India's growth prospects

Financial Express, 27 September 2007

Over the last one year the spectacular perfomance of GDP growth in India led to many sceptics wondering if India was overheating. The recent crisis in the US economy has added to the concern that India faces a slowdown. While it is true that a downturn in the US economy adds to the risks that India faces, and the domestic business cycle may move down with a global business cycle, the medium term prospects for the Indian economy remain strong.

India's rapid growth for the last 3 years is seen to be a puzzle by many students of the Indian economy. India's dilapidated infrastructure is often compared with China's wonderfully planned roads. How can the present rates of 8-9 percent GDP growth in India possibly be sustained? Will not the infrastructure, shortages of power and roads and a poorly educated labour force pull Indian growth down?

While it appears reasonable that there is a cause for concern, it is still not evident that medium term growth is showing signs of slowing down. Recent data shows that there is a sharp increase in investment activity. CMIE's capex data on projects under implementation shows that nearly half of investment being planned is in infrastructure -- in power and transport. National Income Accounts data for investment shows that Gross Fixed Capital Formation rose to 27.9 percent of GDP in 2006-07. This was 1.4 percent higher than in 2005-06. In the mid-1990s, there was an investment boom with investment outstanding showing levels as much as 30 per cent year-on-year growth. In recent years, a powerful investment revival is visible, with year-on-year growth reaching a 64.5 percent in March 2007.

Will the sharp growth in investment not be able to deliver high growth because it would hit a labour shortage? Will high salaries push up costs and make companies unprofitable? While sharply rising wages are giving CEO's sleepless nights, this has not affected profit margins yet. The concern is that since there is no sustained effort by the government to improve supply, it soon will. While it is true that the government is not making any meaningful effort to supplement supply by improving education, there are other factors at work.

These include learning by doing on the job by thousands of young people who have completed school and are eager to improve their skills. From 1991 onwards, a next-generation labour force has been built in India. This comprises of young people who have grown up working in private firms in the context of competition and globalisation. What they have learned on the job is qualitatively superior to the skills found in India in the olden days.

While education in government schools may not teach children to read and write, with the first few extra rupees parents earn, children are admitted into private schools in the hope that they would learn some English. As a result, nearly half of urban children and one fourth of rural children in India go to private schools. The quality of education in these unregulated schools may not be very high, but the pressure of paying parents and children wanting to join the labour force will, no doubt, act as a significant force.

These two aspects imply that while weak education is no doubt a drag on the economy, it may not be hold back the economy to the extent that some people fear.

A third source of potential trouble is sometimes seen to be the inflow of global capital into India. Global capital, with its destabilising characteristics is feared by many in the country, especially in the policy making circles, who are used to being able to manage the macroeconomy much more easily. Today it is the norm, rather than the exception, for every international finance company to be part of the India story. This has done India good on two fronts. First, it has helped India raise its investment rate above the domestic saving rate. Second, it has brought modern practices into India's domestic financial markets, put pressure to improve corporate governance and create a competitive environment. Morevoer, through all of India's natural disaters like the earthquake and the supercylone and the government made disaster like the nuclear tests, global capital has stayed around. In recent days, India again proved to be a hot favorite as money flowed into India after the rise in Fed rates.

There is no doubt that a more globalised economy does make India more susceptible to global business cycles. A downturn in the US economy could shake India much more than it could have done 20 years ago. It is also true that India still has a lot of problems to solve -- these include urban plannning, governance, labour laws, monetary policy, infrastructure and so on. Yet, it it too soon to declare that we are not solving the problems we are facing and it is inevitable that there will be a slowdown in the medium term.

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