To anybody visiting New Delhi during post-Diwali winter, it is as if Apocalypse has set in. Acrid fumes hit your nostrils and people can be seen scurrying around for the safety of indoors to escape the toxic air, wearing face masks. A host of respiratory illnesses lurk around the corner. This is the time schools and colleges in the national capital ask students to take online classes. Private, government and municipal offices allow their staff to work from home. Lesser but similar scenes are enacted in other big cities.
A recent report published in the Lancet points out that no one in India lives in an area where the yearly average pollution levels are below the WHO norms. In fact, the report adds that more than 80 per cent of the Indian population lives in areas where the air quality does not even meet the country’s National Ambient Air Quality Standards of 40 µg/m³ of PM2.5 – higher than the WHO’s recommendation of 5µg/m³. The study’s estimates of deaths due to air pollution are also higher than that of the Global Burden of Disease.
Solutions for such a problem are not always easy – the US and the UK, for instance, took decades to clean up the air, as did China to an extent. But the Modi government’s near-radio silence on this issue has dismayed many, including the normally tight-lipped diplomats.
A Viksit Bharat cannot be built on its people choking on polluted air and dying of heat strokes (as it happened this summer). Or that almost 129 million Indians are living in extreme poverty in 2024, on less than R180 a day (according to the latest World Bank report). Suddenly, the hype is dissipating and warts are becoming visible. A sobering picture is emerging. But clearly, it is not enough to move our policy makers.
The latest GDP numbers are a case in point. Between July and September 2024, the economy slumped to a seven-quarter low of 5.4 per cent, well below the Reserve Bank of India (RBI) forecast of 7 per cent – and perhaps even the worst of North Block’s expectations. While it is still robust, compared with developed nations, the figure signals a slowdown. The world’s fastest-growing big economy is in the news for wrong reasons.
Two major challenges that have emerged in 2024 are stagflation (a mix of low growth and high inflation) and slowing consumption. While pent-up demand from the pandemic years fuelled consumption in recent times, one is now seeing a shift as growth in consumer credit and income levels
has become slow, leading to a moderation in consumption patterns. The government appears clueless on how to tackle this.
Critics have been warning that the ‘hyping up the narrative’ of India as the fastest-growing economy is hindering essential reforms to boost investment, exports and job creation. “We are still a poor country,” says Rajeshwari Sengupta, associate professor, Indira Gandhi Institute of Development Research. “Our per capita GDP is less than $3,000, while the US is at $86,000. If you say we are growing faster than them, it makes no sense at all”.
Indermit Gill, chief economist, World Bank, recently said that middle-income countries, including India, are more prone to slow-down, compared to low-income or high-income countries. India needs to accelerate its structural reforms to transition to a high-income country. He identified three major structural inefficiencies in India’s economy that needed urgent attention: under-utilisation of capital, under-utilisation a major portion of its talent pool, particularly women, and energy efficiency. “Time is of the essence for India to accelerate its structural reforms, and the changes needed are not happening quickly enough,” he added.
Not just the economy, India appears to be losing steam in other areas as well. India’s relations with its neighbours, particularly its ‘Neighbourhood First’ policy, launched with great fanfare by Prime Minister Narendra Modi, are at an all-time low. The situation in Bangladesh, a country where India once enjoyed tremendous goodwill, after the fall of Sheikh Hasina signifies the drift. The government recently had to rush Vikram Misri, foreign secretary, to Dhaka after irate mobs there systematically targeted domicile Hindus and other minorities as well as religious and cultural institutions in recent weeks.
After his meetings, Misri announced that India was keen to work with the current Bangladesh administration headed by Muhammad Yunus, noted economist, to ensure that their differences do not break down ties that directly affect millions of families on both sides of the border. But walking that talk will not be easy.
Both governments face domestic political pressures that they must acknowledge, if they are to rebuild any trust. Given the ruling Bharatiya Janata Party’s politics in India, the attacks on Hindus in Bangladesh make it impossible for New Delhi to not highlight the concerns of religious minorities to Dhaka, though India itself faces global scrutiny for its track record on the protection of minority rights under Modi’s watch.
And sectarianism is not limited to the traditional Hindu-Muslim rifts. The 16-month-old strife in BJP-ruled Manipur between Kuki Christian tribals and Meiti Hindus has claimed more than 220 lives and uprooted over 60,000 – most of them are Christians. But Modi hasn’t visited the state, despite repeated demands. This festering sore has attracted global censure.
Policy paradox
Prime Minister Modi’s tenure has been marked by a paradox in India’s foreign relations. While there has been notable leadership in the Global South and engagement with major powers, relations with immediate neighbours have seen a regression, despite India’s ongoing development partnerships, project acceleration and humanitarian and technical assistance.
The subcontinent is rife with terrorism and insurgency. India’s neighbours are diverse in geography, society, economy, demography and especially politics, with many facing chronic social and political unrest. Their significant disparities in growth, resources, population and size compared to other regions’ neighbours compound these challenges. Modi 3.0’s foreign and security policies were expected to maintain continuity, but there is certainly room for improvement in South Asia. To start with, a more sensitive approach to India’s relations with its neighbours in matters of trade could have fostered better understanding and co-operation, given that the balance of trade is so overwhelmingly tilted in our favour.
Situation building up
Coming back to the economy, the situation had been building up for some time. Consumer demand had weakened, private investment had been sluggish for years and government spending – an essential driver in recent years – had been pulled back. Exports, which have long struggled, with their global share standing at a mere 2 per cent in 2023, weren’t doing too well either. Who is to be blamed for all this?
The Modi government’s inability to stitch together long-pending Free Trade Agreements (FTAs) is being cited as a key factor impeding export gains. In October, the department of commerce announced its decision to take a break from negotiating several such pacts in order to review its extant strategy in respect of these agreements and develop standard operating procedures (SOPs). Though talks with the European Union and the UK are said to be on track, the on-again, off-again negotiations on these two agreements have become a bit of a joke (see box: FTAs in a flux).
Fast-moving consumer goods (FMCG) companies are reporting tepid sales, while salary bills at publicly traded private firms, a proxy for urban wages, shrank last quarter. Even the previously bullish RBI has revised its growth forecast to 6.6 per cent for 2024-25.
RBI’s role
The central bank’s focus on curbing inflation has led to excessively restrictive interest rates, potentially stifling growth. High rates make borrowing more expensive for businesses and consumers, and potentially reduce investments and dampen consumption, both key drivers of economic growth. The RBI has kept interest rates unchanged for nearly two years, primarily because of rising inflation which surged to 6.2 per cent in October, breaching the central bank›s target ceiling (4 per cent) and reaching a 14-month high. It was mainly driven by food prices, comprising half of the consumer price basket – vegetable prices, for example, rose to more than 40 per cent in October. There are also growing signs that food price hikes are now influencing other everyday costs, or core inflation.
Even as calls grow to lower interest rates and boost liquidity, the central bank is propping up a falling rupee by selling dollars, which tightens liquidity. Since October, the RBI has spent $50 billion from its forex reserves to shield the rupee. Buyers must pay in rupees to purchase dollars, which reduces liquidity in the market. Maintaining a strong rupee through interventions reduces competitiveness by making Indian goods more expensive in global markets, leading to lower demand for exports. “Why is the central bank shoring up the rupee?” asks Arvind Subramanian, former economic adviser to the government. “The policy is bad for the economy and exports. Possibly they are doing it because of optics. They don’t want to show India’s currency is weak,” he adds.
But high interest rates alone may not fully explain the slowing growth. “Lowering rates won’t spur growth unless consumption demand is strong,” says Himanshu, development economist, Jawaharlal Nehru University. “Investors borrow and invest only when demand exists, and that’s not the case now”.
But, there will be demand only when there is more growth and jobs – and higher incomes. As of now, the Modi government does not seem to have the magic wand as boosting growth and consumption will not be easy in the short term. Lacking private investment, Himanshu suggests raising wages through government-run employment schemes to increase incomes and spur consumption. Others like Sengupta advocate reducing tariffs and attracting export investments moving away from China to countries like Vietnam.
Among the factors that have led to this situation, over-regulation figures prominently. While checks and balances are necessary, wherever warranted, to run a system smoothly, regulatory overkill can hurt growth.
The central bank has come under criticism for reasons well known. However, it is the RBI’s recent over-regulation of banks that could have unintended consequences. For instance, bankers are sweating over what is likely to be a tough time in the next fiscal year as the RBI is expected to unleash stringent rules, tightening provisioning requirements for project finance, introducing a new expected credit loss framework and imposing a higher liquidity coverage ratio for deposits to hedge against sharp outflows through digital channels. Bankers fear these rules will hurt profitability in the medium term.
Besides, earlier this year there were reports that the RBI has been poking its nose into how the top personnel at banks are being compensated, leading to fears that lenders may flee to greener pastures. Apparently, the banking regulator had asked IDFC First Bank to cut the pay of one of its top executives by 30 per cent. And, similar things are happening at Catholic Syrian Bank and IndusInd Bank too. Even in the case of banking giant HDFC Bank, the RBI had approved the CEO’s performance pay for 2021-22 only a year later.
Should the RBI get involved in such trivial matters? The official explanation is that the root of this issue can be traced back to the 2008 global financial crisis, when it was noted that the compensation practices at large financial institutions are one factor, among many, that contributed to the crisis. High short-term profits led to generous bonus payments to employees without adequate regard for the longer-term risks they imposed on their firms.
Under rules enacted in 2019, the RBI now keeps a watch on the total remuneration paid to bankers. It has told banks to include clawback clauses on bonuses and compensation paid to bankers. This means that past bonuses given to the CEO can be taken back, if some decision they made turn sour later. Such rules in Israel had led to several CEOs leaving banks and insurance companies and moving into industries like construction which were poles apart.
Another regulator, SEBI, has also been accused of selective overkill. Brokerages are being barred for meeting capital adequacy norms. A recent well-publicised case was that of First Overseas Capital, which was barred from taking any new mandate as a lead manager for any public issue of debt securities until further orders for allegedly violating the norms (net worth: Rs5 crore) and merchant bankers’ rules. Not so well publicised, however, is the story of several small brokers, who have been driven out of business.
The market regulator has now proposed a set of new rules to tighten how small and medium enterprises (SMEs) list on the stock exchange, raise money, and handle governance after going public. The focus is on stricter rules for the Offer for Sale mechanism, better monitoring of how IPO funds are used, and stronger protections for investors. The SME platform was launched in 2008 to help smaller businesses raise money more easily. Unlike the Main Board, it was designed to be more flexible and less complex. And it worked – over the past couple of years, the SME segment has grown rapidly. As of October 2024, as many as 745 companies are listed on SME exchanges with a combined market cap of Rs2 lakh crore. In 2023-24, 196 SME IPOs raised over Rs6,000 crore, and 2024-25 is close behind, with 159 IPOs raising Rs5,700 crore by October. The rapid growth of SME IPOs could not get stalled.
Low urban demand
Economists point out that, despite record-high retail credit and rising unsecured loans, indicating that people are borrowing to finance consumption even amidst high rates, urban demand is weakening. Rural demand is a brighter spot, benefiting from a good monsoon and higher food prices.
Some economists believe that the ongoing crisis was borne out by the fact that India’s economy was operating on a ‘two-speed trajectory’, driven by diverging performances in its ‘old economy and new economy’.
The old economy comprising the vast informal sector, including medium and small-scale industries, agriculture and traditional corporate sector, is still waiting for long-pending reforms. In contrast, the new economy, defined by the boom in services exports post-Covid, experienced robust growth in 2022-23. Outsourcing 2.0 has been a key driver, with India emerging as the world’s largest hub for global capability centres, which perform high-end offshore service work. According to Deloitte, a consulting firm, over 50 per cent of the world’s GCCs are now based in India. These centres focus on R&D, engineering design and consulting services, generating $46 billion in revenue and employing up to 2 million highly skilled workers.
Offshore services boom
“This influx of GCCs fuelled urban consumption by supporting demand for luxury goods, real estate and SUVs. For 2-2.5 years post-pandemic, this drove a surge in urban spending. With GCCs largely established and consumption patterns shifting, the urban spending lift is fading,” says Sengupta.
So, the old economy appears to lack a growth catalyst while the new economy slows. Private investment is crucial, but without strong consumption demand, firms will not invest. Without investment to create jobs and boost incomes, consumption demand cannot recover. It’s a vicious cycle, so to speak.
There are other confusing signals as well. Our average tariffs have risen from 5 per cent in 2013-14 to 17 per cent now, higher than Asian peers trading with the US. In a world of global value chains, where exporters rely on imports from multiple countries, high tariffs make goods more expensive for companies to trade, making it harder for them to compete in global markets.
The government, however, remains upbeat over the India story: banks are strong, forex reserves are robust, finances stable and extreme poverty has declined. V Anantha Nageswaran, chief economic adviser, says the latest GDP figure should not be over-interpreted. “We should not throw the baby out with the bathwater, as the underlying growth story remains intact,” he said recently.
Government optimistic
Indeed, the government continues to paint a bright picture. Shaktikanta Das, RBI’s outgoing governor, believes India’s “growth story remains intact”, adding the “balance between inflation and growth is well poised”. Nirmala Sitharaman, finance minister, asserts that the decline was ‘not systemic,’ but a result of reducing government spending during an election-focussed quarter. She expects third-quarter growth to offset the recent decline. India will probably remain the fastest-growing major economy despite challenges like stagnant wages affecting domestic consumption, slowing global demand and climate disruptions in agriculture, she adds.
Such optimism aside, clearly the pace of growth could do with some picking up. And the government could do well to get its act together in other areas, including the long-pending reforms. But a government on 24x7 election mode may find that difficult. That is why scepticism lingers. “There’s no nation as ambitious for so long without taking (adequate) steps to fulfil that ambition,” sums up Sengupta.
BOX-1
Neighbourhood failure
The recent overthrow of Sheikh Hasina’s government in Bangladesh, the installation of an interim government led by Nobel Laureate Muhammad Yunus and the anti-Hindu rampage that one witnessed there have raised serious questions about the durability of India’s relations with its neighbours. India’s ‘Neighbourhood First’ policy, launched with great fanfare by Prime Minister Narendra Modi, has failed to yield the desired results. Instead, the country has seen five of its allies drift closer to China in the past decade. External Affairs Minister S. Jaishankar has rejected suggestions that India’s foreign policy is failing, but the reality on the ground suggests otherwise.
India’s relations with its immediate neighbours, including Pakistan, Nepal, the Maldives, Bhutan, Sri Lanka and now Bangladesh, have faced significant challenges in the last few years. Of these six nations, a regime change has taken place in the Maldives, Nepal, now Bangladesh and Sri Lanka. And, Pakistan went to the elections where Shehbaz Sharif retained power by forming a coalition government.
Of these, the Maldives, Nepal, Pakistan and Bangladesh now have a leadership that is pro-China. Sri Lanka also underwent a regime change following economic crisis. Sri Lanka and Bhutan are maintaining a neutral stance towards China and India.
The rapidly changing situation in Bangladesh has dealt a strategic blow to India, with concerns rising about the potential for Bangladesh to become a hideout for terrorists and infiltration problems in North-Eastern states. Sheikh Hasina’s government in Bangladesh had been a relatively stable partner for India, helping to manage anti-India sentiments and supporting trade and border security. But with Hasina out of power and out on a limb, India now faces uncertainty.
The Bangladesh Nationalist Party (BNP), led by Khlaeda Zia, which had a rocky relationship with India, is likely to be a stakeholder in the new government in Bangladesh once elections are held. In the past, the party has used anti-India rhetoric and policies to harm Indian interests and further its domestic political goals. The ‘India Out’ campaign, which gained steam in Bangladesh was inspired by a similar movement in the Maldives is said to have the backing of the BNP cadres.
This isn’t just about Bangladesh. India’s relationships with several neighbouring countries have taken a hit. In the Maldives, President Mohamed Muizzu had pushed an ‘India Out’ campaign, reflecting growing discontent with Indian influence. He’s even asked India to pull out its military personnel and signed deals with Turkey and China, showing a clear tilt away from India.
Nepal, once a close ally, has also started leaning towards China. This shift is concerning given Nepal’s strategic importance. Relations with Sri Lanka have been shaky too, while the ongoing tensions with Pakistan are no surprise. The Taliban’s rise in Afghanistan has added another layer of complication to India’s regional strategy.
When questioned about India’s foreign policy and the increasing influence of China, Jaishankar acknowledged the competition but seemed to downplay concerns. “There are two realities we must recognise. China is also a neighbouring country and in many ways, will as part of competitive politics, influence these countries (the Maldives, Sri Lanka and Bangladesh).” The minister made this statement in response to a question during a session with students at the Indian Institute of Management (IIM) Mumbai in January this year.
“I don’t think we should be scared of China,” he added. “I think we should say, okay, global politics is a competitive game. You do your best, and I will do my best. China is a major economy, it will deploy resources. It will try and shape things in China’s way. Why should we expect otherwise? But the answer to that is not to complain about what China is doing. The answer is, you are doing it. Let me do better.”
BOX-2
FTAs in a flux
Given the pace of their negotiations, trade experts say that there are two facets of India’s involvement with bilateral trade agreements. First, it is a stop-start approach to FTA negotiations, or absence of consistency. And, secondly, it lacks transparency in the negotiating processes.
“The priorities of the government in each of these FTAs and the benefits that it is seeking to achieve through the formalisation of these agreements have never put in the public domain. All agreements were negotiated/are being negotiated in secrecy,” says Biswajit Dhar, former DG, Research & Information System for Developing Countries, a think-tank of the ministry for external affairs.
The absence of transparency in the process of FTA negotiations, he believes, stands out in contrast to the government’s approach in the WTO negotiations, where it has systematically been putting its negotiating positions in the public domain. This helped facilitate discussions among public interest groups, whose interventions on key issues such as food security and access to affordable medicines are particularly significant. Importantly, arguments presented by these groups have stood the government in good stead during the ensuing negotiations. Given the advantages it has reaped through greater transparency in the WTO, it is difficult to understand why FTAs are still being negotiated in secrecy.
In contrast, some of India’s FTA partners have been forthright in putting their negotiating proposals in the public domain. For instance, the EU had made public its entire negotiating position on the proposed FTA with India soon after the negotiations began, following the India-EU summit in Helsinki, Finland, during the UPA I. This PR blitz continued after negotiations were relaunched in 2022 after a hiatus. The EU has clearly enumerated its stand on issues which have become stocking issues like sustainability regulations, labour standards, deforestation rules and carbon tax.
The UK makes no bones of the fact that it wants greater opportunities in India for its service industries like telecoms, legal services, and banking. It also wants India to cut import duties on goods ranging from meat and chocolate to electric vehicles and Scotch whisky. Scotch whisky is popular in India but makes up just 2 per cent of the market due to the 150 per cent tariff on imported liquor. The Scotch Whisky Association of the UK says that a cut in the import duty could drive sales of up to a billion pounds over the next five years.
A note by the UK’s department of international trade explains the strategic aspect of the deal:
• A UK-India agreement would help to put Global Britain at the heart of the Indo-Pacific region, an area representing over 40 per cent of global GDP and containing some the world’s fastest growing economies. As these economies expand, it is key that the UK has access to their markets.
• The UK’s services exports to India amount to £3.2 billion, while India has an expanding services sector which accounts for 54 per cent of its economy. As the world’s second largest services exporter, the UK can complement Indian growth through its world leading financial, creative, digital, professional and business, and technology services. The UK and India’s financial markets are already interconnected, with 35 Indian companies listed on the London Stock Exchange and an investment relationship which supports over half a million jobs in each other’s economies. A trade agreement could enable further collaboration in these areas by easing cross-border friction and encouraging regulatory alignment, allowing the UK’s financial and professional services businesses to set up shop in India.
• A trade agreement would level up businesses throughout the UK, benefitting small and medium enterprises as well as large-scale UK exporters. In 2019, about 9,900 UK businesses exported goods to India. Given financial and operational constraints, SMEs in particular stand to benefit from the increased transparency and reduced costs an FTA could provide, whilst lower importing costs would lead to the further growth of businesses of all sizes across the UK.
India, on the other hand, is still shy of the fact of fully advertising the fact that Scotch whisky imports might threaten sales of India’s homegrown whisky brands, which have been soaring in recent years!
Last month, the department of commerce announced its decision to take a break from negotiating several FTAs in order to review its extant strategy in respect of these agreements. (This decision will not adversely affect negotiations with partners like the EU and the UK.) The ostensible reasons for the government to press the ‘pause’ button on FTAs are to avoid granting ‘unintended concessions’ to non-members of FTAs, monitoring third-country goods entering India via FTA partners and providing assistance to domestic industries so as to enable them to improve their presence in the markets of the partner countries. The government is also putting in place standard operating procedures for the new FTA strategy. Once the SOPs are adopted, so the government has assured, the process of negotiating new FTAs would be put back on track.
“One of the major learnings from India’s experience with FTAs is that lack of transparency in the negotiating processes have not served the country’s interests well,” Dhar believes. “Adoption of a more transparent process in which the government puts in public domain its negotiating proposals, facilitating effective participation of all stakeholders, needs to be one of the more important elements of the SOPs. Such a step can help avoid imbalances in market access commitments as in the East Asian FTAs, or prevent amendment of the Indian patents act, as has been done in the agreement with the European Free Trade Area (EFTA).”
Going by the narratives created around the FTAs that are either being implemented or are currently being negotiated, it is clear that the negotiating processes of these agreements were fraught with weaknesses. Consequently, soon after the FTA with the Association of Southeast Asian Nations covering the goods sector was implemented, it became obvious that not only had the intended benefits for India in terms of enhanced market access for its products not materialised, but its trade balance was also deteriorating due to consistently rising imports.
Not surprisingly, once the Modi government assumed power, it called for review of existing FTAs, besides putting on hold all the FTAs that were being negotiated by the Congress-led United Progressive Alliance government, with the EU, Canada and Australia.
But, it made one major exception: the Modi government decided to remain engaged with the Regional Comprehensive Economic Partnership (RCEP) negotiations. Throughout the process of RCEP negotiations under pressure, the government appeared oblivious to the travails of several manufacturing industries in the country, which were ill-prepared to face competition from their counterparts from the East Asian region, especially China. The concerns of the Indian industry seem to have been taken on board as India opted out of the RCEP negotiations only in 2019.
However, two years hence, the government announced that it was making a major push on the FTA front by negotiating 13 FTAs, including those that were stalled from 2014. Two of these agreements are being fully implemented – with the UAE and the EFTA comprising Switzerland, Norway, Iceland, and Lichtenstein. The wheel has now come full circle.