India Intelligence Report



   Achieving a Sustainable Economic Growth Rate

  In yesterday's piece "Is the Economic Growth Sustainable?" we showed that the Indian economy has excellent fundamentals but is also riddled with risk. In this article, we will list various fixes that are necessary to ensure that the growth rate continues.



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In yesterday's piece "Is the Economic Growth Sustainable?", we showed that the Indian economy has excellent fundamentals but is also riddled with risk. It was argued that while the current pace is good, the foundation is shaky and there are many inherent fissures in the system that needs to be fixed urgently. In this article, we will list various fixes that are necessary to ensure that the growth rate continues.

Firstly, it would need to better its infrastructure through increased private-public partnership. Currently, India spends only 4% of its GDP on infrastructure. In comparison, China spends 9% of its GDP on its infrastructure and in absolute dollar terms seven times the amount that India spends. To maintain the ambitious target of 9%-10% of GDP growth, India has to spend at least 8% of its GDP on infrastructure. However, this will not happen if there is no administrative and regulatory reform that can bring in enforcement of laws and rules at the local level. Thus, if private investors are required to invest in power projects, India needs a better billing collection and power-management system in place. Currently, only 50% of those who get any electricity pay for it. Worse, Chief Ministers use electricity as a tool to gain votes and offer unsustainable power to their constituencies. The same argument can be made for other infrastructure areas such as roads and ports. As has been seen in the case of telecom, the common man is willing to pay for better service if it is guaranteed and only if he has to.

Secondly, the nation needs labor reform to ensure that international companies do not have to deal with outdated bureaucratic processes dealing with labor. For instance, in some states, the companies need to pay into a labor welfare fund, have to maintain outdated records that are should be open for scrutiny, maintain entitlement programs, and also not have the latitude to layoff employees for performance or attitude reasons. Firms employing more than 100 people cannot fire workers without government permission, which discourages expansion. While theoretically state governments can modify these laws under the federal system, they usually don't for political reasons just as the federal government. To get around these issues and reduce the tax burden on companies, the idea of special economic zones (SEZ) was mooted. Unfortunately, without clear directives and parameters on what constitutes an SEZ has led to nepotism and favoritism that would further the financial wealth of some corrupt politicians. Another case in point is the privatization of airports. The company that assumed responsibility for Delhi Airport, the GMR group, promised to absorb the entire staff of the Airport Authority of India (AAI) and hike their pay scales by 2 steps automatically in exchange for performance. However, labor unions have been recalcitrant on accepting this plan arguing that they want job-protection in addition to the pay increase. Such attitude fanned by the communist parties is inimical to the nation's growth plans.

Thirdly, there needs to be substantially more investment in education to get over skill shortages. While India produces hundreds of thousands of graduates, most of them are unemployable because the educational system does not give them the skill sets they need in the modern world. More importantly, the education system depends highly on rote memorization and not ability to think and learn. For this to happen, existing educational infrastructure is not sufficient and would need external funding and participation. However, the current political system is bent on making political statements and imposing caste, religious, and economic conditions on privately funded universities. Recently, the Human Resources Minister Arjun Singh said that even foreign universities will have to abide by quota systems brought in by the government over questionable legal basis. Such attitude will drive away foreign institutions used to freedom from the government. When the government schools cannot have even half their teachers come to work on school days, as revealed by a survey in 2003, forcing others to lower competence levels is not just unfair but criminal because it denies those who can and want to be educated an opportunity for success.

Fourthly, there needs to be better fiscal discipline. While India has made great strides to achieve this by bringing down budget deficit from 10% in 2001-2002 to 6.2% of the GDP this year, the reduction is driven largely by economic growth and low interest rates. With interest rates going up or if investors were to lose their appetite for risk, inflows, investments, and job will slow down and so will tax revenue. Hence, fiscal policy needs to be tightened to broaden the tax base to net in those outside the ambit if direct taxation, bring more consumer durables under the tax radar, and enforce the concept of notional taxes on those buying consumer durables. The other aspect that needs addressing is that the government and its officials need to stick to the budget and limit unplanned expenditure which according to the Controller General of Accounts is 73% (which includes interest payments).

Fifthly, India has several hidden subsidies that need addressing. For instance, according to some estimates, subsidies for off-budget commodities such as oil and power amount to 1.8% of the GDP which remains vastly under-reported. Government employees' salaries are set to go up higher in 2009 and this increase is expected to be financed by tax revenue that assumes continued economic growth or through public debt. India already has debt that is equal to 80% of the GDP and is the highest in the world, thus adding to this burden will be nearly impossible-even if most of such debt is through domestic investment and not external debt. These are dangerous assumptions that commit ongoing budget commitments that cannot be lowered if there is an economic slowdown. While the economically poorest man has to be supported through grants, building it into pricing that benefit everyone is wasteful.

Sixthly, with internal avenues in short supply and reaching saturation levels, India has to seek external funding to finance growth in education, social programs, infrastructure, and job creation. For this to happen, the nation needs to further reforms in core sectors that can generate employment. For instance, retail is one area where international investors are ready to supply but disallowed because of fear that local small time retailers will be subsumed by larger international retailers. Congress President and United Progressive Alliance (UPA) Chairperson Sonia Gandhi has suddenly realized the dangers of retail reform and has written to the Prime Minister asking for a review when such policy has been in the open for the last several months. Timed with an election in several key North Indian states, the suspicion is that politicians may sacrifice reforms and national development to further party and narrow interests and this is something that needs to be resisted.

Seventhly, India boasts of the largest youth population in the world that could then fuel it past China in about fifty years. The argument is that with 60% of Indian population in employable age, India will be more capable of economic expansion than other nations. Theoretically, this is true. If India can find employment or opportunities for its large youth population, the economic growth will be unprecedented and much more than what the baby boomers in the US had accomplished for that nation. However, this theory banks on the premise that India will be able to find jobs and create opportunities for such a large population. As shown earlier, this is entirely possible only if there is an encouragement of external investments and creating an environment that will facilitate such investment. Unlike the US where the numbers were much smaller and there was virtually no competition for that nation at the end of the Second World War, India faces intense competition from China, Brazil, and Russia and the population that it needs to provide for is four times the size of the US. Therefore, if India does not provide the opportunities for its large youth population, which unfortunately will happen in the worst managed and financially bankrupt states of India, the resultant social upheaval will be disastrous.

Eighthly, the Indian government needs to remove various procedural hurdles on businesses. A recent study commissioned by the Department of Commerce and executed by the Associated Chambers of Commerce and Industry of India (ASSOCHAM) says that inadequate infrastructure and complicated procedures cost exports by as much as 13.24% in pharmaceuticals, textiles, leather, metals & ores and engineering goods sectors. The high transaction costs for imports impacted manufacturing cost of goods old and affecting global competitiveness. The government has to rationalize these procedures and reduce the burden on industry.

It is now widely accepted among all policy makers that a faster growth in Indian economy is not only necessary but is also possible. This is the only way that India can sustain its large population and alleviate poverty. Currently, the economic growth is championed by a small minority while over 60% of the population is unemployable and relegated to the agrarian sector generating less than a fifth of the GDP. To fuel this growth and therefore help people, the government needs to accelerate reforms and rationalize its policies. Unfortunately, coalition politics of the day places accommodation of those who would keep the whole nation poor so they can stay in power.

National leaders such as Prime Minister Manmohan Singh, Finance Minister P. Chidambaram, Opposition leader L.K. Advani, and other forward thinking politicians need to focus the nation on these fundamentals, bring about awareness on the dangers of not reforming, and create plans to bring about change.

The nation needs to be careful about two major pitfalls. One is to drink its own hype potion and run into complacency. The second is to be held hostage by naysayer groups who value their narrow agendas more than national good.