India's Economy: Managing the Impact of the Global Economic Crisis and Regaining Momentum

The recent global economic crisis, while damaging for many national economies, caused only a modest downturn in India's; growth declined from pre-crisis averages of 9 percent to 6.7 percent. While much of the world is still struggling to recover, India's economy is strong. Just this week, New Delhi announced that the country enjoyed nearly 9 percent growth over the last quarter. On November 30, the Asia Program hosted an event with Ajay Shankar, the Wilson Center's FICCI Scholar. Shankar, who served in India's Commerce and Industry Ministry during the 2008-09 crisis period and helped craft India's stimulus package, discussed India's economy and how it managed to avoid the worst of the crisis's effects.

Shankar began with some historical context. From the 1950s through the 1970s, India's economy languished. This was because the country embraced a statist economic model that emphasized a strong faith in central planning and government-owned firms. India also refused to open its economy to the world, instead insisting on a policy of autarky and self-reliance. Only in the 1990s, after the country launched a series of reforms, did the economic situation improve. India passed deregulation measures and empowered the country's private sector. It also liberalized trade and opened itself to foreign investment. Such policies were accompanied by "prudent macroeconomic management" that lowered tax rates and contained fiscal deficits.

The positive effects of these reforms began to manifest in the early 2000s. Gross domestic product (GDP) growth rose, fiscal deficits fell, investment rates soared, and trade boomed (in the year before the financial crisis, trade's share of GDP registered at 24 percent). Indian firms invested overseas speedily and prodigiously—including $25 billion in the United States. Conversely, foreign firms' profitability in India went up, with consequent spikes in foreign direct investment (FDI). Another "huge breakthrough," recalled Shankar, was the success of India's manufacturing sector—a critical source of blue-collar jobs. Just before the world economic crisis, India's reserves were valued at about $280 billion. The country's economy appeared both strong and safe.

Given such economic successes, most Indians were not overly concerned as the crisis began to fester in early 2008, reasoning that the country could withstand any shocks. However, once the crisis exploded later in the year, India's vulnerabilities began to emerge. Pre-crisis, Indian capital markets enjoyed heavy investment, with about $20 billion of inflows per year. Yet once the crisis hit, nervous investors began withdrawing their capital, and outflows reached $10 billion. Suddenly, India faced a liquidity crisis.

At this point, Shankar explained, New Delhi began developing its stimulus plan. In an effort to ensure that the final package reflected consensus, the government held daily, in-depth consultations with industry groups across the board. Shankar also emphasized how quickly the government worked: A nation not known for swift decision making formulated and implemented the policy in a span of only several months.

Shankar highlighted some of the stimulus plan's key components. One was a successful government effort to persuade banks to roll over debt obligations for another year. This brought great relief to small business owners. New Delhi also implemented two key measures that had been developed before the crisis. One was a debt write-off program for farmers from around the country, and the other instituted pay raises for public servants. In all these cases, Indians were now in a better position to inject money back into the economy. New Delhi also undertook a variety of small rural development projects—including those involving housing and water provision—that sought to strengthen rural safety nets.

The effects of the stimulus package soon became clear. In addition to rapidly rebounding GDP growth rates, Shankar explained, India's industrial growth increased significantly (from 7 percent in 2009 to double-digit rates in 2010). Furthermore, Shankar noted, India was one of—if not the only—country where FDI maintained momentum throughout the global downturn.

Even while describing India's impressive "growth story," Shankar acknowledged that India's economy is by no means trouble-free. In his closing remarks, he underscored the "critical" challenges that remain—chief among them inflation and the fiscal deficit. Additionally, efficiency in providing public services can stand to improve. Finally, India must attain more "inclusive growth," whereby the country's "backward" areas more fully benefit from India's economic triumphs.

By Michael Kugelman
Robert M. Hathaway, Director, Asia Program