The Elephant and The Dragon
Until two years ago, most participants in international seminars on Asia’s economic performance presumed that the western reaches of the continent ended with Thailand. With its seemingly listless performance, India was outside the pale of the Asian growth discourse. China was the cynosure of all eyes, romping along as it did year after year at over 9% growth.
Perceptions changed in late 2003, when it became apparent that for the first time since the advent of economic reforms in 1991 the country would be achieving over 8% growth. The developed world was seeking an alternate growth pole to China, and the prospects of over a billion strong, democratic, multi-cultural, youth dominated federal nation gearing up for knowledge-driven 8%-9% growth was an attractive proposition indeed. Released in October 2003, Goldman Sach’s now famous BRICs Report (Brazil, Russia, India and China) upped the ante by forecasting that a modestly but steadily growing India would overtake Italy in 2016, France in 2019, UK in 2022, Germany in 2023 and Japan in 2032; New York Times’ columnist Thomas Friedman’s book, The World Is Flat, released in April 2005, did the rest.
Until 2001, there were occasional international write-ups on N.R. Narayana Murthy of Infosys, Azim Premji of Wipro, Ratan Tata of the Tata group of companies and the Ambanis of Reliance. By 2005, this group had expanded to accommodate others such as Nandan Nilekani of Infosys, S. Ramadorai of TCS, Sunil Mittal of Bharti Televentures, Naresh Goyal of Jet Airways, Dr. K. Anji Reddy of Dr. Reddy’s Laboratories, K.V. Kamath of ICICI Bank, Deepak Parekh of HDFC, Kiran Mazumdar-Shaw of Biocon, Kumar Managalam Birla of the A.V. Birla group, Anand Mahindra of M&M, Baba Kalyani of Bharat Forge, to name some. Suddenly, Indian corporates captured attention; and with them, the country.
Growth and Macroeconomics
Given the hyperbole — downbeat until 2002 and highly upbeat thereafter — it is difficult to get a balanced view of the current state of economics and realistic future prospects for the country, not only in its own terms but also in comparison with China. It is important to begin with growth, not for the past few good years but over a longer period. From fiscal year 1993-94 up to 2005-06 (which comes to an end on 31 March 2006), India has achieved a compound annual real GDP growth rate of 6.2%. As Chart A shows, even in its worst years, India grew faster than the USA and quite a bit more than the Euro zone; and barring 2000-01, which was a poor year of the economy, India grew significantly faster than Brazil.
In fact, with a single exception, no country in the world whose national income exceeded India’s in 2004-05 has grown faster than the Indian average of 6.2% per year over the past thirteen years. The solitary exception, of course, has been China. As Chart A depicts so clearly, even in its best year — 2003-04, when GDP grew by 8.5% — India did not grow faster than China.
Two aspects about India’s growth need emphasising. First, the country seems to be less dependent upon the vicissitudes of monsoon and agriculture swings. In the 1970s and 1980s, a year of bad monsoons invariably led to significantly lower overall growth. That has changed. Between 1993-94 and the current fiscal year, agriculture posted negative growth in three years and negligible growth in another three. Yet, it hardly affected the fortunes of industry and services. The explanation lies in the steady decline in the share of agriculture in GDP — from 42% in 1980-81 to around 22% today.
The second feature has been the phenomenal increase of services. In 1993-94, value added from services accounted for less than 43% of India’s GDP. Since then, its share has grown steadily to around 52%. Chart B shows that, barring two early years, services have consistently grown faster than GDP. In fact, for 10 of the 13 years, services grew at rates higher than 7%, and for seven at above 8%.
Given India’s strides in software, services growth has been often equated with information technology (IT). There is no doubt that IT has shown spectacular double-digit growth in the last decade, and will continue increasing by more than 25% per annum over the next seven to eight years. However, the country’s growth of services goes far beyond IT. India’s nominal GDP for 2005-06 will exceed US$800 billion, of which services will account for about US$420 billion; the most optimistic estimate of IT and IT-enabled services is under US$40 billion. Services, therefore, are much more than IT. India has witnessed impressive growth in communications, hotels, restaurants, tourism, entertainment, finance, insurance and real estate. Growth of each of these is an outcome of liberalisation that has finally freed India’s latent entrepreneurial talents.
There is, however, a problem with India’s huge preponderance of services (52% of GDP) and a significantly lower weight of industry (around 26%). Each Asian tiger grew through manufacturing and industries. Services growth came later. Even today, South Korea with a per capita GDP which is 22 times that of India’s has an industrial sector that accounts for over 40% of its GDP; with seven times India’s per capita GDP, Malaysia’s share of industry is 48%; and China, whose per capita GDP is more than double that of India’s, has an industrial sector comprising over 50% of its GDP.
For a country of over 1.1 billion people and a per capita income of around US$730, India has a very lop-sided distribution of value added between industry and services. This has implications for future growth. To significantly reduce mass poverty, India will have to move to a steady growth of around 8% per annum over the next 10 to15 years. That requires the industrial sector to grow at over 11% per year, and so increase the share of industry to GDP from 26% to around 33%. It is a task that requires much greater focus on building better infrastructure and creating a far more enabling investment climate.
As far as foreign currency reserves go, at over US$145 billion, India has more than enough to cover 15 months of imports. Of course, this looks small compared to over US$700 billion of China’s. But beyond a point accumulating reserves means nothing; its what you do with it that counts. Inflation, too, while marginally higher than China’s — under 4% for India versus 2% for China — is not a threat to growth.
India’s most obvious macroeconomic hazard is its fiscal deficit. At over 8% of GDP, India’s aggregate federal and state government deficit is too large and too persistent for comfort. Although interest rates are still quite reasonable thanks to a steady increase in foreign capital inflows, this deficit is seriously worrisome on at least three counts. The first has to do with the size of the country’s overall public debt. Today, it stands at over 80% of GDP compared to under 30% for China. Second, these deficits don’t build infrastructure but largely finance unproductive government consumption — wages, salaries and pensions of a huge bureaucracy, costly subsidies and, of course, interest payments on past debt. Third, and most significantly, the deficits are acutely constraining federal and state governments from building infrastructure. For all the talk of greater private-public partnerships, the reality is that for most countries with per capita income under US$1,500, the bulk of infrastructure financing has come from public expenditure, and not private investments. It is difficult to imagine well heeled investors immediately lining up in New Delhi and state capitals to participate in rural irrigation, village roads, state highways or the supply of drinking water. The investment needs are huge, and can hardly be funded by a cash strapped government. Therefore, a strong fiscal correction is a must, and cannot be postponed any longer.
The dreaded I-word
Anyone even casually familiar with today’s India will affirm the terrible state of the country’s physical infrastructure — an area where it lags woefully behind China. India’s airports are among the worst in Asia, with their inadequacies even more exposed by the huge growth in domestic and international air traffic. Forget comparisons with Changi, Kuala Lumpur or Hong Kong. The ‘best’ Indian airport, if such a word is at all permissible, is way worse than Bangkok, Pudong, Jakarta or Manila. There is droll joke which says it all: Mumbai’s Sahar Airport exists for the sole purpose of making Delhi’s Indira Gandhi Airport look better.
Despite some improvements in recent years, India’s ports are still inefficient and are simultaneously underutilised and congested thanks to inadequate transport linkages. Poor port infrastructure is the major reason why India’s lead-time for an export consignment to the US is anywhere between 7 and 12 weeks, while China’s is between 3 and 4.
While in recent years there has been some focus on modernising highways, India has a long way to go compared to China. Only 22% of the 65,500 km of national highways have been earmarked for 4-lane or 6-lane modernisation, of which less than half has actually been upgraded. The remainder plus an additional 137,000 km of state highways are in terrible shape. The total investment in the much talked about 5,850 km Golden Quadrilateral linking Delhi, Mumbai, Bangalore, Chennai and Kolkata will be about US$16 billion over a period of almost eight years. In contrast, China has been spending almost US$24 billion year on upgrading its highways.
Electricity supply also leaves much to be desired. India faces a shortfall in excess of 7.5% of energy requirements and over 11% of peak demand. The country is still to have a synchronous national grid. Transmission and distribution have been the perennial choke points — transmission because of inadequate capacity, and distribution because of obsolescence, poor pricing due to extreme cross-subsidisation, inefficiencies, inadequate metering and outright power theft. Not surprisingly, therefore, the cost of power for an industrial user in India is more than twice that of its Chinese counterpart. A 2003 World Bank Investment Climate survey found that 61% of the factories in India had to invest in their own generator sets compared to 27% in China. Even so, Indian manufacturers claimed that over 8% of their output was lost due to power cuts, versus under 2% in China.
The only internationally comparable success story has been telecommunications, especially mobile telephony, Before opening up in 1994, the sector was characterised by underinvestment, outdated technology and limited growth. Today, India has over 115 million subscribers; mobiles exceed fixed lines; and over 1.5 million mobile subscribers are being added every month. Of course, at over 50%, China’s teledensity is way ahead. Nevertheless, India has one of the fastest mobile growth rates in the world as well as the cheapest tariffs — a testimony to the power of competition and an effective consumer-oriented regulatory regime.
The need for investments in infrastructure is huge. An estimate for roads, railways, ports, airports, telecom and power over the next decade is about US$440 billion. Of this, less than two-thirds can be possibly financed by the exchequer and surpluses of some state owned monopolies like oil, natural gas and petroleum. The remaining third will have to be sought from the private sector — be it domestic or foreign investments. Thus, fiscal prudence as well as creating the right investment climate through better public governance are critical to the economic fate of India.
Much of the problem of physical infrastructure is due to outdated procedures, the need for multiple clearances at various levels and the sheer lack of implementation. Irrespective of ideology, India’s political class has recognised that better physical infrastructure is a top priority. Between cognisance and action, however, lies a huge shadow.
Great corporate performance
Despite poor infrastructure, Indian companies have performed excellently, especially over the last four years. A sample of 1,005 listed manufacturing companies which accounted for US$190 billion of sales have shown a steady increase in profitability over the years. For 2004-05, their average operating profit was 15.7% of sales, and post-tax profit 7.9%. These are, without doubt, the best results among all Asian corporates. So, too, is the case for service sector companies: operating profit of 17% of sales and post-tax profit of 9% (see Charts C and D).
Indeed, reforms and globalisation have forced competitiveness within Indian industry — not just in IT, but across many sectors of manufacturing. 1996-2001 saw a large cross-section of manufacturing companies focusing on costs, efficiency, productivity, scale and good old fashioned sweating of machinery to maximise the return on capital employed. This has started paying dividends, not only in terms of higher sales and profits but also in sustained cost efficiencies. Just to give one example, in 1992-93 wages and salaries accounted for over 8% of sales for listed private sector manufacturing companies. Despite rigid labour laws and growth in corporate pay, this share has steadily dropped over the years and, in 2004-05, accounted for under 5%.
Higher sales, excellent margins, coupled with an efficient stock market, good accounting and financial disclosures and what are probably the best corporate governance norms in Asia have played a large part in growing interest of foreign portfolio investors in Indian equity. Between June 2003 and today, cumulative foreign portfolio investment in Indian stocks has increased from US$16 billion to over US$46 billion, or a growth of US$30 billion in two and a half years. The interest in Indian companies continues unabated and, today, India’s market capitalisation accounts for over 80% of its GDP.
Here lies an interesting hypothesis. Indian companies score over the Chinese in terms of profitability, corporate governance, transparency, better accounting standards and superior shareholder returns. These have contributed to stronger international portfolio investment interests in India than in China. The contrast couldn’t be starker when one looks at foreign direct investment. Here, China has routinely rakes in over US$50 billion per year, while India at its very best has managed no more than US$7 billion. Why?
Perhaps the reason is best found in India’s dichotomy between corporate and public governance. The country’s corporate governance in its broadest sense of the term is, along with Singapore, the best in Asia and among the best in the world. Thus, Indian corporates attract the attention and risk capital of foreign portfolio investors. In contrast, the country’s public governance leaves much to be desired. A milieu of complex procedures, multiple clearance needs, needlessly prolonged bureaucratic delays and a civil service that is yet to understand the importance of the opportunity cost of lost time does little to attract foreign direct investment.
And yet, size matters
Nobody doubts the enormous challenges to growth. Infrastructure and fiscal deficit are but two. There are others. By 2020, India will have over 350 million children of school and college going age. How will the nation re-engineer its education system not only to produce many more engineers but also to impart essential vocational training to the vast number of students in rural India so that they too are educationally empowered to seek their place in the work force? Clearly, brick and mortar schools will no longer do. These will have to supplemented by IT-enabled interactive distance education which, in turn, will require investments in electricity as well as broad-band connectivity. By 2020, almost 470 million Indians will live in its towns and cities. How will the country cope with faster urbanisation? The challenges are no less for energy, environment and water.
All said and done, however, it is now a foregone conclusion that India has moved on to a higher growth trajectory. Barring some serious and sustained external shocks, implementing fairly routine reforms should suffice to help the country achieve an average compound annual growth rate of 7% for the next decade. With extremely cautious assumptions, such growth would translate to:
These are large numbers, and they could be larger still. The global investing world is aware of the fact that, barring China, few nations can offer such opportunities. There will be huge scope of growing businesses in infrastructure, in housing, in retail, in financial intermediation, in education, in medical and health care — and increasingly so in the lucrative, yet untapped, high aspirational semi-urban heartland of India. Think of the China opportunities eight to ten years ago. Those are what India offers today.
Could India have achieved 9% plus growth if it less democracy and greater administrative and political control a la Singapore under Lee Kwan Yew? That’s a sterile question. One cannot wish away 58 years of post-colonial history that has created a rich and deep rooted tradition of political voice. India is too heterogeneous and multi-cultural to have the “iron rule of the good”. It needs to let off steam. Democracy is that escape valve. And if the cost of it is a percentage point of GDP growth per year, most Indians will say, “So be it.”
Global investors are not being foolish about their interest in India. After all, they usually put their money where their mouth is. None expect India to rapidly morph from a pachyderm to a jaguar. Everyone is betting on India growing at somewhere between 6.5% and 7% over the next decade and a half. That’s eminently possible. With more concentrated emphasis on implementation and execution and some hard political decisions, the country could even transit to the 7.5%-8.5% range. That’s would be a great bonus.
For the growing tribe of the newly gung-ho Indians, there are two things worth considering. First, the iron law of compound interest. A nation with a GDP half that of China’s and growing at a rate at least 1.5 percentage points less cannot be expected to catch up with the Middle Kingdom. That race is over. China is the clear winner. Equally, however, India will be the second most important power and together, these two nations will be the twin engines of Asia’s growth. That too is a given.
The second has to do with body language. For too long, India was used to being an economic also ran. Suddenly, it has the spotlight. This has unleashed an army of suave English-speaking CEOs, commentators, business association leaders and economists to make scintillatingly persuasive cases for a resurgent India. Much of what they say is true. But the tone is worrisome. It is almost as if the battle has been won.
It has not. With over 250 million people living in abject poverty, India needs to achieve consistently high growth before it can claim success. For a country whose real development race has just begun, it makes good sense to learn from the best of others. That’s what China has done so well. Rarely does a Chinese claim to know all the solutions; rarely does he not want to learn. Humility, not hubris, matters for development. As the spotlight shines on the sub-continent, that’s what Indians need to understand more than anything else. And to follow the good old-fashioned Nike maxim: “Just Do It.”
Published: Far Eastern Economic Review, December 2005