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13 reasons why India can keep booming

February 11, 2004

Given all the hype and hoopla surrounding India in recent days, it is always interesting to read a sceptical report questioning the view that India has arrived. One such report I came across recently was written by the folks at BCA, who published a special report on India.

In the report they basically conclude that despite progress, the current euphoria over the economy and stock markets is unjustified and there is no conclusive evidence to suggest that economic growth in India has entered a 'take-off' stage.

The report specifically compares the growth record of India with China and points out the following:

  • Since 1990 China has been growing at 8.6 per cent per annum , while India has delivered 5.6 per cent.
  • Till 1985, India on a per capita basis was actually wealthier than China, but today China at $1,100 (GDP per capita) is double India's level.
  • In the area of trade, India and China were at roughly the same level of exports/GDP till the mid 1980s, but today China has an export share of nearly 30 per cent compared to 10 per cent for India and accounts for 5.5 per cent of world trade compared to less than 1 per cent for India.
  • Using urbanisation as a proxy for industrial development they point out that in the 1960s, both India and China had over 80 per cent of their population living in rural areas while today in China this is below 60 per cent (despite no improvement till 1978) compared to 70 per cent in India.

The report basically pins the blame for the poor relative record of India, to its economy being the most regulated, protected and subsidised in Asia.

Highlighting valid concerns on the effective tariff rate, fiscal deficit and low domestic savings rate, it makes the case that not enough has been done to fundamentally change India's growth trajectory.

The report also points out that while good things are happening in software and services, the sector is not yet big enough to make a meaningful impact on the whole economy.

It questions how significant is the relocation of service sector jobs to India by multinational corporations when India attracts only $2 billion of foreign direct investment per annum? The authors also point out an interesting correlation between China mania and interest in India.

Pointing out that the Indian market normally does well whenever China fever is high(like today).

It is almost as if having made money in China, investors feel compelled to look for the next big thing, similar to equity investors moving down the quality curve once established stocks have had a big move.

While I do not fully agree with this report, it throws up some interesting questions.

Can India really grow at 7 per cent over the next decade? This is the critical issue in my mind.

We do not have to match China's 8.6 per cent; even near 7 per cent if sustained for a decade and more will be sufficient to transform the economic landscape and deliver 20 per cent per annum corporate earnings growth.

But the question on every sceptic's mind will be why is this not like 1994-97, when the economy delivered three years of 7.5 per cent per annum growth only to stumble thereafter, or 1988-91 when we had three years of 7.6 per cent growth ending in a FX crisis.

There was great hope then also about India having entered a new growth trajectory, but it was not to be. What makes things different this time?

I would like to highlight some differences which I think make this growth phase more sustainable.(I hope).

1. Firstly, unlike the previous boom periods, the significance of software and IT services is far greater today and they alone add more than 0.5 per cent to GDP growth. Their importance will only increase, and we have other sectors like pharmaceuticals, textiles and possibly autos/components poised to replicate the software wave.

2. The importance of agriculture has continued to decline and it now accounts for about 20 per cent of GDP, the drag it places on overall growth is therefore that much lower.

3. The mindset of Indian industry is vastly different today, compared to 1994-97, manufacturing is far more competitive and many companies have the desire, skills and cost structure to go global.

In earlier periods, industry was by and large totally India centric in thought and ambition and had really no idea of their global competitiveness.

Today exports is a viable growth alternative/strategy for many companies effectively multiplying their addressable markets many fold.

4. The financial health of corporate India is far better today, leverage is down, industry is free cash flow positive and interest costs have collapsed. Companies are a lot more disciplined about capital budgeting and capex.

5. The general level of interest rates in the economy is much lower and penetration of retail finance much greater today than in the mid 90s.

The development of retail banking and willingness of consumers to take debt is a huge boost to consumption and combined with demographics is a growth multiplier which was non existent earlier.

6. The degree of economic freedom (strongly correlated with economic growth) in the country has improved significantly.

In almost every sector, the extent of government regulation has declined, and intensity of competition increased.

Even in the fast growing services arena, be it telecom, banking, insurance or even tourism/aviation the extent of competition, efficiency and private sector participation has increased dramatically.

7. The network effects of inter-linking India, be it through the mobile revolution and rising telecom density or through the national highways programme, will be a big boost to economic growth with significant multiplier effects.

8. Entrepreneurial spirit is far more vibrant today, venture capital/private equity is actually available and start-up activity is being provided a fillip with the wealth creation demonstrated by first generation entrepreneurs in IT/pharma.

9. There is today far greater accountability in the financial system, banks have cleaned up their books, are more disciplined in lending and have legal recourse. The drag on the system through willful corporate default and large NPA accretion will reduce.

10. There is a clear trend of a reverse brain drain beginning to manifest itself. While still early this could be hugely positive were it to continue gaining momentum. Do not underestimate the impact this phenomena had on accelerating growth in Korea/Taiwan and now China.

11. Political uncertainty marked the mid-90s in India and was a clear deterrent to economic growth. While still premature, one hopes that the completion of a full term by the National Democratic Alliance government is the beginning of a new era of stable coalitions in India, irrespective of who comes to power.

12. While the current state of infrastructure is still abysmal and a clear constraint on growth, a clear template is now available in most sectors (roads/ports/power/airports) on how to proceed with private sector participation, very different from the mid 90s. Massive infrastructure investments in these areas should be around the corner.

13. While the issues of crowding out and rising interest rates may reappear with strong economic growth (remember the mid-90s), the country today has far greater access to foreign capital be it through FDI or portfolio flows (debt and equity).

Most of the above are touchy feely issues and thus may not show up as hard statistical data.

Nevertheless I think they are important and set the background for why this growth episode may be more sustainable than the sceptical view.

Undoubtedly the poor fiscal situation and lack of progress on health and education are areas of concern and need to be addressed on a war footing, but that is why 7 per cent is the best we can hope for.

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