India’s Economic Slowdown: The marvel of services-led growth?

Suranjana Nabar-Bhaduri, guest blogger

Recent months have seen public concerns being voiced about the incipient slowdown in the Indian economy. Manufacturing output grew at only 0.1 per cent in April; the Indian rupee has been on a downward spiral since late 2011; exports have fallen; and capital inflows have been inadequate relative to India’s current account deficits. India’s GDP growth has declined to a nine-year low of 6.5 per cent in the financial year 2011-12.

The current situation draws attention to issues surrounding India’s services-led growth development strategy, and its persistent trade and current account deficits. It will hopefully provide a much-needed wake-up call to Indian policy-makers to undertake policies beyond “reforms”. A recent paper emphasizes that India’s services-led growth entails questions of long-run sustainability with respect to its balance of payments (BOP) and has a limited ability to raise the living standards of the population as a whole.

It has been generally argued that India’s earnings from services exports, remittances and capital inflows have helped to sustain current account deficits. Though India is nowhere close to a BOP crisis, the current strategy neglects the constraint imposed by external demand. There is no guarantee that the strong export performance of India’s services can be indefinitely sustained and generate sufficient foreign exchange earnings to finance rising deficits. The slow economic recovery in the US, the economic recession, and the possibility of tighter immigration laws in Europe have the potential to significantly affect India’s exports of services and remittances. Even the potential to significantly increase receipts from the Middle East, another major source of India’s remittances, has narrowed with the slowing down of the oil boom in these countries in the late 1990s and early 2000s and the plateauing out of the Indian diaspora in this region with respect to size and economic scope.

Moreover, short-term inflows such as portfolio investment appreciate the real effective exchange rate and further widen trade and current account deficits. The persistence of large trade deficits can, over time, reduce investor confidence, ultimately resulting in a reversal of inflows and speculative attacks on the domestic currency. The 1994 Mexican peso crisis is an obvious example.

Further, the main drivers of this growth have been services such as business, finance, communications, and software. The ability of these sectors to incorporate workers has been insufficient given the size of the Indian labor force and the fact that a major part of this labor force remains rural and unskilled.

To a large extent, the growth in India’s services exports has been associated with the offshoring process in the developed world. The ability to provide English-speaking workers at relatively lower wages has given India an edge in emerging as the preferred choice for offshoring. In this sense, the success of the services-led strategy has depended on relatively lower wages in the Indian call centers, which facilitates lower prices for those services in the developed countries. Thus, technological improvements in the software and telecommunications industries that have allowed for the expansion of the service sector have not remained in India in the form of higher wages.

This inability of services-led growth to address the unemployment problem and to lead to a significant increase in the size of the domestic market especially makes the sharp slowdown of the Indian manufacturing sector a serious cause for concern. So far, the policy response to these economic problems has been myopic and passive, focusing mainly on measures to attract short-term capital inflows.

If anything, the current situation reinforces a strong need for proactive efforts to be directed towards more research and development programs (through public-private partnerships), credit policies that will make it easier for industrial entrepreneurs to replace outdated or inefficient capital equipment, the establishment of more development financial institutions, and subsidies to firms for investing in R&D. Public investment and government procurement policies should be directed to the increase of well-paid, high-productivity jobs that reduce the need for imports, and limit the dependence on low-wage exports, remittances, and volatile capital flows as a way to finance persistent trade and current account deficits. More comprehensive employment generation initiatives through infrastructural development and rural development programs are needed, despite what think-tanks like Morgan Stanley say.

Promoting the growth of the domestic market in order to raise the living standards of its population without hitting the external constraint should be the goal of India’s development strategy. India should not seek simply to integrate into global markets on the basis of exports of people through a reliance on services exports, implying the exploitation of its workers, for the benefit of global consumers.

Suranjana Nabar-Bhaduri is a post-doctoral fellow at the Frederick S. Pardee Center for the Study of the Longer-Range Future at Boston University.

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