How India Stumbled

When the United Progressive Alliance, a group of center-left parties led by the Indian National Congress, came to power for a second term in 2009, it seemed that India could do no wrong. The economy had sailed through the worst of the global economic recession with GDP growing at a fast seven percent annually and accelerating (it reached 10.4 percent in 2010). Inflation was low, officials were finally starting to take India's social problems seriously, and politics in the world's largest democracy were contentious but robust. The rest of the world was even looking to the country as a serious global power. "India is not simply emerging," U.S. President Barack Obama told the Indian parliament in November 2010; "India has emerged."

Just two years later, however, India's growth is slackening, its national deficit is growing, and inflation is rising after having fallen between early 2010 and early 2012. Plans to build a more inclusive nation are in disarray. Income inequality has risen. According to the economists Laveesh Bhandari and Suryakant Yadav, the urban Gini coefficient (a measure of inequality, with zero indicating absolute equality and one indicating absolute inequality) went from 0.35 in 2005 to 0.65 today. And access to basic services, such as water, health care, and sanitation, remains woefully inadequate. Meanwhile, the country's democracy putters along, but in the absence of leadership, policymaking has ground to a halt. India seems to have gone from a near-sure thing to, as the financial analyst Ruchir Sharma put it in Breakout Nations, a 50-50 bet.

Yet the change in India's economic performance is not nearly as stark as the comparison between 2009 and 2012 suggests. The economy has been troubled all along; all the hype in 2009 disguised a number of real weaknesses. Despite some economic liberalization in the years before, a whole range of regulations still made India a stifling environment for most businesses. In addition, the Indian agricultural sector, which accounts for around 15 percent of the country's GDP and employs about 50 percent of its work force, was a constant cause for worry. Strictures such as tight labor regulations, the inconsistent application of environmental laws, and arbitrary land-acquisition practices made it difficult for producers to respond to any changes in demand. Swings in food prices, a heavy burden on India's poor and farmers, could have thrown the economy into disarray at any time.

That said, the current pessimism about India underestimates some real strengths. Even as a few indicators have soured since 2009, India's household savings rate has stayed above 30 percent (compared with under five percent in the United States). According to India's Central Statistical Office, the country's private consumption rate is around 60 percent (compared with China's 48 percent). These solid figures mean that India's economic ups and downs have neither overtaxed the public, forcing it to dip into its savings to make it through tough economic times, nor dampened its appetite for goods and services quite yet. Indian companies, too, are flush and can rapidly begin to invest in new labor, machinery, or production processes when they believe the timing is right. And for its part, the government still has plenty of room to make tax collection more efficient, so it can finance greater public spending without raising the burden on citizens. Beyond that, one must not discount the optimism among the country's poorest and most marginalized. Growth opened up new opportunities for them, and the correlation between caste and occupation continues to weaken. In addition, they have come to believe in the economic benefits of education and spend extraordinary amounts to send their children to good private schools.

In other words, just as in 2009, India is still fully capable of entering the ranks of world economic heavyweights. The problem, however, is that its politics are getting in the way.

TOO GREAT EXPECTATIONS

In a sense, melancholy about India's economic prospects is the result of miscalibrated expectations. When India's GDP growth surpassed ten percent in 2010, many in India projected that the economy would continue growing just as fast for years to come. And given the steady progress in the fight against poverty, they thought that India would soon be a world-class model for inclusive, high-growth democracy. That hope has dimmed, with the Indian economy's growth rate now projected to be as low as six percent annually. Of course, that is no small achievement by international standards, and expecting ten percent growth was wildly unrealistic to begin with. Still, there is no reason India cannot do better. And its failure to do so has cast a cloud over the country's future.

But the public did have some reasonable economic expectations, too, ones set by the government itself: when Manmohan Singh, now prime minster, served as finance minister in the early 1990s, he spearheaded a number of economic reforms that were supposed to create a new social contract for the country. Under his initiatives, the state would dismantle domestic controls on private enterprise, gradually integrate India into the world economy, rationalize the tax and tariff structures, and provide transparent regulation. The resulting growth, he promised, would benefit everyone. It would expand the country's tax base and lead to a boost in government revenue. Those funds could be spent on health care, education, and improved infrastructure for the poor. Eventually, they, too, would become productive components in India's economic machine.

But India's social contract hasn't panned out as planned. In addition to slowing growth and rising interest rates and inflation, the country has seen the value of the rupee fall by around 20 percent since last summer. The economy can still pick up if the government makes wise policy choices. But New Delhi has yet to indicate how expansionary a monetary policy it is willing to pursue. It seems hesitant to consider the tradeoffs: whether it would like to preside over an economy with six percent annual growth and four percent inflation or one with eight percent growth and eight percent inflation. Eight percent inflation might seem too high to be palatable, but it might be a lesser evil: just to absorb enough new workers into the labor force to keep unemployment levels steady, the Indian economy needs to expand by seven to eight percent each year. Until New Delhi sends a clear signal about its intentions, companies will be hard-pressed to make assumptions about the future and invest the cash they have on hand.

Singh's reforms also suggested that India would become more transparent in its economic policymaking. But one of the most disconcerting developments of the last two years has been the Finance Ministry's backtracking on that commitment. Two recent actions illustrate the trend. First, earlier this year, the government decided to sell shares of the state-owned Oil and Natural Gas Corporation, but there were no real buyers. So in March, it simply coaxed the state-owned Life Insurance Corporation of India into investing in ONGC. The investment raised hackles in the financial community, and Moody's downgraded the Life Insurance Corporation to Baa3 from Baa2. Second, in May, New Delhi decided to retroactively tax the takeover by the British telecommunications company Vodafone of an Indian phone company; the move is still being disputed, but if it goes forward, it could generate between $2 billion and $4 billion. What this measure means for foreign investment has been hotly debated. Such investment does not always depend on transparency and regulatory clarity. China, for example, has been able to paper over its lack of either. But in India, which is not yet quite as economically dynamic as China, many fear that such arbitrary interventions will scare away foreign investment.

Moreover, the government's commitment to a kind of growth that could serve all Indians has been inconsistent. Rather than create a propitious environment for small businesses, which would boost entrepreneurship and add to India's economic dynamism and growth, New Delhi has gone out of its way to make life better for big businesses, granting them access to easy credit, dedicated power plants, and protection against currency fluctuations. That is a problem because India's big-business sectors, such as mining, land development, and infrastructure, are its most corrupt. The government's backing of them has started to erode the public's fragile consensus on capitalism, and the old association of capitalism with corruption has returned.

On the social side, the picture is mixed. India has indeed rolled out a number of entitlement and welfare schemes. The 2005 National Rural Employment Guarantee Act, which guaranteed 100 days of employment per year to at least one member of every rural household, has had the desired effect of raising wages in the countryside. (Although patterns vary across states, a majority of participants in the program are women.) And central government spending on the social sector, including health care and education, has risen from 13.4 percent of the total budget in 2007 to 18.5 percent today. But due to inefficiencies and corruption, much of that money never reaches the targeted beneficiaries. And it is too soon to assess whether the most hailed employment and educational schemes have built the skills people will need for longer-term participation in the economy. Furthermore, most of the initiatives reek of central planning, with New Delhi micromanaging the design 0f each program. States rightly complain that they are not given enough leeway to experiment with the programs in order to tailor them to the particular needs of their constituents.

Some have said that the Indian social contract has broken down entirely. They point to the continued Maoist insurgency in the country's east, farmer protests over government land grabs across India, and the disconcerting phenomenon of farmer suicides. But some historical perspective is in order. According to Devesh Kapur, director of the Center for the Advanced Study of India at the University of Pennsylvania, overall communal violence in India has "plummeted to a tenth of the 2002 level," and "in the last decade all forms of political violence have declined markedly, save one -- Maoist-related violence." Most protesters today realize that they have something to lose if India's economy suffers. And rather than a sign of economic stagnation, many of these uprisings signal that India's rise has created new expectations that New Delhi has yet to meet.

DELHI DEADLOCK

So why hasn't the government been able to fulfill the public's hopes? First, politics in India are deeply fragmented, which makes consensus hard to come by. For example, an important tax reform, the introduction of an integrated goods and services tariff, has been delayed for three years. This national levy would replace various complicated state-level taxation systems, and economists believe that it could boost growth and promote trade. Another example is the haggling over whether to to open up India's retail market to foreign megafirms, such as Walmart. For its part, the Singh administration has said that doing so would create more than three million jobs and could be implemented in a way that did not hurt small local stores. But after announcing a plan in late 2011 to open the sector, the government quickly backtracked because of protest among the opposition, within Singh's own party, and on the street.

Larger than life: a cutout of Rahul Gandhi, Allahabad, India, November 2011 (Jitendra Prakash / Courtesy Reuters)

Second, the authority of politicians has eroded considerably. To be sure, they have done an admirable job of keeping democracy going and improving political access among marginalized groups. But they have also been deeply inefficient and self-serving. The public has grown tired of their mismanagement of India's economy and welfare system. In addition, a series of scandals in 2010 and 2011 -- including the sale of telecommunications licenses to political allies, sweetheart deals for construction contracts, and the granting of real estate development rights allegedly in exchange for incredible sums of money -- called the integrity of a whole range of institutions, from the courts to the army, into question.

The political leadership, instead of recognizing its failures and working to restore moral order, has evaded responsibility. The Indian National Congress' top brass, which includes Singh; Sonia Gandhi, the party's leader; and Rahul Gandhi, Sonia's son and political heir, seldom speak in parliament or give press conferences. When they do, they complain about India's governance problems without acknowledging that they, in fact, are the very center of government. For example, Sonia Gandhi, speaking in November 2010 at the tenth Indira Gandhi Conference, admitted that "graft and greed are on the rise" and lamented that India's "moral universe seems to be shrinking." Her tone indicated that she interpreted these developments as being someone else's problem. Indeed, the Congress' leaders use their offices as relay centers, simply forwarding concerns along rather than taking charge and addressing them. The political vacuum they have created has further eroded public confidence.

The government's favorite scapegoat for the dysfunction is coalition politics. "The difficult decisions we have to make," Singh told parliament in March, "are made even more difficult because we are a coalition government." That means, he continued, that "we have to formulate policy with the need to maintain consensus." There is some truth to what Singh said. The Congress party does not have the numbers to pass legislation on its own. And its alliance partners have routinely opposed important reforms, such as rationalizing energy prices by lifting subsidies for all but the country's poorest, implementing changes to the pension system, and creating a national counterterrorism center. They argue that the moves would trample on states' rights. Of course, just as for the opposition parties, so it is for the Congress party's coalition partners: both gain power and public support if they can show that the Congress is not adept at governing.

Still, India has been governed by coalitions before, and they haven't always had trouble passing difficult legislation. In 2003, parliament, then in the hands of an alliance led by the Hindu nationalist Bharatiya Janata Party (BJP), passed the Fiscal Responsibility and Budget Management Act. The main goal of the legislation was to reduce India's budget deficit to three percent. Whether the bill had a positive outcome is debatable; some argue that it slowed growth in social-sector spending too much. But overall, the act signaled that the government was committed to prudent financial management and, more fundamentally, to governing. The Congress party, especially bad at managing the vagaries of Indian politics, has proved no such thing. And that is at the heart of the current malaise.

THE WEAKEST WINNER

The Congress party is something of a puzzle. It is India's dominant party, electorally competitive in more than 400 of the 545 seats in the directly elected lower house of parliament. It now holds 206 of them -- more than any other party. It has ruled India for 53 out of the 64 years since independence, in 1947. Even so, it fails on a major score: state politics. In India, government often happens at the local level. Most voters never cross paths with central government officials, and thus they form judgments about political parties through their performance in the states.

Yet the Congress rarely fields strong state-level leaders. The party's leaders have historically been suspicious of politicians with independent bases of their own. So rather than letting local leaders emerge organically, the Congress party typically imposes them from afar. In the recent state elections in Uttarakhand, for example, the Congress party nominated Vijay Bahuguna as chief minister above the objections of local legislators. Bahuguna, a Gandhi loyalist, was previously chief minister of another state. There are exceptions to this pattern: for example, Y. S. Rajashekara Reddy, a politician whose populist bent got him elected as chief minister of Andhra Pradesh, one of India's largest states, in 2004. Reddy helped deliver the district to the Congress and skillfully managed local conflicts during his two terms. But when he died, in 2009, the Congress party was left with no local politician to promote.

Beyond such specific problems, the lack of local leadership means that the party is out of touch with grass-roots movements and demands. For example, it has continually misjudged the intensity of the demands by the population of Telangana, a region in Andhra Pradesh, for its own state, since it has not paid attention to local leader's voices. Worse, in April, the party even suspended eight parliamentarians from the region for disrupting the parliament's proceedings by agitating for a new state. Without strong ties to locals, the Congress party is also less able to explain its policy choices to an impatient public. As a result of all these missteps, the Congress is increasingly thrown into complicated alliances with more regionally connected parties.

Democratizing the Congress party could help it overcome its problems -- and India's. Most Indian political parties, the Congress included, have archaic decision-making structures that are controlled by small groups of elites. Their incentives are to service their existing power structures more than their constituents. There are no transparent processes by which decisions are made or party platforms are shaped, which means that there are no real checks on party leaders.

Rahul Gandhi, now the political face of the Congress, has talked up his intentions to democratize the party. He started the process by reforming the Indian Youth Congress, the Congress party's youth wing, of which he became chair in 2007. Since then, he has worked toward what he calls "internal democracy," opening up the group's membership to everyone and holding internal elections with impartial observers present. That is all well and good, but it has had a minimal impact on the rest of the party. For one thing, there has been little change at the top of the Congress party, where loyalty to the Gandhi family is rewarded more than competence.

The lack of democracy within the Congress party is all the more problematic given the little that is known of its soon-to-be leader's governing philosophy. Take, for example, a local's response to one of Rahul Gandhi's speeches in Bihar. As Gandhi pontificated on his pet theme, that there are two Indias, one shining and one increasingly left behind, a journalist asked a farmer in the audience for a reaction. The farmer replied, "For 50 years they have ruled, and now they say there are two Indias. If we give them five years more, they will come and tell us there are three Indias!" Gandhi and his party seem to assume that the two Indias in his story are unconnected. In fact, economic growth has given the state the resources it needs to address inequality. It is New Delhi's failure to use those resources to do so that has caused so much public distress. Gandhi and the Congress party cannot rescue India from its malaise by pointing out problems; they have to demonstrate actual achievement.

YOU SAY YOU WANT A REVOLUTION?

To be fair to the Congress, India is undergoing a broad reformation of its political culture that any party would struggle to manage. Until recently, Indian politicians and bureaucrats all shared four basic management principles -- vertical accountability, wide discretion, secrecy, and centralization -- all of which made for a government that was representative but not responsive. Today, these principles are becoming obsolete.

In the past, vertical accountability meant that any official in the state was largely accountable to his or her superiors, not to citizens or other institutional actors. But now, government institutions such as the Supreme Court of India and the Office of the Comptroller and Auditor General are starting to exert more horizontal control, partly because there is a such a dearth of leadership at the center. The media, too, have become more powerful than they once were, as the number of television channels has expanded. Government functionaries are less and less able to act as if their superiors are the only people they must answer to.

No government can function without a range of discretionary powers. What matters is how governments justify the use of such powers to constituencies affected by their decisions. India's officials, preoccupied with keeping their superiors happy, have seldom seen fit to explain anything to the public. Take the recent scandal over the government's sale of millions of dollars' worth of cell-phone spectrum to politically connected companies. Indians were not only shocked by the magnitude of the deal; they were also outraged by the fact that the government never even tried to justify its decision not to auction the licenses. In the wake of that debacle, there is immense pressure on New Delhi to publicly record the reasons for its moves.

The Indian government has also historically used secrecy to hold on to power. In the past, the public could not easily access information of any kind: government files, statistics, explanations of procedures. Opacity made it hard for citizens to hold the state accountable and was the foundation of state power. That has changed dramatically. The current government's single greatest achievement in its first term was passing, in 2005, the Right to Information Act. This act gave citizens the right to request information from any public authority, which is required by law to reply within 30 days. The bill was the brainchild of Aruna Roy, a social activist, and had the full support of Sonia Gandhi, often against the wishes of other politicians in her party. Now, civil-society groups are able to challenge New Delhi and local governments on a whole range of issues, from corruption to the environmental impact of industrial policies. Many in government claim that New Delhi's paralysis is due to the fact that any new policy or reform is challenged at every turn and in every forum.

Finally, power in India is more decentralized than ever. In small steps, more functions are being transferred to local governments. For example, the program of the National Rural Employment Guarantee Act is administered by village councils, which can decide what projects to pursue and better ensure that workers actually show up to the job sites. But many procedures, including the yearly financial allocations of the central government's Planning Commission, which develops five-year economic plans for the country, do not take this new reality into account, causing conflict and tension along the way.

The evolution of India's traditional culture of governance has yet to work itself out. This is a process long in the making, and it will go on for some time. No one in the political class, not in the Congress or in the BJP, has quite figured out how to harness it. For its part, the Congress party will have to make drastic changes, first by putting a greater premium on performance and by purging a whole range of committee members and cabinet ministers. The party has a sufficiently centralized structure to be able to switch course swiftly, if it so decides. Second, it needs to restore authority to the office of the prime minister. Real power now lies in the hands of the Gandhi family. But on the books at least, Singh is the one tasked with the responsibility for governance. In other words, when something goes wrong, the wrong actor is held accountable. Singh is called ineffective while the real power brokers carry on.

The silver lining for the Congress is that the BJP is struggling with succession and organizational issues of its own. The BJP chapters in Karnataka and Rajasthan are in open revolt against the central leadership and may well defect. And recently, the party has not been able to articulate a coherent ideology. The next major face-off between the Congress party and the BJP will be the general elections in 2014, which is still a long way off. The side that understands that India is fundamentally changing and that old modes of governance no longer work will have the best chance of winning.

India's economic future depends on the country's politics, and that is both good and bad news. True, India's politics will often be mired in brinkmanship and inefficiency. But Indian politicians have a remarkable capacity for reinvention. They can rapidly change course when need be, and there is nothing like a crisis to concentrate their minds. It is difficult to imagine that the entrepreneurship India has unleashed, the growing strength of its civil society, and the sense of hope among India's poor for a better future will remain stymied for long. The anxiety among India's politicians is, in part, a recognition that something new is taking shape.