Why this could well be India's moment

In the span of less than a decade, India has gone from being the next great growth global story to a basket case in the emerging world. Genuine economic reform piloted by a technocratic tribe of cerebral-types, the creation of entire new industries like offshore outsourcing of IT and other knowledge services and a zeal for frugal innovation ("jugaad" in the vernacular) once caught the attention of investors, country heads and economists alike.

Today, India is rarely spoken of in such adulatory tones. The tailwinds from the economic liberalization of the nineties have run their course and no real substantive reform has picked up the baton so far in this millennium. As the economy has slowed, a meshing of increasingly dangerous strains of populist, identity-based politics and rising youth unemployment have created a potentially explosive mixture that could rekindle the communal tensions of yesteryear which, many would have relegated to India's pre-liberalization history. The economic growth of the past two decades, while impressive, has proven to be massively unequal in nature and this has only served to fuel the agenda of identity-based demagogues who have cleverly exploited a general sense of disillusionment to develop and strengthen their base of followers.

Many would say that India's botched handling of the Covid-19 crisis is the perfect metaphor for all that ails the country -- a clumsy federal structure with little coordination between states which makes nationwide planning highly ineffectual, a rickety governance machinery with poor grassroots level organization and a woeful lack of investment in the most basic of "public goods" like healthcare.

Indeed, Covid-19 has exposed the frailties of India's governance institutions like no other recent calamity has. In the process, it has also dealt a massive body blow to a patient that was already ailing. The banking system which was already tottering from massive infrastructure project delays, crony-lending practices and generally poor governance and underwriting standards is now staring into the abyss. Sovereign downgrades could well take Indian government bonds into "junk" territory before the end of this calendar year. Animal spirits show no signs of returning; with a recovery in the capital investment cycle looking as distant of a prospect as it is ever been and given the utter devastation of the informal services economy through the double blow of demonetization and virus-related lockdowns, it seems like India's economic growth will be anemic for years to come just as its demographic bulge creates a surge in demand for jobs. However, there are reasons to believe that this perfect storm of global and domestic factors which have landed India in a mess are just the medicine or "shock therapy" that the country needs. Provided that the medicine does not too prove so strong as to eventually kill the patient, there are reasons to be hopeful. Here is why:

Necessity is the mother of economic reform: If history is any guide, messy, chaotic democracies like India (Brazil would appear to belong in the same bucket) need big shocks to get them to embark on substantive reform. India's first -- and, some would argue, last -- major reforms came when it had its back to the wall, facing a balance-of-payments crisis in 1991 which led the Congress-led government to embrace liberalization and dismantle the "License Raj" structures of the colonial-era economy and the Soviet style command economy that followed after independence. After years of foot-dragging on key reforms and a slew of pseudo-reforms which prioritized "optics" over substance, the Indian government seems to have suddenly woken from its deep slumber. Talk of labor and land reform, which had all but disappeared, are now doing the rounds again in policy corridors. With the banking system buried under a rising mountain of non-performing loans, a lack of fiscal space to cushion the economy through public spending or stimulus and weak consumer confidence and business sentiment the government has virtually no tools at its disposal to make "quick fixes" to the economic malaise. The time for tinkering at the fringes has gone and I believe the government realizes that. The incumbents in power will have to risk losing their political capital to get painful but necessary structural reforms through. Even Hindu nationalism as a tool of distraction would appear to have run its course given the degree of current economic distress.

China has laid bare its territorial intentions: As I write, Indian and Chinese troops are locked into forward positions high up on the Tibetan plateau. With multiple casualties on each side in a recent flare-up in tensions and India unwilling to accept China's attempts to unilaterally change the status quo with the respect to the LAC ("Line of Actual Control" for the those of you, dear readers, who are not South-Asia experts), this dispute has created a heightened sense of vulnerability in Indian policy and defense circles. There is an acute realization of the fact that, when "push comes to shove", India is actually on its own facing down China on the Himalayan border. Not least because involving the US or another ally there would be tantamount to "internationalization" of the "Kashmir" issue which is very sensitive for India. As hardy or battle-experienced as your forces might be, in the end, the size of the defense wallet matters. Add to that the fact that wars are expensive affairs, particularly for governments that run twin deficits, as India's does. The real vulnerability here for India in protecting its borders, therefore, is economic and China is fully aware of this and wants to capitalize on this weakness, especially as the Indian governments feels hugely pressured to channel public funds into battling the Covid-19 crisis and the economic devastation left in its wake. Add to this the potential impact of an armed conflict with China on India's sovereign risk perception and the consequent spike in government borrowing costs could well send the government finances into a downward spiral and spur inflation down the road. With the power asymmetry growing and China increasingly at logger-heads with the US in a bid to bring all of Asia under its sphere of influence, Chinese belligerence can only be expected to grow over time, not abate. Indian policymakers have come to the uncomfortable realization that territorial integrity cannot be maintained without getting the economy back on track.

China has lost geopolitical goodwill, globally: As adhered to in an earlier article, China is coming out of the Covid-19 crisis, vastly more unpopular than it was going in. China's intentional delays in reporting the virus outbreak to the world and decision to continue operating international flights (even while suspending domestic ones) even while authorities were well aware of the fact that virus was being transmitted from human-to-human have drawn the ire of Western politicians. As millions of people around the world lose their livelihoods -- and their loved ones -- due to the pandemic, there is growing public anger at China and a recognition of how its authoritarian political system was largely to blame for the secrecy around the virus which could have been stopped early in its tracks in a more open society. To add to this, China has sought to capitalize on the fact that many of its geopolitical rivals and neighbors are currently distracted, fighting the contagion and the resulting economic fallout, as evinced in its stepping up of territorial claims in the Himalayas (with India) and in the South China Sea, recently sinking a Vietnamese fishing boat and continuing to build infrastructure on the illegally occupied reefs in the region.

Concurrently, the Covid-19 crisis has exposed just how dependent the world is on China-linked supply chains -- even the world's largest generics drugs producer, India, imports close to 70% of its active ingredients from China. The US and Europe have realized how exposed they are in terms of their dependence on China for basic medical supplies like Personal Protective Equipment (PPE) and how easily this reliance on China could be weaponized by the leadership of an increasingly belligerent China in the event of a territorial spat with the US or its allies. This is likely to result in a concerted drive by the US and Europe to "re-shore" supply chains and build up domestic manufacturing capacity for critical goods.

However, not all of what is sourced by the West from Asia today could practically be manufactured in the West, and this supply chain reconfiguration certainly cannot be achieved overnight. While automation is part of the answer to making this re-shoring drive feasible, entire value chains which are centered around Asia cannot be transplanted overnight to Mexico and Eastern Europe. While South East Asian manufacturing hubs like Vietnam will be obvious choices for a "China plus one" sourcing strategy, India is the only country that can offer scale both in terms of its domestic labor pool as well as domestic market to match China.

With Indian public sentiment also incensed at China's border aggression, calls within India for a boycott of Chinese imports are only growing louder. Some observers might find this notion of a "boycott" laughable given India's unwieldy dependence on imported Chinese wares all the way from smartphones to festive "Diwali" firecrackers and -- rather ironically -- the bullet proof vests that Indian soldiers wear as they stare down their Chinese counterparts, perched up on their celestial Himalayan border outposts. However, the recent cancellation of large Indian government contracts to Chinese infrastructure firms could well be a sign of things to come -- it is not unreasonable to expect that some canny local entrepreneurs will look to capitalize by trying to develop domestic substitutes for imported Chinese wares. Even if this means importing components from China but assembling the products within India, that still amounts to some manufacturing value added within India's borders (versus none previously) which could then catalyze upstream investment in components and parts manufacturing. Emerging Asian sourcing hubs like Vietnam have also entered entire new export sectors like consumer electronics through late-stage assembly operations, all the way downstream in the value chain and this is slowly catalyzing the development up a component supply ecosystem with Samsung now making its LCD screens in the country in addition to assembling a vast portion of its handsets there. This shows that China's current dominance of industry value chains does not mean that other countries cannot compete.

India has an unemployment problem on its hands: India's youth unemployment numbers were ticking up well before Covid-19 hit due to a lack of manufacturing investment (key bottlenecks being the archaic labor and land laws) to absorb the approximately ten million youth entering the workforce each year and also due to a lack of vocational and other training infrastructure to prepare them for higher skilled jobs in the services sector. However, the huge informal services sector still acted like a giant sponge, absorbing surplus labor into some form of gainful employment, even if it meant that it was not common to run into engineering graduates working as baristas. Demonetization and Covid-19 have disproportionately harmed those very types of businesses that constituted this giant "sponge" for mopping up cohorts of formally unemployed youth -- with thousands of restaurants, cafes, street eateries and mom-and-pop retail shops having downed their shutters for good, the government should be worried about a giant class of economically disenfranchised, unemployed youth. Particularly in a country where one's eligibility in marriage is inextricably linked to one's earning ability and where raising a family is critical to social status, a large class of unemployed youth could be explosive for society, as their anger and frustration finds expression through religious or communal ideology or, still worse, in terrorist activity.

The huge expansion in the idle labor force, while dangerous, could present a perfect opportunity for India to capitalize on the other factors above that make it a natural contender for the new workshop of the world. The huge surplus of young labor is likely to keep a lid on factory wages for years to come just as China and parts of Southeast Asia experience acute upward pressure on wages.

For those of you, dear readers, to whom I sound like a hopeless optimist, I will throw in the caveat that while the stars would appear to have aligned for India to be "jolted" out of its economic stupor, I certainly don't think that India's manufacturing ascendancy is preordained. It will take real political will -- and pain -- to capitalize on the confluence of factors we are seeing now that create a unique window of opportunity for India to catapult itself to manufacturing preeminence. It is for India and it's leaders to seize the moment.