India’s 9% Growth Is A Crisis In Slow Motion

Listening to Indian officials explain how they plan to cap a surging debt load, it’s hard not to be transported back to the Japan of 20 years ago.

The basic—and failed—strategy of then-Japanese Prime Minister Junichiro Koizumi is precisely the one current Indian Narendra Modi is embracing: growing the economy’s way out of debt.

How did that ploy work out for Tokyo? Dismally. In 2001, when Koizumi rose to the premiership, Japan’s ratio of debt to gross domestic product was 104%. At the time, Koizumi spelled out an ambitious plan to curtail public-works spending, the ultimate political boondoggle.

Koizumi proposed a roughly 27% cut in wasteful construction aimed more about juicing GDP than improving Japan’s already world-class infrastructure over five years. Such efforts explain why, to this day, Koizumi stands out as the most important Japanese economic disruptor in decades.

With his “no reform without sacred cows” mantra, Koizumi engineered the privatization of the sprawling Japan Post, which included the world’s biggest savings bank with trillions of dollars in assets. It was pork-barrel central, where wayward politicians went to fund pet projects in home districts: giant dams; bridges to nowhere; commuter train lines few used; white-elephant stadiums and museums; repaving pristine highways everywhere.

This obsession with concrete economics to create jobs left Japan with an unsustainable debt load, particularly in the 1990s. After the 1980s “bubble economy” went awry, Tokyo borrowed and borrowed—and borrowed—to boost GDP.

And then Koizumi’s reform push went awry. Though Koizumi’s team succeeded in prodding banks to dispose of bad loans, his government pivoted back to increased government borrowing. Even Koizumi bought into the canard that a giant economy can grow its way back to fiscal sobriety. So did every one of his predecessors since 2006. That’s why today, Japan’s debt-to-GDP ratio is about 256%, a more than 146% increase from what Koizumi started with.

This leads us back to Modi-era India. Modi’s team is, sadly, reading its own press highlighting the likelihood of 9% growth in 2022. Moody’s Investors Service, for example, sees India expanding 9.1%. While down from an earlier 9.5% forecast, Moody’s analysts still have Modi’s economy blowing away China’s hopes of growing 5.5%.

That outperformance despite Covid-19, global inflation and supply-chain stumbles and Russia-Ukraine uncertainty is clearly going to Modi’s head. Last month, Finance Minister Nirmala Sitharaman pledged to spend big to fulfill Modi’s grand ambitions. At the same time, India targeted a sharply lower budget deficit of 6.4% of GDP in the fiscal year beginning April 1.

This alone seems fanciful, considering the previous year’s 9.3% deficit. How does New Delhi plan to keep credit rating analysts from pouncing as debt rises? You guessed it, booming growth that papers over all manner of fiscal sins. The idea being that Modi’s team will linearly focus on paying down debt with the expected boom in government tax receipts.

And who knows, perhaps India will succeed even as the pandemic’s fallout on poverty rates necessitates even bigger public safety nets.

But ask today’s Japanese Prime Minister Fumio Kishida how the nine previous governments who placed the same bet as Modi fared? At about $12.5 trillion, Tokyo’s debt load is more than three times the size of Germany’s annual GDP. Or ask President Joe Biden as the U.S. national debt tops $30 trillion.

The good news is that India is acting to head off a bigger bad-loan crisis. In June 2021, New Delhi set up a “bad” bank project. The role of the National Asset Reconstruction Co. Ltd., or NARCL, is to remove the globe’s biggest piles of non-performing loans from bank balance sheets to accelerate lending.

At the time, officials were targeting roughly $27 billion, about one quarter of India’s soured loans. Yet as Japan reminds us, governments delving into the opaque lending practices of banks under pressure often find themselves having to add a zero to such tallies. The longer these crises drag on, the more they hit national growth and the more they squander its benefits.

Surely, 9.1% growth is a great thing for India to have. The same with the somewhat more muted 8.5% GDP range India’s government is circulating. But unless Modi’s team creates a clear and transparent mechanism to ensure a sizable ratio of revenue increases goes toward deficit reduction, no exceptions, India’s grow-your-way-out-of-debt strategy will end in tears.

There are no guarantees that 2022 assumptions won’t go sideways. China could slow sharply. The Federal Reserve’s tightening cycle could upend emerging markets. Fallout from Russia’s Ukraine war could widen. The cheap Russian oil Modi’s cozying up to Vladimir Putin might score in the short run could damage India’s global standing in the longer run.

Debt reduction isn’t a given. It takes a real and nuanced plan–not just big GDP numbers. Ten Japanese governments over two decades can provide Team Modi with cautionary tales galore. Unless India acts boldly, today’s 9% may sow the seeds for its own huge debt reckoning. And soon.