The Indian economic juggernaut rolls on and the country’s economy is almost unrecognisable from the underperformer it was just as little as 10 years ago. There was a time, for example, when insufficient foreign reserve levels were a major issue, which hardly seems plausible now that the country’s foreign reserves stand at a whopping US$200bn and the country has become an important player in the global economy.
So phenomenal has been the rise in foreign exchange reserves that the Indian Government has had to take steps to temper dollar inflows. Paul Rawkins, sovereign analyst in charge of India at Fitch Ratings in London, for one, believes that “there is a lot of money still to come into India. Many more people have yet to discover India.”
Atsi Sheth, chief economist at Reliance Capital in Mumbai, agrees that the Indian growth story remains strong. “We’ve had a good four years, and the long-term outlook is very favorable,” she said. “Even though the Reserve Bank of India’s monetary tightening may result in GDP growth leveling off in the near-term; that will be good for the economy in the long-term as it will prevent the demand-supply gap from widening too much.”
Over the past four years, foreign investments, corporate capital expenditure, domestic consumption and, of course, the outsourcing story, which has brought in vast amounts of outside capital, have been the main drivers of the Indian economy and have fueled growth to its current level. These factors have created a solid foundation for economic growth and continue to play a keen role in driving it, but there are nonetheless a few cracks that need to be mended if India is to continue on its present course, and ensure that more than just a fraction of the population benefits from the rapid economic growth.
“The government has realized that the growth thus far has only benefited around 30% of the Indian population,” says Rohini Malkani, chief economist at Citigroup in Mumbai. “The trend now is to make growth trickle down to the rest of the economy.”
To be sure, economic growth so far been concentrated in just a few states and this has resulted in large discrepancies in per-capita incomes and social sectors such as education and health, Malkani says. Addressing the growing disparity will be vital for the Indian government, since 60% of the incremental rise in India’s population up until 2051 is likely to occur in three of its poorest states, Bihar, Uttar Pradesh and Madhya Pradesh.
More than anything else, these states, and almost every other Indian state, are desperately in need of proper infrastructure. The government needs to spend heavily on infrastructure to keep growth going, said Rawkins, particularly in the rural areas, and it needs to spend fast if it wishes to maintain its high economic growth rate.
One of the reasons infrastructure needs to be invested in quickly is so that efficiency gains can be realized because, according to Narhari Rao, principal economist, and Hiranya Mukhopadhyay, economist at Asian Development Bank’s (ADB) India Resident Mission in New Delhi, the recent strong economic growth has all but eliminated excess capacity in manufacturing, meaning inflationary pressures will rise. They also warned that if this excess demand was not properly managed, it could cause a balance-of-payments problem.
Of course, the Reserve Bank of India (RBI) has taken steps to curb excess demand by tightening monetary policy and, on the fiscal side, India seems to be
in good health. With the introduction of
a VAT and a generally more fiscally-conscious approach, India’s budget deficit appears to be heading down.
“Things haven’t looked this good since reforms were introduced and the general government deficit, which was down to 5.5% in 1995, is approaching that level again,” said Rawkins.
Indian states, which for decades have been a drag on the economy, have also been getting their books in order and most have signed on to the Fiscal Budget Management Act, and some are even running surpluses.
Rating agencies have acknowledged this with Fitch Ratings and Moody’s Investors Service upgrading India to investment grade and many expecting Standard & Poor’s to follow suit shortly.
Challenges ahead
While India’s macroeconomic outlook remains excellent, the country nevertheless faces some key challenges,
One important issue is the growing skills deficit, which more and more pundits have been talking about recently.
India’s greatest strength is its educated, English-speaking population, but the economic boom means that there are still not enough skilled people to meet demand. Today, there are about 500 million people under the age of 30 and if they are to be a credible part of the workforce, they need to be both educated and skilled.
“Everyone is complaining about the skills shortage, and not just in the highly specialised areas of IT, for example,” Reliance Capital’s Sheth said. “Even in areas like retail, people need to have a mid-level skill set.”
Job creation is the second major issue. India’s favorable demographics and skilled workforce have been touted as key factors contributing to the economy’s growth, but if this is to continue being the case, job creation also needs to become a priority, especially if social tension is to be avoided, said Citigroup’s Mulkani.
“India’s economic boom has not been preceded by a scaling up of talent supply, so herein lies a major paradox: the need to create more jobs on one hand, and an emerging talent shortage on the other,” she wrote in a recent research report.
Nevertheless, many companies have been aware of this problem for some time and have been investing in in-house education and training so the private sector is playing a role on the education front.
A third concern, and one the World Bank, in particular, has drawn attention to, is the slow growth rate of India’s agricultural sector. Around two-thirds of Indians depend on rural employment for a living, and current agricultural practices are neither economically nor environmentally sustainable. India’s yields for many agricultural commodities are low, largely as a result of poorly maintained irrigation systems and almost universal lack of good extension services. Farmers’ access to markets is hampered by poor roads, rudimentary market infrastructure, and excessive regulation.
Finally, some believe that politics is still an area that calls for some caution, in particular the Naxalite threat in the eastern part of India. The Naxalite movement, which basically refers to groups engaging in a violent struggle on behalf of the landless and the tribal people against landlords and their agents, is believed to have spread across 165 districts in 14 states, and if not curbed, could seriously undermine investment activity.
“All new investments planned in metals and mining take place in the ‘red’ area,” Malkani says, so that problem is certainly something to keep a watch out for.” However, the government has shown its resolve to address the issue properly, so she does not see the issue spiraling out of control.
Many Indian companies have become noteworthy borrowers on international capital markets, and are becoming more and more involved in cross-border M&A activity. Even though the government, as part of its moves to curb foreign exchange inflows, has recently placed a ceiling on the amount of external commercial borrowings that companies can bring into India, this should not deter companies from continuing their M&A activity.
Looking ahead, most analysts and observers believe that the Indian economy can sustain a growth rate of 8%-8.5% with moderate inflation and without this putting a strain on the balance-of-payments. Last year, inflation — as measured by the variations in the wholesale price index (WPI) on a year-on-year basis — up from 4.1% at end-March 2006 to an intra-year peak of 6.7% at the end of January this year, according to
the ADB. But with the central bank maintaining a tight vigil, inflation declined to 4.08% by the third week of June, and remained at 4.5% at the end of July.
Savita Iyer