India 8% Growth

CRISIL Young Thought Leader 2005

“How can India achieve 8 per cent plus growth? What is the recipe?”

Dissertation by Rahul Bhargava 2nd Year, PGDBM, XLRI Jamshedpur [email protected]

Executive Summary This paper mainly deals with reforms required to achieve a growth rate of 8 percent plus for the Indian economy on a sustainable basis. It analysis the structural impediments and the steps to be taken to overcome them, formulated as the recipe for growth. Nine such impediments, followed by reforms required, have been identified in the study. Apart from these, there are number of other factors also that would affect our growth, like international interest rates, exchange rates, oil prices etc. but we have focused on those factors which are controllable by us. Comparison with and the learning from other countries, wherever possible, have also been made.

India Inc. looks like a company on a turnaround track. Though, this turnaround began way back in 1991, the process is still going on. If one values the country, the methodology used being Discounted Cash Flow model, the value would not depict the true picture as there are lot of ‘options’ in form of reforms and policies on which decisions have to be taken. When FIIs decide which country to invest their money in, they must be judging the choices available so as to find a good investment bet. Here, India’s valuations through the ‘Real Options’ model must be coming to be quite attractive as can be seen by the massive inflow of money in the capital markets during the past one year. The ‘options’ that are in our hands need to be exercised wisely and timely as they can either unlock tremendous value or become worthless on the exercise date depending on our actions today.

Indian Economy: vital signs

Indian economy can be broadly divided into three sectors – Agriculture, Industry and Services. Among these sectors, as has been the trend, it is the services sector followed by industry that acts as growth driver while the agriculture sector ‘makes or breaks’ the final growth figures for the year. It has been essentially the service sector that has driven expansion and maintained GDP growth during all the cycles that have affected agriculture and industry in the past decade and shall probably continue doing so. Looking at the post-reform period, real GDP growth has stepped up from 5.8 per cent per annum during the 1980s to 6.2 per cent per annum between 1992-93 and 2004-05. Over the same period, per capita growth has recorded a more impressive increase from 3.4 per cent to 4.3 per cent.

However, problems are as prominent as has been the growth in the past few years. Poverty everywhere, inadequate public services, substandard infrastructure, law and order which are considered a luxury beyond reach; the list can go on and on. It appears that these problems have been there perennially but so is the “real cause” of inaction – lack of political will. A lot has been written by economists, researchers, committees formed by the Government itself, about what needs to be done to put India on the fast track of growth, but in comparison to what has been suggested, little has been done and the reason is none other than lack of political will. Yet again, another attempt would be made in this paper to figure out what impedes the growth and what could be the necessary reforms required to overcome the obstacles. Perhaps, we can take cue from other countries which started at the same level as us but have left us far behind. But, what has worked for other countries might or might not work for India because of the cultural, political and economic differences existing between India and those countries. Hence a mantra of high growth rate cannot be adopted from a country, say, China. However, as per sociologists, there is one factor that was common to the kind of explosive growth seen in Japan in the 1950s and 1960s, in South Korea in the 1970s, and in China today - the spirit that asks "why not?" instead of "why?". It is this spirit that transformed South Korea from a country with a per-capita income on par with India's into a member of the OECD in just four decades, that built a sleek futuristic city in the Pudong district of Shanghai in what was largely farmland just a decade ago, and that is currently responsible for the development of the world standard, on-time New Delhi Metro. This spirit entails intolerance for laziness, for shoddy products, for open corruption, and for the usual excuses.

Another area where we can learn from these countries is the physical infrastructure area. Table 1 compares how India stacks up against its Asian peers. Table 1

Country

GDP per capita (constant US$)

Investm ent in infrastru cture*

Safe drinking water**

Improved sanitation**

Mobile users( per 1000)

Paved roads (km / 1000)

Rail (km / 1000)

Phone (lines / 1000)

Power generation (KW/1000)

China Hong Kong

815

20

75

38

66

0.25

0.05

112.72

229.87

23762

4

100

100

817

0.26

0.00

560.14

1633.03

India

461

5

84

28

4

1.50

0.06

32.56

106.69

Indonesia

986

14

76

66

18

0.75

0.03

27.80

97.08

Korea

13244

7

92

63

583

1.37

0.07

448.59

1067.12

Malaysia

5017

9

NA

NA

213

2.22

0.08

208.78

581.37

Pakistan

455

2

90

62

2

0.70

0.05

19.86

108.93

Philippines

1161

3

87

83

84

0.49

0.01

35.19

162.45

Singapore

32072

5

100

100

684

0.84

0.01

528.61

1886.74

Sri Lanka

885

NA

77

94

23

4.88

0.08

42.72

85.33

Thailand 2793 4 80 96 50 1.03 0.07 * as a % of GDP ** Percentage of people with access to Source: World Bank Data, ADB, individual country reports, Businessworld, January 31, 2005

85.55

305.23

Even if we cannot emulate other countries, probably Indian states can learn from each other. Four states – Andhra Pradesh, Karnataka, Kerala and Tamil Nadu – have tackled issues such as land reform, primary education and rural infrastructure and have averaged GDP growth of 8 to 9 percent in real terms over the past decade, much higher than the national rate.

Recipe for growth

Productivity is the biggest driver of GDP growth and factors that hinder productivity are also those that act as barriers to GDP growth. Accordingly, 9 impediments to economic growth have been identified. These impediments can be removed using the recipe, the ingredients for which are given along with the barriers below.

1. Product market regulations – Regulations that affect the price or output in a sector damage competition and productivity. Following are few examples: a. Enforcement problems – The regulations, though existing, need to be enforced equitably on all players. More visible and larger players cannot escape the regulations while the smaller player underreport sales to avoid tax, resort to stealing electricity and other irregularities and thus compete with the larger players without increasing their productivity b. Small Scale Industries – As announced in Budget 2005-06, 497 products are exclusively reserved for small-scale industries (reduced from 605 earlier). The number is still large and limits efficiency of operations due to small scale and size rendering the products uncompetitive to imports c. FDI – Regulations prohibit FDI in certain sectors in the economy. For example, in Retail, though the government has started discussions with the Left on allowing FDI in retail in select cities, with initial investment cap of 49%, the Left wants sufficient safeguards such as locating retail outlets outside city limits to protect local neighborhood grocers. What they are ignoring is the fact that FDI would not only improve local supply chains but the discount offered by large stores would also lead to improvement in general standards of living of Indians across social spectrum. 2. Widespread government ownership of business – Government controlled entities suppress potential competition and productivity improvements and hence the GDP growth. The need for privatization can be seen from the example of the power sector. Till 2002, the Delhi Vidyut Board used to have losses as high as

50% mainly due to thefts. Government subsidies and corruption obviated the need to check the losses. Now, with BSES (Reliance) and NDPL (Tata Power) supplying power, the losses are down to 33-34% in 2005. To manage political opposition, the government might consider creating a trust or special-purpose vehicle to act as a holding entity, much as Singapore's Temasek does. After the assets have been transferred, the holding company could be taken public, effectively diluting the state's share in the companies (without privatizing them) and releasing them from statutes applying to the public sector. 3. Distortions in the land markets – These affect agriculture, housing and retail sectors predominantly and thus also impeding the GDP growth. Due to distortions, land prices in India are very high, making the cities unattractive from the point of view of foreign investments. While the majority of land area in India is subjected to legal disputes, the tardiness of courts to resolve disputes and bureaucratic title-clearing process worsen the matters further. Stamp duties, which are exorbitantly high, must be reduced to international levels and the government must streamline the registration system by establishing fast-track courts and implementing electronic record-keeping systems. Andhra Pradesh's progress in this area should encourage other states to follow its lead. 4. Act to boost demand – To attract investments, India as a market needs to be further developed. Following steps can help in this regard: a. The Reserve Bank of India must keep interest rates regionally competitive to sustain a buoyant economy. Since 2002, the bank has reduced them to the current 6 to 8 percent, from 14 to 18 percent, leading to increase in

consumer lending by more than 30 percent a year, along with healthy growth in residential construction and consumer durables. b. India's 28 states and union territories must all implement the value addedtax (VAT) system. The VAT system will allow overall consumption taxes to fall to 15 to 20 percent by 2007, from the current 30 to 60 percent, thus releasing a flood of latent demand, as according to McKinsey estimates, for every 25-percentage-point decline in prices, consumer demand increases three-to-fivefold. 5. Unpredictability in agricultural – If in 2002-03 we had a drought resulting in abysmal agricultural growth, then in 2003-04 we had spectacular 10% growth coming from this sector. Such are the vagaries associated with this sector. Following are the thrust areas for this sector: a. Better availability of commodity derivatives to minimize the impact of prices uncertainty; reducing monsoon dependency through schemes like water harvesting; and, further augmenting the flow of credit to the rural sector. b. Revival of the $150 billion project that would link a number of India's rivers (the Brahmaputra, the Ganga, the Godavari, the Krishna, and the Yamuna) with a system of waterways. If completed, these canals would provide much-needed water to millions of Indians and boost agricultural productivity.

c. Diversification of the cropping pattern to non-traditional activities in line with the changing agricultural demand pattern and making use of recent advances in bio-technology. 6. Inadequate Infrastructure – Many executives claim this is the biggest constraint on business. At any given time, up to a quarter of our national and state highways are in a logjam; trucks and buses crawl at average speeds of 25 kmph as against the world average of 50 kmph. Most ports are handling traffic way above their capacities. The two main international airports, Mumbai and New Delhi, are in desperate need of reconditioning. Less than a third of the country’s billion people have access to proper sanitation. Following is the “3-point agenda” that can be adopted to reform the infrastructure sector: a. Regulator - Infrastructure regulatory bodies need to be developed so that delays like Bangalore’s airport project do not occur b. Funding - Long term debt market needs to be developed through mobilization of long-term insurance money, making more funds available for infrastructure c. Private Sector - A single body for contracting, clearing and interacting with private developers and investors should be constituted to encourage projects by private sector 7. Labor laws – Labor laws need to be more flexible as in the current form they inhibit productivity in labor intensive and export oriented manufacturing sectors

such as clothing by making it difficult for firms to shed workers rendered redundant by changing market or production conditions. 8. Poor social sector indicators - Our social indicators are lower even in comparison with the levels achieved by some of our Asian peers twenty five years ago, when they first began to grow rapidly. a. Literacy - Although overall number of illiterates in the country has encouragingly declined from 329 million in 1991 to 306 million in 2001, there are at least seven major States with more than 15 million illiterates each. It is necessary that public expenditure on education should reverse its declining trend: total expenditure by the State Governments on education is budgeted to decline from 2.5 per cent of GDP in 2003-04 to 2.3 per cent in 2005-06. Given India’s comparative advantage in services, the quality of secondary and higher education in the country has to be improved so that adequate skills are developed to realize the benefits of the knowledge economy b. Health - The combined government (Centre plus States) expenditure on health as a percentage of GDP has stagnated at around 1% of GDP over the last decade and a half, lower than many other developing countries such as Brazil (3.4%), China (1.9%) and Malaysia (1.5%). The infant mortality rate in India is almost double that of China (63 in India versus 37 in China) while the maternal mortality rate at 407 is manifold as compared to China’s 56. Hospital beds (per 1000 population) at 0.7 for India are less

than one-half of other developing economies such as China (2.4), Thailand (2.0) and Malaysia (2.0). 9. Fiscal deficit – Economic growth cannot be sustained in the medium-term unless the government puts its financial house in order. Table 2 compares India's fiscal position with some other 'crisis-prone' economies. The combined deficit of the Central and state governments at 10.2% of GDP is higher than the level reached in 1991, when the economy toppled over into its worst-ever crisis. The central government has pledged to cut its deficit to 3 percent of GDP by 2009, from the current 4.3 percent – the aim should be to cut the total public deficit to 4 to 6 percent of GDP. Table 2 Country

Fiscal Deficit (%)

Debt/GDP (%)

Debt/Govt. Revenue (%)

India 10.2 80.6 441.2 Turkey 19.2 81.2 289.4 Argentina 12.8 174 668.2 Hungary 9.5 49.9 135.8 Philippines 8.3 99.4 573.8 Brazil 4.7 95.1 127 South Africa 1.2 39.9 149.4 Russia -0.7 34.7 223.9 Note: Fiscal deficit is combined for Central & state govts. Source: Kalpana Kochhar (IMF), Businessworld

Conclusion After more than four decades as a closed economy and fourteen years of reform, India has ascended the world stage. However, in a world where technology is changing at a fast pace, the reform process should not be slow moving just because we are a federal state. At least in major projects, the tiered structure of the government should not become a bottleneck. The recipe lays the foundation for rapid growth, but further effort and

unwavering commitment are needed for India to emerge as an undisputed global economic leader. According to McKinsey Global Institute, removal of the first three barriers listed above can itself increase the GDP growth by 4 percentage points. To conclude, the stars are well aligned for India; its future is in Indian hands and will be what Indians make of it.

References: ♦ "India—A hub for globalization," speech given by Raghuram G. Rajan on January 7, 2005, at the Pravasi Bharati Divas Conference, in New Delhi) ♦ “India: The growth imperative”, McKinsey Global Institute, 2001 ♦ Address by Dr Rakesh Mohan, Deputy Governor of the Reserve Bank of India, at the 99th Foundation Day Celebration Function of the Indian Merchants’ Chamber, Mumbai, 8 September 2005. ♦ “India’s economic agenda: An interview with Manmohan Singh”, The McKinsey Quarterly ♦ “Can Dr. Singh Cure his Economy?”, Arvind Panagariya, Economic Times ♦ “A richer future for India”, Diana Farrell and Adil S. Zainulbhai, The McKinsey Quarterly ♦ “Why believe in India”, Ranjit V. Pandit, The McKinsey Quarterly ♦ “GDP growth: Dynamism in Indian Industry”, Economic and Political Weekly