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Building A Better India

Luis Pita
08/12/2003

BUILDING A BETTER INDIA

OUTLINE

1. Who is India’s enemy?
2. Is the current situation so bad?
3. What are the plans for the future?
4. Building a better India

WHO IS INDIA’S ENEMY?

In the afternoon of March 20th 2003, a group of MIT MBA students and I were having coffee with A.P.J. Abdul Kalam, President of India, and one of the most impressive persons I have ever met. During our conversation with the President, he mentioned an anecdote that happened to him when talking to some high-school students in the north of the country:

“I asked the students a simply but powerful question: Who is India’s enemy? Some of the students said Pakistan, others China. Then one of the students stood up and said: Our enemy is poverty”

For the President, as for the child, it is clear that the main challenge of India is to cope with underdevelopment and poverty. I completely share his vision, and this is why this paper is focused on how to build a better and more developed country, and how to end with poverty.

By the end of the meeting, the President asked us:

“And you, the leaders of tomorrow, what are you going to do to solve this problem?” During the rest of the trip I was thinking continuously what I could do to help. I loved India. I loved its people, its culture and its traditions. I think that India has a lot to teach the world and a lot of value to add to our whole society. This is why it hurts me so deeply to see it underdeveloped.

IS THE CURRENT SITUATION SO BAD?

Yes, for two reasons:
a) India’s current macroeconomic situation is weak compared to its key competitors
b) The perspective in the future is not much better

A. India’s current situation

By the beginning of the 1990s, China and India were almost in parity in terms of economic indicators. In 1991 India suffered an important balance of payment crisis. The crisis was a painful but valuable wake-up call. It was the driving force behind an ambitious reform program undertaken during the following years. The reform program included a significant industrial and trade liberalization; financial deregulation; improvements to supervisory and regulatory systems; and policies encouraging foreign direct investment.

India made impressive progress over these years:

• GDP growth averaged 6 percent a year, led by strong advances in the services sector. The IT industry was particularly dynamic and is now of global renown proving that India is perfectly capable of competing and succeeding at the top international levels.
• Poverty dropped significantly, from 55 percent of the population in 1974 to an estimated 26 percent in 2000. Life expectancy increased from 55 to 63 years; the infant mortality rate dropped from 108 to 70 per thousand live births; and literacy rose from 45 to 68 percent for men and from 29 to 45 percent for women.
• The external position also strengthened: since the 1991 balance of payments crisis, official reserves have risen steadily and now stand in excess of six months of goods and services imports.

Unfortunately, the economic momentum achieved through the early part of the 1990s has not been maintained. Growth has been slowing since 1997. While a number of external causes can be pointed to — droughts, high energy prices, the earthquake in Gujarat — it is more plausible to attribute the growth slowdown fundamentally to a slackening in the pace of reform.

Moreover, China, India’s main competitor in terms of foreign investment destination and regional preponderance, has done significantly better than India, and now almost doubles it in economic terms:

Key Economic Indicators (2001) India China GDP (US$ billion) GDP per head (ppp US$) GDP growth (%) Inflation (%) Current account balance (% GDP) External debt (% GDP) Population (million) Population growth (%) 485 2,489 5.4 3.7 -0.6 21 1,027 2.5 1180 5,575 8.2 0.7 20.1 12 1,295 0.7

Growth during the past decade has not been sufficiently broadly based. Despite the impressive performance of the services sector, industrial growth — which still has the greatest potential to provide high-wage employment for the 70 percent of the labor force still working in agriculture — has slowed sharply since the middle of the decade. India's appalling infrastructure has also been a major constraint to higher rates of growth. Although recent government pronouncements have increasingly emphasized the need to secure investment in major infrastructure projects, real progress has only been made in the "new economy" telecommunications sector. Power shortages amounted to 6% of total demand, rising to over 12% at peak times. Official targets for increased generation capacity have been set below required levels for decades, and even these have not been met.

An unwieldy fiscal deficit makes things worst. It reached 6.6% of GDP in 1991/92, when India experienced a payments crisis. Sustained attempts at fiscal restraint brought it down to 4.1% in 1996-97. The succession of weak coalition governments that followed raised it to about 5.9% in 2001/02. The states run another 1.5-2% of deficit. As a consequence of this underdeveloped economic situation, about 260 million Indians still live below the official poverty line.

B. Future perspective

Roberto Rigobón, Professor of Macroeconomics at the Massachusetts Institute of Technology, used to tell us that the best way to evaluate the future perspectives of a country is to talk to the people at the streets: taxi drivers, shop sellers, etc. So that is what I did during the trip…

I asked all the people that I met what was their perspective for the future: the CEOs of the biggest Indian Corporations, the hotel room service, the poor people at the street, the shop sellers, the taxi drivers, the business students, the politicians, the policemen and the farmers.

There were two clearly different views of the future of India:

• The view of politicians and top executives: they shared an optimistic view of the country potential. Nevertheless, they were afraid of the increasing threaten of Chinese competition.
• The rest of the people had quite a pessimistic view of their future, what hinders consumption and private investments.

Foreign investors also share a pessimist view on the future of India, which contrasts dramatically with their optimism about China’s growth. Investors believe that India will be an important player in the service outsourcing sector, but will not held a significant internal demand or exporting manufacturing capacity. They think that very few Indian companies will become big international players. This perception, together with higher that average import duty and indirect taxes, discourages foreign direct investment: $35 million in 2002, compared to $50 billion for China. International markets have a clear winner — China — and are betting for it.

WHAT ARE THE PLANS FOR THE FUTURE?

India has a long tradition of economic planning, starting just after its independence. The quality of its planners and policymakers is widely recognized:

“In some countries, a speaker from abroad can bring fresh analytical insights and experience to bear, and frame the domestic debate. That is not really the case in India. Indian policymakers know full well about the important impediments to stronger growth […]. Economic policy discussions in India are at a high level. Indian government commissions and reports are generally highly professional and highly relevant to the issues at hand. On the question of how to increase India's growth to 8-9 percent per annum — rates that are entirely possible at this stage of economic development — there is no better guide than the excellent report in February last year of the Prime Minister's Economic Advisory Council, which laid out an impressive and comprehensive agenda for second-generation reforms.” (Stanley Fischer, IMF, Special Advisor to the MD) In December 2002, the Planning Commission of the Government of India issued “India Vision 2020”. This is a roadmap of policies and reforms aimed at providing sustained growth and self-reliance for the nation for the next two decades. It focuses on the following key development areas:

• Agriculture and food processing: with a target of 360 million tones of food and agricultural products in a year. Including other areas of agriculture and agro-food processing that bring food security and prosperity to rural people and speed up economic growth.
• Education and healthcare: aimed at increasing the employment potential leading to social security and population control.
• Infrastructure development: including reliable and quality electric power for all parts of the country, vital for all core sectors.
• Information and communications technology: promoting education in remote areas and creating massive employment and national wealth through export earning.

The “India Vision 2020” roadmap envisions key economic reforms in these areas, from industrial deregulation to labor market reforms, agriculture reform and modernization of infrastructures.

Industrial deregulation

Priorities include eliminating preferences for small-scale producers, further easing constraints on foreign direct investment, streamlining regulatory procedures, and revamping bankruptcy legislation.

Privatization of key industrial sectors is expected to increase dramatically its productivity:

Labor market reform

The repeal of legislation blocking layoffs in medium- and large-sized firms, plus legislation to ease constraints on the hiring of contract labor will also foster competitiveness and productivity:

Agricultural reform

Controls on the prices, trade and movement of agricultural commodities will be abolished. A sharp reduction in the role of government procurement agencies and the dereservation of agricultural processing would also be sensible. The costs of the existing system are visible in the growth in government food stocks, which represent a significant drain on the fiscal accounts and which far exceed what is needed for food security.

Reform of the power sector

This is primarily the responsibility of the states. But the central government will have to help them by making funding conditional on necessary reforms. For example, metering, energy audits, commercialization of distribution, and the raising of tariffs to economically sensible levels.

BUILDING A BETTER INDIA

After reading all the articles and plans about India’s development that I could find, there were some specific areas which I would like to tackle here. I would expose my personal beliefs on overpopulation, government structure and investment policies that are, in certain way, quite different to the existing thinking about India.

Overpopulation

During the whole trip, none of the leaders that we met mentioned overpopulation as one of the biggest problems for India’s development. Nevertheless, I strongly believe that this is one of the main issues that hinders development, as it limits the GDP growth per capita and the development of a strong internal demand for goods other than food.

China, for example, launched several national initiatives, that reduced dramatically the population growth and had a positive impact on the income per capita:

India is the largest democracy in the world, and discussing openly about birth control in democracies is usually a risky exercise for the politicians. I don’t think that India Government should issue the same kind of top-down laws and policies as the China Government, but should definitively commit publicly on strong measures on this front, through mass education and the media. For instance in Venezuela, a very successful birth control program was backed by the most popular soap operas, that started educating the population on the poverty and problems associated to having too many kids.

Government structure inefficiency

India currently has a delicate balance between the Central Government and the States. The fact that the governing party needs the support of local parties creates a situation where the Government is not able to apply the right policies and reforms, because of the pressure from certain states and minority parties.

Prior to launching an ambitious strategic program of economic reforms, India should establish a political and governing structure that allows these reforms to be successfully implemented.

In my opinion, local parties should not run for the India’s parliament, but only for the state ones. This system would incentivize the parties to look for the interest of the whole nation, and not only of a particular region.

Investment policy

To carry on with its planned growth rate, India needs to sustain an enormous investment effort. The Government has selected some preferred sectors for these investments, where India possesses a competitive advantage versus other countries.

In addition to this sector-selective investment policy, I believe that India should focus its investments on certain regions. This would allow to develop good infrastructures in same key areas and to boost the internal demand in these markets. The returns on these areas could be lately used to develop other regions. This method was used in China, where most of the foreign investment was directed to five key developing areas.

It can be argued that this method produces strong inequalities among regions. This is true in the short term, but the reality is that the fast growth of the preferred areas is contagious in the medium term to all the surrounding regions. This is why, from the twenty fastest growing regions in the world, sixteen belong to China.

A former director of IIT Madras explains this argument with very simply and powerful analogy:

“Suppose you have three children. Would you give for Diwali a new shirt for only one child, and nothing for the other two? Almost definitely not! That would be unfair. However, suppose, you have money for only one shirt, and no more. Which would you prefer - to stitch a shirt in turn for the three children, or give all three of them a banian each year? Think!

This is a problem in queuing theory. The way traffic lights operate provides the solution. At any one time, traffic lights halt traffic in all but one direction. However, they rotate the green light to let through traffic in all directions by turns. It would appear at first sight highly undemocratic to prefer one direction over all others - to halt traffic in all other directions. However, as we all know from bitter experience, when traffic is allowed democratically from all directions, the result is utter chaos. Nothing moves.

India's development is in a similar predicament. Investment is spread everywhere and too thinly to be viable. […] When resources are spread thinly, change will occur in a number of small steps, often too small to be progressive. They could actually obstruct progress - the way our congested roads do. On the other hand, when we plan development like traffic lights, progress is swift. Facilities are installed in one go. There will be less risk of damage to quality. Thus, we can guarantee proper progress but only by taking different locations by turns.” (P.V. Indiresan, former Director of IIT Madras)

SOURCES OF INFORMATION

• “India Country Profile 2002”. The Economist Intelligence Unit, 2002.
• “India Commerce Report 2002”. The Economist Intelligence Unit, 2002.
• “India Vision 2020”. Planning Commission Government of India, 2002.
• “India’s China problem”. Business Week Articles, 2002.
• “China - India, Comparison on Economic & Social-Economic factors”. "China Daily", Beijing edition 2000.
• “Breaking Out of the Third World: India's Economic Imperative”. Stanley Fischer, Special Advisor to the Managing Director. India Today Conclave, 2002.
• “Vision for 2002”. Dr. A.P.J. Abdul Kalam. The Nation, 2003.
• “Are we only a paper tiger?”. Financial Times, 2002.
• “India, from emerging to surging”. McKinsey Quarterly 4 2001.
• “India and China: Asia’s non-identical twins”. McKinsey Quarterly 2 1995.

(During the Spring of 2003, about two dozen MBA students from MIT Sloan School of Management enrolled in a Special Course related to India and spent 10 days in India. Dr. Amar Gupta, Co-Director of the PROFIT Initiative at the MIT Sloan School, served as the Faculty Advisor for this course. The student papers dealt with a wide variety of topics including Finding Profit Opportunities in the Indian Fast Moving Consumer Goods Market, The Business Process Outsourcing Industry in India, A Rich Diaspora, The Hindu Growth Dilemma: Talented Apathy?, Overview of the Indian Power Sector, Biocon India: A Market & Non-Market Strategy, The Role of Microfinance in Reducing Poverty, Steps for India to Spur Economic Growth, Patent Law Changes in India - Effect on the Pharmaceutical Industry, Building a Better India, Comments on India's Future Economic Development Strategy, ICICI: Indian Financial Services for the Future, Hindustan Lever and the Challenges of Rural Marketing in India, Opportunities, Challenges and Innovations in Marketing Consumer Goods to Rural India: Observations of a First-time Visitor, and Indian Banking: History of Reform and Personal Observations from Recent India Trip and will be published in upcoming issues of Lokvani newsletters. )

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