India's Economy, Its Challenges, Opportunities, and Impact

Bollywood Is More Popular Than Hollywood

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••• Photo by Kevin Frayer/Getty Images

India is the world's fourth-largest economy. It produced $9.4 trillion in goods and services in 2017. But it has a long way to go to beat the top three: China, with a production worth $23.1 trillion, the European Union with $19.9 trillion, and the United States with $17.4 trillion.

India had rapid growth despite the Great Recession. It grew 6.7% in 2017, 7.1% in 2016 and 8% in 2015. From 2008 through 2014, it grew between 5% and 11%. That phenomenal growth rate has reduced poverty by 10% in the last decade. 

Prime Minister Nahrendra Modi is facing relection. He was elected on May 16, 2014, ending 60 years of leadership by the party led by Mahatma Gandhi. Mr. Modi, a successful businessman, promised to reduce bureaucracy and regulation, greenlight infrastructure projects, and simplify the tax code. 

Opponents say he has not fulfilled his campaign pledges. Although growth rates were greater than 6% between 2014 and 2017, unemployment is still 8.5%. The government-owned banks had bad debt that reduced their ability to lend. The rupee declined through 2016, allowing 3.6% inflation. A goods and services tax was unpopular.

What Type of Economy Is India?

India has a mixed economy. Half of India's workers rely on agriculture, the signature of a traditional economy. One-third of its workers are employed by the services industry, which contributes two-thirds of India's output. The productivity of this segment is made possible by India's shift toward a market economy. Since the 1990s, India has deregulated several industries. It's privatized many state-owned enterprises, and opened doors to foreign direct investment.

India's Strengths

India is an attractive country for outsourcing and a cheap source of imports. Its economy has these five comparative advantages:

  1. The cost of living is lower than in the United States. Its gross domestic product per capita is $7,200, half that of China or Brazil. This is an advantage because Indian workers don't need as much income since everything costs less.
  2. India has many well-educated technology workers. 
  3. English is one of India’s official languages. Many Indians speak it. This, combined with the high level of education, attracts U.S. technology and call centers to India. For example, an Indian call center employee only costs $12 per hour. That's almost half the American counterpart of $20 an hour. According to the Technology Manufacturing Corporation, more than 250,000 call center jobs, as a result, were outsourced to India and the Philippines between 2001 and 2003.
  1. India’s 1.3 billion people come from a wide range of economic and cultural backgrounds. This diversity can be a strength or a challenge. Socioeconomic status is largely determined by geography. India’s three main regions each have distinct class and education divisions. Annually, 11 million people leave the rural areas to live in the cities. Most of them are young and educated. They seek a higher quality of life.
  2. The profitable Indian film industry is called "Bollywood." It's a portmanteau of Bombay, now called Mumbai, and Hollywood. Bollywood makes twice the number of movies Hollywood makes. The most popular actor in the world is India's Shah Rukh Khan. In 2016, Bollywood contributed $4.5 billion to India's GDP. It generates less revenue than Hollywood’s $51 billion only because its ticket prices are much lower. On the plus side, Bollywood films cost less to make: $1.5 million on average versus $47.7 million in Hollywood. 

    These comparative advantages mean great opportunities for American business. Foreign direct investment in Indian companies could be very profitable. The Indian middle class is almost 250 million people, bigger than the U.S. middle class. It will continue to drive India's consumer spending and economic growth. 

    In addition to FDI, India has seen more than 100 initial public offerings in the last 18 months. Private equity funding grew in 2012 and 2013, a trend that is expected to continue. Energy, health care, industry, and materials have been the top four sectors. While inbound mergers and acquisitions deals have declined in the last year, outbound deals have increased substantially in the emerging markets in the Middle East, Asia, Africa and South America. These deals are driven by depressed valuations due to the recent recession.

     

    India's Challenges

    Prime Minister Modi is a Hindu nationalist leader. Many blame him for the violence against Muslims while he was governor of India's Western region of Gujarat.

    Modi is up against India's bloated government bureaucracy. That makes the execution of any fiscal or monetary policy difficult. In August 2015, he was blocked from passing a bill to acquire land to promote infrastructure.

    U.S. monetary policy has hurt India’s economy. When the Federal Reserve began its quantitative easing program, the lower interest rates strengthened the value of the dollar. This caused the value of India's rupee to fall. The resulting 9.6% inflation forced India's central bank to raise its interest rates. This action slowed India's economic growth, resulting in mild stagflation in 2013. In the second quarter, it had 9.6% inflation and 0% GDP growth. Inflation was caused by a declining rupee. Slow growth came from contractionary monetary policy to stem inflation.

    By 2017, inflation had slowed to 3.6%. 

    Investors backed off from India and other emerging markets when the U.S. Federal Reserve began tapering its quantitative easing program. When the dollar rose 15% in 2014, it forced the value of the rupee and other emerging market currencies down. 

    Climate change threatens India's attempts to improve its citizens' standard of living. More than 600 million Indians face acute water shortages. Bangalore and New Delhi are two of the 21 cities that could deplete their groundwater in 2020. Around 200,000 people die from contaminated water. By 2030, 40% of the population will have no access to drinking water.

    Most of India's rainwater falls during the four-month monsoon season. It isn't captured efficiently. Climate change will increase flooding from these monsoons. Sea level rise threatens the 4,660 miles of coastline.

    India’s Foreign Relations

    The United States is one of India’s biggest military allies, and China is one of its biggest economic partners. In 2006, the United States agreed to defy the Nuclear Non-Proliferation Treaty by allowing full civil nuclear cooperation with India. This is despite India’s violations of the treaty. They exploded nuclear devices and did not put its program under the International Atomic Energy Agency’s safeguards.

    India wants to be treated like the official five nuclear powers: United States, Russia, Britain, France and China. The United States wants India to cap its production of fissile material, which consists of highly enriched uranium and plutonium. But India has refused. India plans to increase its warheads from 50 to 300 by 2010.

    This bending-the-rules for India looks bad to U.S. allies that agreed to refrain from building nuclear capacity: South Korea, Taiwan, Brazil, Argentina, South Africa, Ukraine, Kazakhstan and Japan. The agreement was part of an overall increase in the business relationship between American companies and India. ​The United States and India should place greater importance on military cooperation, including joint defense exercises and counterterrorism efforts. 

    Modi has promoted closer ties between China and India, two of the world’s largest and fastest growing economies. Because of their tight economic partnership, the countries are often called Chindia. China and India have complementary economies. India has raw materials while China has manufacturing. India has high-tech while China has the businesses and consumers to use them.

    They also have long-standing trade disputes stemming from their common borders and China’s friendliness with India’s enemy, Pakistan. There are few airline routes and many visa delays. These disputes will not be solved by one friendly trade agreement. Both realize the potential advantages of a partnership. A trade agreement is a good first step toward a “Chindia” of some sort.

    With one-third of the world’s people, Chindia could be a tremendous economic powerhouse in the global economy. It could also be a threat to the balance of power in that region. It is in the United States’ best interest to maintain its alliance with India. That will offset the growing power of China in the region.

    Raghuram Rajan

    Raghuram Govind Rajan was the Governor of the Reserve Bank India from September 5, 2013, to September 4, 2016. He raised interest rates and deregulated India's currency, the rupee, by easing banking regulations. He forced banks to write down bad loans. That freed up their capital to invest in healthy new ventures.

    Rajan is most noted for warning central bankers about the 2008 financial crisis. In 2005, pointed out how structural flaws in the economy would lead to a financial crisis. He presented a paper entitled "Has Financial Development Made the World Riskier?" at the annual Economic Policy Symposium of central bankers.

    Rajan found that banks were holding onto derivatives to boost their own profit margins. He warned that, if an unexpected "black swan" event occurred, banks' exposure to these derivatives could cause a crisis similar to the Long-Term Capital Management hedge fund crisis, and for similar reasons. Rajan pointed out, "The interbank market could freeze up, and one could well have a full-blown financial crisis."

    The audience scoffed at his warnings, and then-Harvard University President and economist Lawrence Summers called Rajan a Luddite. But Rajan's prediction was exactly what happened two years later.