The Banking Executive Magazine - September Issue 2022

The Indian Economic Prospects ronment. China’s economy has slowed. The United States may not be able to avoid recession, and Eu- rope is already in one. So it is not clear whence demand for India’s ex- ports will come. Every Asian econ- omy that has successfully expanded its manufacturing sector has scaled up by exporting, but this avenue may no longer be available to India. The country can of course borrow abroad to finance its current-account deficit and domestic investment. But India continues to underperform as a destination for foreign direct invest- ment, which is deterred by bureau- cratic obstacles to doing business. Having discarded suggestions that it issue dollar bonds, the government now seeks to encourage foreign in- vestors to purchase local currency bonds. But this revised strategy is no less risky. Foreign investors in local currency bonds tend to cut and run at the first sign of trouble, since they otherwise will be hit by the double whammy of falling bond prices and a falling exchange rate. Nor does the government have space to borrow from residents to finance additional spending on the infra- structure, health care, and education needed to sustain long-term eco- nomic growth. General government debt is already 90% of GDP. The pri- mary budget deficit, which excludes interest payments, is 3% of GDP. The government pays an average of 8% interest on its debt. But the authorities are able to keep interest rates at that level, and main- tain a veneer of debt sustainability, only by requiring banks and other in- stitutional investors to hold govern- ment bonds. This in turn limits the banks’ ability to provide essential in- vestment finance to the private sec- tor. Meanwhile, much of what the government takes in as revenue goes to entitlements and interest pay- ments. Additional capital spending will therefore have to come from the private sector. And private savings are low by international standards. Most fundamentally, the government seems to have found it hard to imple- ment structural reforms. Having ex- perienced pushback from vested interests, it has basically taken signif- icant reforms of labor and product markets off the table. Given its favorable demography, democratic polity, and large and di- versified economy, India can in prin- ciple grow at 7% or higher for years to come. But the only route to such growth that remains open runs through structural reforms that relax all of the aforementioned constraints at a stroke. ISSUE 165 SEPTEMBER 2022 the BANKING EXECUTIVE 23