Can India Live Up to Its Potential?

Op-Ed / Opinion | 16 June 2005

India is a paradox. The success of a group of sectors, from information technology to industry and services, is creating an urban elite showcased as the builders of a modern and vibrant country on the cusp of joining the world's major economic powers.

But just outside their corporate campuses and air-conditioned shopping malls, 840 million Indians continue to survive on less than US$2 (S$3.30) a day.

An increasing gulf between these groups poses a major social, political and economic dilemma. The challenge is threefold. India must create rapid growth in the number and size of its islands of excellence; it must strengthen the development of bypassed regions and peoples; and it must expand the ability of the poor to improve their economic lot.

India's future will depend on how well and how quickly it meets these challenges to ignite growth, broaden its inclusiveness and sustain a long period of inclusive growth.

India's growth prospects are bright. Per capita income is less than a tenth of that of the United States, leaving plenty of room to grow while remaining competitive.

In the coming years, a demographic dividend will significantly increase the growth rate of the working-age population. The consequent decline in the dependency ratio could lead to an increase in savings and investment rates.

These three factors together could make annual growth rates of 8 to 9 per cent achievable over the next two decades, up from average growth of about 6 per cent in the past decade.

If these growth rates were realised, India is projected to rise to third, after China and the US, in terms of share of world gross domestic product (GDP) at purchasing power parity by 2025. This prospect has greatly heightened interest in India's future.

Igniting and sustaining higher growth rates will require bold action. In the medium term, India will need to introduce aggressive reforms to address central challenges.

Macroeconomic imbalances, particularly budget deficits running at close to 10 per cent of GDP, must be corrected. This problem is aggravated by deficit financing of a lot of poorly targeted expenditure on subsidies for power, fertiliser and loss-incurring state-owned enterprises.

Linked to the budget deficits, under-investment in social and physical infrastructure has to be reversed. Highly distorted land and labour markets must give way to greater competition and flexibility with security.

Institutional strengthening for improved governance is required to improve the business and investment climate and reduce transaction costs for investors. These reforms are preconditions for productivity improvements. The government will play a critical role in making them happen.

But there are considerable political obstacles to change in each of these areas as reform will produce both winners and losers. This makes it imperative that the government is able to expand the constituency for reform.

In this regard, early success of the government's Common Minimum Programme that focuses on improving the well-being of farmers and low-income citizens takes on heightened importance. The programme focuses on increasing infrastructure in rural areas, providing universal access to basic education and health, as well as guaranteeing 100 days of minimum wage employment for one person in each poor household.

Public investment, carefully targeted public expenditure programmes and strengthened governance are critical to the success of this programme.

Inclusive growth will require smart government spending. First, revenue generation, both in quantity and quality, must improve. Rapid and sustained GDP growth is necessary for increased budget revenue. While acknowledging the importance of government action in broadening inclusiveness, it is important to keep in mind that the government can only serve as a catalyst by ensuring the provision of adequate public goods and services.

Economic growth is the driver of improvements in living standards, especially for the desperately poor. And it is the private sector that will be the engine of growth and the creator of new jobs.

Greater integration with the world economy is an area of great promise, but India lacks a political consensus for open markets. The country accounts for only about 0.8 per cent of world trade. The share of trade in GDP is 22 per cent. Greater trade openness will promote learning, impart market discipline and increase productivity at the corporate level by exposing Indian firms to intense competition and encouraging technology improvements.

In responding to the trade liberalisation of the 1990s, India has demonstrated it has world-class firms with an increasing share of profits coming from foreign sales. These firms have demonstrated their competitiveness by exploiting India's software capabilities, domain knowledge and its large pool of educated technocrats. These capabilities have also led to an expansion of research and development and the advancement of technology in key sectors.

But globalisation and competition pose a dilemma. To benefit from the opportunities offered by globalisation, India's institutions, infrastructure and incentive regimes must be harmonised with those of its competitors. Without this benchmarking, Indian firms will face major constraints to becoming, and remaining, competitive.

Reforms, in turn, could result in significant short- and medium-term adjustment costs. The benefits would take longer to realise, but once realised, they would increase exponentially.

The political economy ramifications of short- to medium-term pain versus long-term gain will determine the pace and nature of reform.

Two more factors will be critical to India's growth path - its ability to strengthen interdependence with industrial countries and energy security.

India's ability to ignite and sustain an 8 to 9 per cent growth rate will depend on how effectively it can exploit the opportunities presented by globalisation, which provides an outlet for sustained export growth and a means for improved technology.

Growth of manufactured exports could trigger an industrialisation process that has barely begun and could provide a major source of jobs. Manufacturing requires energy and energy costs will be an increasingly important aspect of competitiveness.

High prices could constrain greater participation in global trade. India has large coal supplies and must learn to use them in an environmentally friendly way. Its neighbours have both hydropower and hydrocarbon energy sources but tapping them would require a dramatic shift in the political and security mindset.

India's ascendance is not assured. It must balance a challenging combination of competition, cooperation and coordination as it strengthens its interdependence with industrial countries, deepens integration with its neighbours and broadens inclusiveness within the country.

Bold and sustained reforms designed to make economic efficiency and social justice mutually reinforcing are needed to realise its potential.

The Indian elephant has begun to stir. Whether it will start off on a lively march that will improve the lives of hundreds of millions of poor people will depend on a complex set of interacting social, political and economic factors.