Indias growth prospects

Written by Ila Patnaik | Updated: Sep 28 2007, 05:10am hrs
Over the last one year, Indias spectacular GDP growth performance led many sceptics to wonder 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.

Indias unprecedented fast growth over the last three years is seen as a puzzle by some students of the Indian economy. Indias dilapidated infrastructure is often compared with Chinas wonderfully planned roads. How can the present rates of 8-9% GDP growth in India possibly be sustainedWill not infrastructure gaps, power shortages, apologies for roads and a poorly educated labour force pull Indian growth down at some point

While it appears reasonable that there should be 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. CMIEs capex data on projects under implementation shows that nearly half the investment being planned is in infrastructurepower and transport. National Income Accounts data for investment shows that Gross Fixed Capital Formation rose to 27.9% of GDP in 2006-07. This was 1.4% higher than in 2005-06. In the mid-1990s, there was an investment boom, with investment outstanding showing levels as high as 30% year-on-year growth. In recent years, a powerful investment revival has taken place, with year-on-year growth reaching 64.5% in March 2007.

Will the investment boom 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 said to be giving CEOs 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. Indeed, from 1991 onwards, a next-generation labour force has emerged in India. This comprises young people who have grown up working in private firms, and thus began their careers 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, parents admit their children to private schools with the first few extra rupees they earn 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 of children wanting to join the labour force will, no doubt, act as a significant force.

These two aspects imply that while weak education is an obvious drag on the economy, it may not hold the economy back 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 people in India, especially in policymaking circles, who are used to being able to manage the macroeconomy much more easily. Today, it is the norm, rather than exception, for every international finance company to be part of the India story. This has done India good on two counts. First, it has helped India raise its investment rate above the domestic saving rate. Second, it has brought modern practices to Indias domestic financial markets, and pressured the country to improve corporate governance and create a competitive environment. Moreover, through all of Indias natural disasters, like the earthquake and supercyclone, and state-made ones like the nuclear tests, global capital has stayed around. In recent days, India again proved to be a hot favourite, as money flowed into India after the cut 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 solvethese include urban planning, governance, labour laws, monetary policy, infrastructure and so on. These are indeed troublesome problems on which progress has often seemed much too slow. Yet, it is too soon to declare defeat. Or that a slowdown in the medium term is somehow inevitable.

Ila Patnaik is senior fellow at National Institute of Public Finance and Policy. These are herpersonal views