Friday, July 22, 2011

India's economy - The half-finished revolution

India’s liberalisation began with a bang in 1991, but two decades on the unreformed parts of the economy are becoming a drag on growth. Time for another bang

IN A strange reversal of the norm elsewhere, in India the economic policymakers and economists have become the optimists while bosses do the worrying. In June a deputy governor of the central bank predicted that the country’s economy would grow at a double-digit rate during the next 20-30 years. India has the potential for such a feat, with its vast and growing labour force and now famous entrepreneurial spirit.

But in the past six months the private sector, which is supposed to do the heavy lifting that turns India from the world’s tenth-largest economy (measured at market exchange rates) into its third-largest by around 2030, has become fed up.

“Why the hell should I pay my taxes?” asks the boss of one of the country’s biggest firms. “What happens in India is not because of the government but in spite of the government,” says the head of a pharmaceutical company. Corruption has “paralysed the government,” reckons the chief executive of one of India’s most prestigious firms. “We know what the problems are and we have done nothing…somebody’s neck has got to be on the line,” says the leader of a bank. Some important foreigners are fed up too. The former head of one of India’s largest foreign investors shakes his head and says it was naive about putting shareholders’ cash there.

Businesspeople have always loved to carp about India’s problems even as they have rushed to take advantage of its terrific growth rates. But lately their irritation has had a nervous edge. In the first quarter of 2011 GDP grew at an annual rate of 7.8% (see chart 1); in 2005-07 it managed 9-10%. The economy may still be slowing naturally, as the low interest rates and public spending that got India through the global crisis are belatedly withdrawn. At the same time, the surge in inflation that began last year and was first caused by food prices has spread more widely, causing some to doubt whether in the medium term India can really grow at the 8-10% the optimists hope for without overheating.

To raise the economy’s growth potential, India could do with another dose of reform, aimed at markets for inputs, from electricity to labour and land, that are still choked. The chances of that look slight. The government has been clobbered by a corruption scandal over the award of telecoms licences in 2008, which has already brought down two ministers. Meanwhile, efforts to make it easier to buy land, cut the large public deficit or introduce a new sales tax have been allowed to drift.

Faced with ominous long-term problems, for instance in electricity supply, the government has frozen. And there have been long delays over small decisions, such as the approval of investments by foreign firms. Even when decisions are made they sometimes seem to backfire. On July 8th reports of a draft bill aimed at settling the terms on which mining companies can acquire and exploit land ended up sending the shares of firms in the industry lower rather than higher. A cabinet reshuffle on July 12th was widely dismissed as a damp squib.

Not all is doom and gloom. The outside world chortles at a good Indian fiasco, such as the 2010 Commonwealth games, yet pays less attention to successes such as the cricket world cup this year. Some well-run states, such as Gujarat, continue to motor along; some former basket-cases, such as Bihar, are creating a strong record of reform. Exports are roaring, with engineering doing particularly well, helped by special economic zones, which are freer of red tape than the rest of India and account for 22% of all exports.

But in India as in many fast-growing places, the confidence to invest today depends on the conviction that the long-term trajectory is intact, and it is that which is in doubt. Already big Indian firms sometimes seem happier to invest abroad than at home, in deals that are often hailed as symbols of the country’s growing clout but sometimes speak to its weaknesses—for example, purchases of natural resources that India has in abundance but struggles to get out of the ground. Now, with reform flagging, firms could cut their domestic expansion plans.

The data are both unreliable and mixed, but suggest that in the first quarter of 2011 capital expenditure slowed sharply. Foreign direct investment into India has been subdued for a year (though it did pick up in May). The most recent industrial-production figures have been soft, showing an annual growth rate of 5.6%, about half that of 2010. A further dip in investment could be self-fulfilling: if fewer roads, ports and factories are built, this will both hurt short-term growth figures and reduce the economy’s long-term capacity, which will in turn do little to boost confidence.

Don’t worry, we’re on autopilot

From the stately avenues of New Delhi, such worries are viewed as hysterical. After all, there have been doom-mongers about India’s miracle ever since liberalisation began in 1991. And despite outsiders’ desire for more orderly progress and their endless whingeing about the roads, India’s chaotic model of development has rewritten the rule books. Compared with that of East Asian tigers, it often seems back to front. Services have boomed and manufacturing has stagnated as a share of output (see chart 2), while most people still work informally and live rurally.

India has world-class information-technology exporters but imports lots of fridges; it has 15 times more phone subscribers than taxpayers; and in the coming years most Indians are likelier to be connected to a national, biometric, electronic identity-system than to a sewer.

But overall, the formula seems to work. It has yielded rapid growth for two decades and India has sailed through the financial crisis that has battered the West. Growth has transformed living standards and cut poverty (see table), although there is some controversy over how to measure the latter. Middle-class folk say their children laugh when told what it was like before 1991, when phones took years to get, soap burned your skin and red tape suffocated the economy. Back then, the leading founder of Infosys, a big technology firm, has recalled, importing a computer would take about three years and require 50 trips to Delhi to get official approval.

That all came to an end 20 years ago, on July 24th 1991, when Manmohan Singh, then minister of finance, facing a balance-of-payments crisis, told parliament that “the room for manoeuvre, to live on borrowed money or time, does not exist any more.” He attacked the prioritisation of producers over consumers, and swept away tariffs and the mesh of licences used to micromanage firms. The reforms were less dramatic than events in the Soviet Union—where a month later Boris Yeltsin stood on a tank and denounced an attempted coup—but also changed hundreds of millions of lives. Mr Singh’s speech marked India’s entry into global capitalism. He ended by paraphrasing Victor Hugo: “No power on earth can stop an idea whose time has come.”

Today such radicalism seems alien, even though Mr Singh is prime minister, heading a coalition led by the Congress party. Plenty of heavyweight people think that progress is still being made, if more quietly. Suman Bery, an economist, speaks of the “old Indian formulation that at the end of every two-year period it seems as if you have got nowhere but in each seven-year period you look back and things have been transformed.” Reform is not a word that describes what happens in government any more, says a senior official, but “nuts-and-bolts” changes do occur, at a pace that India’s democracy can handle. Added up, they make a difference.

That may be good enough if the foundations of growth are strong enough. Assessing those foundations is not easy to do neatly, but demography, at least, is in India’s favour, with the ratio of workers to dependants forecast to rise until 2030 or so, in marked contrast to China. Over the past decade demography has added about 1.7 percentage points to the growth rate of GDP per person, reckon Shekhar Aiyar and Ashoka Mody, of the IMF. This boost will not get much bigger but it will last for a couple of decades. Better still, because workers save more than non-workers, India’s saving rate is rising towards East Asian levels and should provide more domestic funds for investment. Taken together, more workers and more capital explain about half of the recent growth rates of about 8%, estimates Chetan Ahya, of Morgan Stanley. A recent OECD study put the proportion at three-quarters.

It can be a short leap from there to the view that because a fair amount of growth is assured the government doesn’t have to try very hard. Entrepreneurs can be relied on to work their magic. This fits a romantic view of Indian businessmen who triumph against the odds, from Bangalore’s IT gurus to Mumbai’s dabbawallas, who deliver 200,000 lunches daily, and the car-valet squads who will miraculously find scores of parking places for your wedding guests, often by bribing the neighbours’ janitors. But if more capital and bodies are to support near-double-digit growth, they have to be used ever more efficiently. For that, wheeler-dealing and inert government are unlikely to be enough. More reform is needed too.

For a start, the demography cuts both ways. India will need to create 10m-13m jobs a year in the next two decades as people enter the workforce, many of them from its poorest regions and unskilled. That will probably require more manufacturing or large service companies; and that in turn demands a state that is better at organising such things as education and transport. Nor is an unreformed state certain to shrink. It may find new things to mess up: the telecoms industry, once a pin-up of Indian capitalism, has been battered not just by graft but also by a licensing system that has become incoherent.

From outputs to inputs

Most important, the reforms that began in 1991 are half-finished. They freed markets for products, so that vibrant competition reigns from shampoo to ringtones. At the same time, what economists call factor markets—those for basic inputs like land, power, labour and to a lesser extent capital—remain less reformed and under more state influence. It is easy to forget the difficulties this can create.

Take an engineer who runs a quarrying firm in Tamil Nadu, providing stone for sands, grits and gravels used in everything from houses to roads. He has done all the right things, including buying kit from Finland, and employs about 100 people (about half of them informally). He has also had a bellyful. “The licensing processes are becoming more difficult day by day,” he says. Clearances that took three weeks in 1997, the year he started up, can take three or four years. Many officials demand bribes. Like many bosses he is keen to replace workers with more machines, despite India’s abundance of people, because of “labour laws that are inimical to employment creation” and an education system that means finding “quality manpower is a major, major problem”. Power is cut for four hours a day and deliveries by lorry that should take three days take nine. He has had enough. “I will not try to grow,” he says. It’s just too hard. He says that if he had known what it would be like, “I would never have come into this business.”

The influence of unreformed India varies. In airlines, where riotous competition has taken hold, its role is confined to a half-dead Air India. It burns a lot of money, but has lost so much market share that it inflicts itself on relatively few travellers. In electricity, however, it is a different story. For India to grow at 8-10% a year, supply must at least double in a decade. The government has rightly sought private investment in power stations. But the supply chain these plants will join is still largely unreformed and in poor shape.

At one end, fuel, which in India means coal, is dug up by a state monopoly that seems unable to raise its production fast enough. Even today there are shortages, although India has the world’s fifth-largest reserves. At the other end, the wholesale buying of power from generators and its distribution to consumers is largely in the hands of state firms that do not charge market prices and together made losses equivalent to 1% of GDP last year. Generating companies, with their big investment plans, are being squeezed by the need to import more expensive foreign coal to top up supplies and by the bankruptcy of their main customers. An industry which should be booming is regarded as toxic by many investors and as a potential source of bad debts by some bankers. “The reforms will happen: after the whole system collapses,” predicts a power-firm boss.

New power-generation plants are just part of the investment in infrastructure that India needs, probably at a rate of about 8-10% of GDP every year, if it is to sustain growth close to double digits. It is difficult to tell whether the economy’s iffy patch has bogged down such investment. Vinayak Chatterjee, chairman of Feedback Infra, a firm which advises on and helps implement projects, jokes about a “decision-paralysis-linked slowdown”. Official figures also suggest that the proportion of big government projects facing delays or cost overruns has risen. Mr Ahya, of Morgan Stanley, thinks that infrastructure spending will still be an adequate 8% of GDP this fiscal year. In the next five years, though, the government wants that share to rise to 10%. Perhaps half of that, or $500 billion over the five years, would have to come from the private sector. Such a sum may not be forthcoming if Indian companies continue their collective strop.

Second best

What does all of this mean for India’s long-term growth rate? In April the Planning Commission, a state body which aims to think far ahead, asked: “Is 10% growth feasible?” It concluded that “even 9% will need strong policy action.” The recent bout of inflation has pushed down some other estimates of India’s sustainable growth rate to 8% or below. Food prices, which were the original cause of inflation, have since moderated but the overall rate of increase in prices is likely to continue at about 10% for the next few months.

That is especially worrying for the poor. On a dusty roadside in north-west India where labourers gather to be picked up in trucks for informal construction work, a man in a T-shirt says his wages have doubled in the past two years but complains that most of the increase has been eaten up by higher living costs. The central bank, which has raised interest rates ten times since the start of 2010, insists that the costs of getting richer—such as diets with more protein—are partly to blame. But India looks like an economy operating at full capacity. Had it managed to build more roads, factories and houses and to educate its people better, it might have grown faster, with less inflationary pressure.

How bad would it be if the Indian economy could grow at only, say, 7% a year rather than 10%? Certainly, the economy would have thinner safety buffers. But in other respects it might not be too shabby. Growth would have to be much slower than that before India’s public-debt dynamics became a worry. The ratio of debt to GDP is 66% and has been falling despite a public-sector deficit of about 8%. The vast majority of the debt is domestically owned, so a wobble from foreign investors would be manageable. A recent improvement in the current-account deficit, thanks to surging exports, suggests that India could be less reliant on foreign funds than in the past. And its reserves of gold and foreign exchange amount to $311 billion.

Might lower growth hurt the banking industry? “Fundamentally the reason why bad debts haven’t built up is because the economy is doing so well,” says the boss of one lender. A slowdown would mean more sour loans, both from infrastructure and property projects and from small firms, he says. Even so, like most bank bosses he does not think there is a systemic problem lurking in banks’ balance-sheets.

Indeed, compared with a fragile world economy, an India on autopilot could chug along quite happily, growing faster than most other countries. The government would carry on acting like a tinkering housekeeper with a habit of pinching loose change. Plenty of new firms would still triumph despite the red tape and most people would be better off. There would be fewer roads and more poor people than there might otherwise be, but the opportunity cost of the forfeited reforms would be a subject confined to scholarly debate. All that would still be a vast improvement on how things once were. Yet it would be a curious finale for the politicians and officials now in power who pushed through the reforms of 1991. Twenty years ago they said the yardstick against which India should be measured was its potential. On that measure, there is much to do. The Economist

No comments:

Post a Comment