AFTER a gap of seven years, India will have successive years of above average growth. The average is what the economy has maintained since 1980: about 5.8% GDP growth. Last year (2003-04), India did 8.2% on the back of strong agricultural recovery; that was the best show of the last 15 years. This year now promises to be at least 6%, and perhaps 6.5%. The average for the two years will thus be over 7% – the first time we would have done this after the high noon of 1994-97.
That last demonstration of businessmen’s ‘animal spirits’ – that Keynesian phrase used frequently by Manmohan Singh – ended with a lot of pain. There was over-heating of the system, manifested in excessive credit growth, rising inflation and too much capacity creation; the managers of the economy responded with a sharp hike in interest rates and a credit squeeze that caught everyone by surprise. There was a collapse of demand, so there were no buyers to match all the new capacity in everything from steel to cement, and from cars to consumer durables. If we ignore the internet bubble of 1999-2000 as an unrelated interregnum, it has taken the economy seven long years to get over the after-shock. At long last, the system began bubbling over last year. And now, despite a sub-normal monsoon and record oil prices, business confidence has remained high as the economy has sustained a creditable growth momentum. The NCAER’s business confidence index in October matched that in January, after a dip in between when the new government was settling down.
With good reason. Industrial growth in October crossed into double-digits for the first time in three years. Export growth in November was a flattering 26%. Investment demand for creating new capacity has surged, as has the related phenomenon of bank credit. Tax revenue is buoyant, the stock market’s indices are at all-time highs, and investor confidence in the future is reflected in the high price-earnings ratios (getting close to 20).
Many factors have helped. There has been cheap credit, riding on the back of low interest rates in a still benign inflationary context (7% is lower than India’s long-term average, and this has been a year of high oil prices). Once interest rates adjusted to the lower trend inflation numbers, consumers took advantage and there was a burst of credit-driven demand for everything from housing to cars and even the buying of consumer durables. Second, the cumulative impact of demand growth since 1997 finally led to the using up of much of the capacity built in the mid-1990s, so that businesses are no longer in trouble. Third, the lower interest rates meant that companies saw their cost of funds dropping, and this along with the greater rates of capacity utilization showed up in a sharp spurt in profits – 22% in the July-September quarter this year, over the same quarter of 2003. So businesses are in better shape and in a position once again to think of investment and expansion.
The global economic situation has also been benign. First, there has been the sustained boom in the prices of metals: everything from steel to copper and aluminium has seen record prices, so that all the metals producers in the country have had their day in the sun. The spurt in the stock prices of both Tata Steel and SAIL tell their own story. Second, the twin deficits (on the budget and on the trade account) that the US has been running at record and ever growing levels has resulted in a surge in global trade (and record shipping rates as a consequence), as well as greater global liquidity than anyone can remember. The trade growth has meant that Indian exports have maintained double-digit growth two years in a row, and a three-to-one export-import ratio with the US. With exports now accounting for 15% of GDP, and the commerce minister hoping to sustain this growth over the next five years, this export momentum alone has contributed handsomely to overall GDP growth.
Also, with so much money sloshing around in the world’s money markets and with the dollar weakening, vast sums of money have naturally flowed into the emerging markets and stock prices in virtually all countries have been on an upward climb; in many, they have gone through the roof. The net fund flows from foreign institutional investors into India topped $6 billion in 2003 and $8 billion in 2004, compared to a half or even a third of that level in previous years. The result is that the stock market has ridden a wave of optimism; the Bombay Sensex, the most closely tracked of all the stock indices, climbed from 3600 in the third quarter of 2003 to record levels of 6200 six months later, then plunged to 4500 because of political confusion before climbing back up to 6300 towards the end of the year on the back of renewed optimism.
Simultaneously, money has flowed into real estate at a significant level for the first time since the price bubble of 1995-96 burst. Hot spots like Gurgaon and Noida (satellite towns around the capital) have seen land and flat prices climb 50% in the space of a year; less favoured spots too have seen 25% price inflation, and the boom seems to have spread to the small towns. This along with the surge in stock prices has meant that, suddenly, there is the return of the wealth effect.
When things start looking good, even the secondary indices contribute to the feeling of well-being. Surveys have shown, for instance, that the suddenly prosperous Indian companies handed out the biggest pay increases in 2004 (about 14.5%), well ahead of their counterparts in all other Asian economies. Companies stopped talking of downsizing and began hiring again. Advertising spends began to climb. The general upswing began in late 2003, as the record kharif harvest began coming in, resulting a year ago in the BJP’s ‘India Shining’ campaign – much derided in political circles but acknowledged in business circles as reflecting reality for them. And so, despite an indifferent and even below-par monsoon in 2004 and record oil prices, there is an air of sunny optimism in business circles. In other words, not just the wealth effect but also the broader feel-good factor – again, not as a political slogan but a business reality.
In part, the new feel-good factor reflects the business community’s sense of itself. Eight years ago, the majority of Indian business houses and companies were still destroyers of capital, in that the return on the capital they used was lower than the cost of that capital. This meant they did not have a positive EVA (or economic value added). In part, this was because the cost of capital then was very high (interest rates on bank loans ranged from 18% to 22%), so earning a rate of return, which topped that, meant you had to be very lucky. But with prime lending rates still moderate, a positive EVA today is much easier to achieve. But that is only half the story. For companies have also trimmed fat, improved quality, invested in new technology, honed their marketing skills and achieved amazing transformations on the shop floor. The result is that they are using both capital and labour more efficiently, and this has helped them improve their rates of return on capital employed.
Tata Motors, which famously lost Rs 500 crore not so long ago, addressed core issues so as to drop its break-even level to two-thirds of the sales level required until then; this meant that the company could break even in a poor year, and do very well indeed when times were normal. The results in subsequent years have shown this. Now Mahindra and Mahindra, which used to have negative cash flow on its core business not so long ago, has done the same thing – and its buoyant share price (like that of Tata Motors) reflects the new business reality.
In sector after sector, companies have shown that they are not the same flabby animals of times past. Whether it is Jubilant Organys, a speciality chemicals company that is transforming itself into a pharma firm, or Bharat Forge, which represents the new age of confidence among automobile component manufacturers, or TVS Motors which has come back to life after a near-death situation, or Shriram Fibres, or a host of other companies, there is a new level of confidence that comes from knowing that they have become globally competitive and that the only thing that can stop them is a lack of ambition and imagination.
That confidence now manifests itself in Indian companies treating the world as their oyster. The privatized Videsh Sanchar Nigam bought Tyco Global Networks in order to increase its international carrying capacity. Before that, Reliance bought Flag. In between, Tata Motors bought Daewoo’s heavy commercial vehicle business in South Korea and Hindalco and Sterlite bought large mines in Australia. Pharma companies, engineering firms and software outfits have all been investing in companies around the world. Indian firms have been seeking either secure access to raw materials (Hindalco and Sterlite), or a powerful brand that brings with it readymade customers (Tata Tea’s acquisition of Tetley), or the opportunity to marry front-end operations in Germany or Britain with back-end operations in the home country, or have just responded to opportunity (the distress sale of Flag and Tyco at a fraction of the cost of setting up their undersea cable networks).
For good measure, both the public sector oil giants (Indian Oil and ONGC) have been investing in oil fields in countries as far apart as Sudan and Vietnam, in the quest for secure oil supplies. In 2004 alone, Indian companies spent over a billion dollars acquiring companies overseas. No one could have forecast that when the reforms began in 1991 and India was shipping gold overseas because it didn’t have enough foreign exchange. Lakshmi Mittal does not represent domestic businessmen, but his being crowned as the king of the global steel industry has a certain domestic resonance in the total context of Indian business.
Through it all, the rapid-growth industries have sustained their tempo. Telecom companies continue to rope in more than 1.5 million customers every month – and now some of the new telecom firms are handsomely profitable to boot. Bharti (which runs the largest private network) reported a 250% growth in profits in the July-September quarter. Hutch (which is privately held and therefore does not release its financial numbers) hopes to earn $180 million as net profit next year, on a turnover of $1.2 billion.
But even that pales in comparison with what the software companies have managed to achieve. Shaking off the post-internet bubble slump, as also the controversy over offshoring and outsourcing, companies like Infosys have ramped up annual growth rates to 50% and more. The industry as a whole, with a turnover last year of $12 billion, should add a third to that number in 2004-05 (or about $4 billion). Break that number down into what it means for jobs and downstream demand, and it is easy to see that software alone will add more than 0.5% growth directly to GDP numbers this year, and at a safe guess as much more indirectly. At an average revenue per employee of about $20,000, additional business of $4 billion in a year means 200,000 more jobs.
At 75 square feet of office space for every one of those employees, the new office space required in one year is 15 million sq ft. Going by the thumb rule that every square foot of office space must be matched by 7 sq ft of residential building, there will be over 100 million sq ft of residential buildings. At an average price per flat of Rs 1000 per sq ft, that’s housing demand of Rs 10,000 crore, with even more to be spent in terms of furnishings and household gadgets. The demand for cement, steel, bricks and so on can be easily imagined. In effect, you will perhaps be adding a whole new township each year, with the attendant demand for schools and hospitals, roads and transport. Add it all up and you are going to get a new boost to GDP from an industry that did not exist as a significant contributor to the economy even five years ago. Is it any wonder, then, that we are now getting back-to-back years of above average growth?
But this isn’t just a services story. Because there are spreading circles of competence and competitiveness in Indian manufacturing. First, there was pharmaceuticals. Then it was automobile ancillaries. Now it is becoming cars, with the export of 100,000 cars annually. Soon it will be textiles, as the global trade in textiles becomes subject to new rules from January. India will be one of the beneficiaries, since its exports to non-quota countries has traditionally grown faster than its exports to quota countries. The evidence so far suggests that India hasn’t done the kind of preparatory work it should have by now, and that the Chinese and some others have been more pro-active, judging by the numbers of new spindles ordered by different countries. But it’s early days, and the guys in Tiruppur and elsewhere are not to be underestimated.
Oddly enough, the government isn’t talking of India shining, except when it has to give an account of its own record. Instead, it is focusing on those who have been left out of the success stories, a natural sequel to the interpretation of the general election results as the demand that reforms have a ‘human face’. In truth, the new focus of policy is determined by two unrelated events. The first is the dependence of the UPA government on the Left, which bagged a record 63 seats in the Lok Sabha because it benefited from the implosion of Mamata Banerjee’s Trinamul Congress in West Bengal and the civil war between the Antony and Karunakaran factions in Kerala’s Congress. The second is Sonia Gandhi’s long-held conviction that the 1991-96 reform exercise did little to benefit the ‘aam aadmi’.
So we have the defining tension of the new government: between (on the one hand) the reformist trio of Manmohan Singh, P. Chidambaram and Montek Singh Ahluwalia, who would like to carry on from where they left off in 1996, and (on the other) the Left Front as well as the National Advisory Council, with Sonia Gandhi in the chair and activist-members like Aruna Roy and Jean Dreze who know what kind of human face is needed. The latter drafted the common minimum programme, with promises like guaranteed rural employment. The former has tried surreptitiously to chart an alternative course, and would rather focus on fiscal abstinence and, if possible, on improving the country’s abysmally inadequate infrastructure: crummy airports, decrepit railways, chaotic roads and overcrowded ports, not to speak of a poor power situation.
And so we have two competing demands: Montek at the Planning Commission wants to spend an extra Rs 25,000 crore every year on infrastructure investment. And Sonia wants to spend Rs 40,000 crore annually on providing 100 days of guaranteed work for one member of every poor rural family. Taken together, that will mean increasing the fiscal deficit by 2%, wiping out whatever rectitude has been managed in the last 14 years, and also kissing goodbye to the goals enshrined in the fiscal responsibility and budget management law on which the ink is barely dry!
The debate on the wisdom of these two proposals dominated the policy agenda-setting exercise for the new government only because some of the leftover items from the reformists’ agenda (the so-called second phase of reforms) have been crossed out by the Left, marking areas where the reformers must now fear to tread. One is labour law reform: there is simply no way in which this government can get legislation passed on the subject, because the Left will not vote for it and the BJP will not want to allow the Congress any parliamentary victories.
A second area of wholesale defeat for the reformers is privatization: despite the overwhelming evidence that the bulk of the public sector still destroys capital (by earning a lower return than the cost at which the government borrows in the market), the hard decisions will be skirted. Instead, there is talk of more revival packages for companies that have run through one or two such packages already, to no good result. All that the government will be allowed to do is disinvest at the margin in profitable companies like ONGC, and the intention there is nothing more than to show a reduction in the deficit, not to reform the public sector.
A third defeat has come in the area of opening up to foreign investment. Three sectors were mentioned in Chidambaram’s budget speech; other than civil aviation, no action has been possible in either insurance or telecom.
For good measure, the government has had to roll back decisions like the progressive reduction of the subsidy on cooking gas. Indeed, the Left Front seems set to win another major victory by getting the government to increase the interest rate on provident fund deposits, taking the payout even further away from the limits imposed by the fund’s earnings-and rendering ineffective the prime minister’s promise that he will not make the PF a repeat of what happened at UTI. Emboldened by its successes, the Left has taken the battle to the enemy camp by holding rallies demanding that the right to strike be made a fundamental right. That is without doubt a case of over-reaching, but it does show who has won the larger number of battles in the first six months of the UPA government.
In short, anyone who thought that a government headed by Manmohan Singh would be the most reformist in this country’s history has had to think again. Where some action is still possible is tax reform, though it is far from clear that the states will be able to introduce a state value added tax in an orderly manner in April 2005. Other than that, the early indications are that Chidambaram in his second budget will focus on cleaning up: get rid of all manner of tax exemptions (a corollary to reasonable tax rates); end the reverse protection to industry in a whole series of sectors where the tariff on the finished product is lower than on its inputs; and hopefully do something about subsidies that do not go to the poor. The more ambitious agenda that Vijay Kelkar had outlined in his reports – integrating the taxation of both goods and services into a comprehensive goods and services tax that would (so Kelkar said) dramatically raise the ratio of taxes to GDP – seems to have been junked, as though this is a BJP agenda item that is not worth considering.
Denied the freedom to move in the directions that he would ideally have liked, Manmohan Singh seems to have focused some of his energies on getting his ministerial colleagues to deliver old-fashioned governance. He has repeatedly asked for action plans, progress reports, review meetings, and sent out letters when he was not satisfied with what he saw. This is not the stuff to impress the likes of Laloo Yadav and Ram Vilas Paswan, who in any case have other fish to fry (preferably each other) in the forthcoming Bihar state elections, but it has struck a responsive chord in Sharad Pawar, who is responsible for agriculture. And so we have the radical proposal aired for the sugar industry: complete decontrol, other than a 10% levy to feed the public distribution system. Even Laloo Yadav’s railways have been persuaded to cobble together a modernization plan, involving investment on the high-density golden quadrilateral and much faster freight trains.
The key question, of course, is how much of a difference will the Manmohan Singh government make to India’s GDP growth rate. On present reckoning, and for all the reasons listed above, the answer is: precious little. The country can rejoice in an honest and decent man having become prime minister, but the deck of cards given to him this time will make sure that he loses some of his reputation as a reformer. The economy as a consequence will probably maintain its new equilibrium growth rate of about 6.5%. Few countries are able to manage that, so it is very creditable. But the country is capable of, and needs, more.
