State Spending Masks Weakness in Indian Economy

Many Indians have confidence in their economy, but a deeper look reveals impressive GDP numbers come from government spending, not real growth

By Mehul Srivastava

As countries around the world saw their economies crumble in the past year, Indians took solace in the fact that their country had escaped relatively unscathed. With two successive quarters of 5.8% growth, India's economy bested much of the world by expanding 6.7%—a low number for its once red-hot economy, but far better than those of the U.S., Germany and even Japan, who all saw their economies contract. And with optimism growing about a turnaround in the global economy, many Indians are confident that things are looking up.

But don't pop the corks just yet, economists warn. Instead, a deeper look into the Indian figures reveals a worrying trend, they say. Since October, India's economic growth has been mostly buoyed by government spending, not by actual private-sector growth. In the last quarter of 2008, for instance, increased government expenditure made up almost all of India's growth, according to estimates by Singapore-based HSBC (HBC) economist Robert Prior-Wandesforde and by BusinessWeek. Without the government spending, the growth figure would have been a paltry (and stock-market melting) 0.1%.

Between January and March, as the country prepared for nationwide elections and politicians went off to campaign, things were only marginally better. India's gross domestic product would have grown by less than 2% if not for money from previously announced stimulus packages flowing into the economy. "If we take these numbers at face value, the private sector has suffered more than the headline numbers would have suggested," says Prior-Wandesforde. "If we stripped out the government contribution, then the degree by which India outperformed other nations would be much less significant."

To some extent, this trend of increased government spending is true worldwide. Both the U.S. and China, for instance, have announced stimulus packages that are far bigger than India's $50 billion to $80 billion in new spending and tax cuts. (China's stimulus was about $586 billion.) But because India's economy is still relatively small (about $1.1 trillion), and the private sector is still small except for the large, publicly traded companies, the government's role in the economy is much greater than in the U.S. or China. In most years since 2000, spending by India's federal government has made up more than 10% of India's economy; that number has recently shot up to 13%. (China doesn't release data the same way the Indian government does, making such comparisons difficult, says Prior-Wandesforde.)

A Soaring Deficit

One thing India has in common with the U.S.: a budget deficit. (That's much less of a concern for China, with its world-leading stash of foreign reserves.) During this slowdown, the government has announced three different stimulus packages that cost approximately $80 billion, not all of which has been spent so far. New Delhi is also committed to spending approximately $14 billion on a rural loan waiver and a rural employment guarantee, and before his Congress Party won a smashing victory last month in the elections, Prime Minister Manmohan Singh promised to spend more if re-elected. On June 6 the government announced it would provide free and subsidized food to its poor, a program that economists estimate could cost as much as $10 billion.

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