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

Bollywood Is More Popular Than Hollywood

Text reads: "facts about India's economy: india has a mixed economy; half of the workers rely on agriculture; the cost of living is lower than in the U.S.; the indian middle class is bigger than the U.S. middle class; it's an attractive country for outsourcing, such as call centers; bollywood contributes billions to india's GDP"

Image by Michela Buttignol © The Balance 2020

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 $23.2 trillion, the European Union with $20.9 trillion, and the United States with $19.4 trillion.

India had rapid growth despite the Great Recession. It grew 6.8% in 2018, 7.2% in 2017, and 8.2% in 2016. From 2008 through 2014, it grew between 3% and 8.5%. That phenomenal growth rate reduced poverty by nearly 10% in the 2010s.

On May 23, 2019, Prime Minister Nahrendra Modi won relection. He was initially elected on May 16, 2014, ending 30 years of leadership by a coalition government that included the party once 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 over 7%. 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 subsidiary languages. Many Indians speak it. This, combined with the high level of education and the wage differential, attracts U.S. technology and call centers to India. It's hard to quantify how many jobs have been lost to outsourcing, and estimates range from 104,000 to 700,000.
  4. 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. Many people leave the rural areas to live in the cities. Most of them are young and educated. They seek a higher quality of life. The level of urbanization reached 34% in 2018.
  5. The profitable Indian film industry is called "Bollywood." It's a portmanteau of Bombay, now called Mumbai, and Hollywood. Bollywood makes more than 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. For example, when the Federal Reserve began its quantitative easing program, the value of India's rupee fell. The resulting inflation forced India's central bank to raise its interest rates. This action slowed India's economic growth, eventually resulting in what some called mild stagflation in 2013. It had 10.9% inflation for the year and a growth rate of 6.4%. 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 surged 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. In July 2019, the city of Chennai ran out of groundwater. Over 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.

The Indus River depends on water from the Hindu Kush-Himalaya glaciers. If nothing is done to reduce greenhouse gases, studies estimate that anywhere from 35 to 94% will melt by 2100.

Sea level rise threatens India's 4,660 miles of coastline. It threatens megalopolises like Mumbai, Chennai, and Kolkata, which are home to over 48 million people. Many of these cities are built on landfill. In Mumbai, seawater spills onto the main oceanside promenade during high tide.

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, such as exploding nuclear devices.

India wants to be treated like the official five nuclear powers: United States, Russia, Britain, France and China. The United States wanted India to cap its production of fissile material, which consists of highly enriched uranium and plutonium. But India has refused and continues to build its arsenal. Although it has not released official figures, experts estimate that they currently have 130 to 140.

Some worried that the bending-the-rules for India looked 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 two countries have continued to deepen their partnership, with an emphasis 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. China has high-tech while India 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 visa issues, though these might be improving. These disputes will not be solved by one friendly free 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 may be 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 2016. He raised interest rates and promised to deregulate India's currency, the rupee, by easing banking regulations. He forced banks to perform asset quality reviews and write down bad loans with the goal of freeing up their capital to invest in healthy new ventures.

Rajan is most noted for warning central bankers about the 2008 financial crisis. In 2005, he 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.

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