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The Golden Bird Defying Rust
Krithika Subramanian, Associate Economist, CARE Ratings    5/30/2011 12:28:52 AM

In times of volatile global and domestic conditions, an otherwise ‘dynamic and vibrant’ economic system is often regarded as being one that is ‘unstable and less secure’. The Indian economy however, has had the unique advantage of having been regarded as dynamic and vibrant, but has not been shunned by the latter traits. It is hence, not a surprise that investors, both foreign and domestic alike have ‘instilled faith in the growth story of the Indian economy’. The pertinent question, thereon is whether this optimism is misplaced?

This question may be answered frontally, in a mono-syllable “no”. At length, however, one may contend two questions — “is the optimism on the growth front unfounded?” The answer being “no”, and “is the optimism on the growth front misdirected?” The answer being “yes”. In a bid to substantiate, these responses let us look at some macro-economic performance indicators. This article primarily seeks its argumentative capacity from past trends redirecting contentions based on expected future inclination.

Why the Optimism Surrounding the Indian Economy?
The Indian economy is one of the fastest growing economies in the world. For the last five years, the economy has registered strong growth in the range of 8-9%. Although major economies of the world saw some setback to production during the years of recession, India maintained a growth of eight percent in FY10 over FY09. Advance estimates of growth in gross domestic product (GDP) reinforce this robustness, indicating that a growth of 8.6% may be expected in FY11. Commensurate with this growth is maintenance of growth in per capita net national product (NNP). Adjusting for an average growth of 1.5% in population, the growth in per capita NNP has been strong at 6.1% in FY10. This very distinctly hints that the gains of growth have not dispersed large and wide amid a growing population base, but rather suggests some improvement in the resources available to the existing population set .

The Indian economy has recorded a secular and permanent shift in its structure, graduating from being a primarily agriculture dependent economy to becoming a global service provider, with a strong foundation in industrial activity. The primary sector currently contributes around 14% to overall GDP while the secondary (inclusive of construction) and tertiary activities contribute 28% and 58% respectively. With greater disposable income and greater availability in choices, growth in the consumer goods segment of industry has been high, additionally yielding backward linkages for growth in the capital goods segment. The well diversified composition of Indian GDP coupled with dominant domestic demand, further makes the economy resilient and less vulnerable to sudden external shocks.

Savings and investments in the economy have posted robust trends over the last ten years. The savings rate of the Indian economy has thrust itself above the historical barrier of 20% touching an average of 34% in the last five years. The investment rate has also recorded high levels of 35-36% in the last five years, with an incremental capital output ratio of around four times. This indicates that the efficiency in production in the economy has augmented, with lower investments required to generate an additional unit of output. Testifying the buoyancy in investments in India, is the eleventh five year plan (2007-12) estimating total investments as high as US $ 439 billion. A very encouraging aspect is that the lion’s share in these investments is targeted towards the infrastructure industry. Even in FY11, 32.4% of the current outstanding bank credit disbursed (as of March 31, 2011) was deployed in the infrastructure sector. India has also attracted 5.6% of total global FDI flows of US $ 410 billion and nearly 26% of global FII flows of US $ 153 billion in 2010.

Banks in the country have registered a capital adequacy ratio of 14% and 14.5% under the Basel II norms in the last two years, well above the RBI minimum stipulation of nine percent. The central bank of the country has been proactive in monetary management. Globally, this promptness and vigil of the RBI in banking and macro-economic management has been appreciated. It has been one of the major contributors to India’s ability to resist excessive damage during economic and financial turmoil. Non-performing assets as a proportion of advances have been fairly constant over the past five years.

Financial markets in general have been buoyant, with the number of new issues and traded volumes increasing manifold, both in the primary and secondary markets. The ratio of market capitalization to GDP has fluctuated in the range of 80-100% in the past five years ending FY11, barring the years of global recession. Though Indian financial markets are young, the level of sophistication already attended is commendable.

On the external sector front, the monetary authority has very cleverly balanced the forces of the infamous ‘impossible trinity’, namely exchange rate, free capital flows (pertaining to interest rate decisions affecting inflows-outflows) and monetary independence (pertaining to the balance between the two policy targets of inflation and employment). The country is backed by a strong foreign exchange reserve position. By March 2011, foreign exchange assets of the country crossed the US $ 300 billion mark, thereby increasing the import cover for the country well above the 11 months level of FY10. The country has registered considerable improvement in other external sector parameters such as current account deficit, trade deficit and fiscal deficit as well. Post-recession, when most economies of the world, especially advanced economies have been pursuing expansionary fiscal policies to support and boost economic activity, India has already begun the process of fiscal consolidation and restraint in accordance with the Fiscal Responsibility and Budget Management Act.

Additionally, India is also strengthening economic ties by increasing integration with the rest of the world through free trade agreements at the level of nations and private corporate mergers, acquisitions and takeovers at a micro-level. A point in case being the recent EU-India FTA, that is currently in the stage of bilateral-talks.

Why is the Optimism Misdirected?
The Indian economy might have the desired strengths to hoist itself as a global economic power, but it has been constrained in harnessing these strengths. Potentials of the economy have stagnated at the level of mere expectations, rather than transforming into reality. This makes the optimism misdirected.

Some of the greatest hindrances lie in the functioning of the economy and polity of the country. India undeniably suffers from problems such as corruption, money laundering, lack of adequate governance controls, transparency and slow judicial system coupled with a passive civil society. Though these attributes are gradually changing for the better, the pace of change is by far insufficient.

On the social indicators front, India has either been stagnant or has registered only minor improvements. Improvements in literacy rate from 64.8% in 2000-01 to 74% in 2010-11 and life expectancy from 63.5 years (in 2007) to 64.4 years (in 2010) are small. Globally as well, out of 169 countries ranked in the 2010 Human Development Index, India ranks a low 119.

The country still suffers from the problems of food and nutritional security. Though more-than-adequate buffer stocks are maintained, an alarming proportion of more than 30% of these stocks are damaged by pests. Warehousing, cold storage and transportation are inappropriate and indirectly feedback into the system in the form of higher primary (food) products prices consequent on accentuated supply-side constraints, over and above the margins added by middlemen. The public distribution system (PDS), for instance, although a classic example of a widespread food distribution network aimed at provisioning for the marginalised, has been constrained by adulteration, hoarding and pilferage.

At the level of policy-making, the country is not deficient. The best practitioners have established committees and made recommendations — be it at the Malegam Committee report on Micro Finance Institutions at the micro-level or the Raghuram Rajan Committee suggesting the ‘100 small steps’ at the macro-level towards financial inclusion, expansion of the banking system and empowering the financially marginalized. The challenge lies in the smooth and fast-paced implementation of policies in the pipeline into real-time actions.

Out of 183 countries ranked in the Ease Doing Business Index, 2011, India ranks 134. The country particularly falls short in areas of starting a business, dealing with construction permits and worst in enforcing contracts (a rank of 182). The Worldwide Governance Indicator further supports the gloomy scenario, assigning negative scores to India in parameters such as political stability, government effectiveness, regulatory quality and control of corruption (as of 2009).

The private corporate sector of the country, in particular has immense potential — access to innovation, upgraded technology, larger markets (both international and local) and greater avenues to raise/invest finances. A necessary and sufficient condition for the private corporate sector to grow is open unrestrictive policies. Support from the government on this front will enable unlock the risk-appetite of entrepreneurs and investors, small and large alike, across the country.

Bureaucracy is yet another limitation that the country is grappling with. While, blueprints such as the Direct Tax Code and Goods and Services Tax are revolutionary in nature; expected to take processes in the country closer to global best practices and unison, their implementation has missed deadlines more than once. As much as democracy and democratic processes are to be respected, the same due to lack of consensus and mismanagement of diversity is proving to become an economic cost for the country.

Gradualism, as against a ‘big-bang approach’ has historically worked well for India. However, if moderation and lack of interest sets in the very pace of gradualism, the objective of any change is lost. In brief, the efficiency levels of the Indian economy are low with utilisation of existing capacity (raw material base and technological competence) falling below expectations; theoretically speaking we are under-performing vis-à-vis the hypothetical full employment level.

The Way Ahead — Defying the Rust?
A two pronged approach is perhaps best suited to tackle the inherent ‘dualism’ of the Indian economy. While on the one hand, there is a section of the economy that has access to resources but is tied by inadequate choices in the modes of deploying them, on the other hand, there is another segment that is precisely cut-off from the very opportunities of development.

The strategy involves the promotion of competitive spirit for the entrepreneurial class, but consequent on providing a freer business environment. A uniform increase in caps and limits, such as limits on ECB holdings, FIIs and FDIs, access to foreign financial and consumer markets, takeover and acquisition and a fast fair judiciary may be perceived as composing the “horizontal expansion component”.

The second component of this two-pronged approach may be termed as the “vertical penetration component”. This would involve the targeting of social support programs that would primarily focus on reducing the proportion of individuals below the poverty line and secondly, provide prospects of income growth. Skill enhancement, training and provision of social security will further enable inclusion of the unorganized sector into the mainstream economy.

A concern that lingers in the economy is the concentration of growth in pockets. The axis of growth primarily remains confined to the western zone of the country. Though states in general have improved their financial positions and their overall economic strength; some states still grapple with impeded growth in priority sectors. A vertical penetration program can target developmental resources specifically towards these segments. Going forward, these regions and segments of the population shall provide for new markets, becoming drivers of growth.

The growth story of India still has immense potential. We firstly and definitely require a concerted effort at improving process flows that would ensure speed and efficiency in the economy. Secondly, considering that domestic and foreign fund flows have been strong, we need to prioritize and target these resources. Lastly, recognizing that any interest in the economy as an investment destination will last only as long as performance reflects, we have to ensure both quantum and quality in our deliverables. This would surely and steadily, lend a new direction to the optimism with regard to growth in the Indian economy. 

(Krithika is currently Associate Economist at CARE Ratings Ltd. Her concentration at CARE pertains to Sub-Sovereign Ratings and Macro-Economic research and reporting. She has been working on the fixed-income side and brings out the CARE Debt Market Review, a monthly bulletin. Krithika has contributed articles such as “Striking a Fine Balance” on the economy of Maharashtra and “Charting Blueprint” on the Budget 2011 to the magazines such as Investment Destination and Search, has written a paper on Government Debt: status and road ahead for the CARE Debt Market Summit, 2010 and partakes as a panellist on discussions on macro-economic indicators in the media. She has also worked on designing a “Measure of Liquidity in the economy” with the Chief Economist of CARE. She is a Gold-medallist in Economics, having done her Masters in Economics from the University of Mumbai and graduation in Economics (with three-year integrated Honours programme) from St. Xavier’s College, Mumbai.

The views expressed in the article are personal and do not reflect the official policy or position of the organisation.)


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