manner and there is only a " pass The buck" approach.
    Indians are in a state of bewilderment. The only hope now seems change in the central regime with someone honest, bold and result-oriented to hold the reins.
    • Atul Paradkar
    • Vice President, CoStrategix
    Indian politics has been the same for years. So I am not sure how much of it is to blame. I think main problem is the US economy, as most foreign investors are bringing back the money to US.

    Onions - I don't know why this question even was asked as this is not the first time the prices have soared.
    • Tim
    • Dir-Expansion, HFS
    As always, too many fancy words.
    Facts are that India has underlying issue's that are being papered over or patched up without underlying causes being addressed.
    Corruption and lack of transparency is at the helm of this, from top to bottom and vice versa.
    Beware, the Arab Spring should be a wake up call.
    • Ravindranath Dudwadkar
    • accountant, Think whynot Integrated commu Pvt Ltd
    You gave answer perfectly right,but along with demand supply is not taken care of
    as every city knows how much truck of vegetables,/Onion,rice required per day
    he govt has that date they can distribute to the farmers
    to produce to that extend with lead time to produce& farmers can even produce more that can be exported thru
    govt. so price can be controlled & more productivity enhancement for regular supply monitoring can reduce
    price& inflation