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12/15/2010

Returning as a Tiger: The Economic Reincarnation of India


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INDEX: INDIA IN COMPARATIVE PERSPECTIVE | GEOPOLITICAL, DOMESTIC, AND ENVIRONMENTAL RISKS | RECENT ECONOMIC PERFORMANCE

For those who grew up with images of India as a land of poverty, recent news would seem veritable proof of economic reincarnation. Indian poverty still exists, of course, and in a land of more than one billion people, a 25% poverty rate means that at least 250 million people—or more than three-quarters of the US population—still live in highly precarious conditions. It will be a long time before its poverty can be eradicated, but India can boast of many recent achievements, and there are good reasons to expect that the country will continue to grow and develop rapidly as it has over the last decade. Investors are naturally interested in how to participate in this story.

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INDIA IN COMPARATIVE PERSPECTIVE

A population of nearly 1.2 billion puts India in a very select group of countries. Only China has more people, at over 1.3 billion; in a distant third is the United States, with a population of just over 310 million. If world population were the solar system, China and India would be its Jupiter and Saturn.

But it is more than population that makes India and China naturally comparable. They are neighbors in a region that as a whole is experiencing rapid economic growth. Both capitalize on an inexpensive labor force and offer a supply of highly educated managers; both have increasingly opened their economies to foreign capital injections. They had similar per capital GDPs (at around $400) as recently as 1992, after which China expanded rapidly through its application of cheap labor, foreign technology, and foreign capital to manufactured exports. India’s growth rates lagged behind China’s for another half decade and began rising towards the end of the 1990s.

Investors seeking the "next China" can consider India is a strong candidate not only because it resembles its neighbor in earlier stages of its growth cycle, but also because it differs and offers diversification. Both nations initiated their growth trends by liberalizing their economies and promoting export industries; however, outsourced services led the way in India, beginning with computer coding in the run-up to the Y2K problem, and expanding into call centers, legal and medical transcription, and other key industries. India has a natural advantage in many services, given its political-economic history, use of English as an official language, and centuries-old respect for science and engineering that has remained largely free from politicization.

Although both India and China will require enhanced industrial and manufacturing sectors to support the consumption needs of populations growing out of poverty and into the working and middle classes, the fact that they do not compete head-to-head for large portions of their exports means that they will likely make good diversification partners in an investment portfolio. Any global slowdown will of course affect manufacturing, services, and every other sector, but barring this systemic risk, substantial diversification among sectors and political regimes can be gained by investing in the two.

Table 1 compares India with the other BRIC countries, Indonesia, and the US on a number of key indicators. India is the poorest of the BRICs on a per capita basis, its income roughly in line with that of Vietnam and the Philippines. It is also the youngest in terms of median age, which means that large quantities of human capital in its prime working years can be deployed productively if given appropriate incentives and access to capital.

Table 1: India's Economic Indicators in Comparison

India Economic Indicators
Sources (accessed December 8, 2010): Economist Intelligence Unit, CIA World Factbook, Transparency International, and Heritage Foundation.

India’s human capital, however, is substantially less literate than that of other countries in the table. This might be surprising given India’s ability to provide services internationally, but one must remember that in a country of over 1 billion people, a small middle class of even 5% translates into an educated workforce of more than 50 million, enough to satisfy international demand until now. Over the long term, the nation is facing a talent shortage, and addressing the education and literacy gap will be key to maintaining its competitiveness going forward.

India's physical infrastructure pales in comparison to China's and does hinder the growth of manufacturing and the distribution of consumer goods. The tradition of graft, corruption and ordinary waste in infrastructure projects does not help. Although there has been some improvement with the reduction of red tape, improving the physical infrastructure will be key to expanding of India's growth firmly into other industries.

Being the world’s most populous democracy affords advantages and disadvantages. A key advantage is that free speech and free association help develop adaptive and innovative businesses in an evolving world. Authoritarian governments often have the effect of constraining imagination, efficiency, and creativity, and these limitations often spill over even into areas that are not explicitly political.

Creating economic policy and regulatory rules in India's democracy can be a slow, time-consuming process, compared to China’s more streamlined “fiat” approach to policy that allows for increased certainty and rapid adjustment. But democracy also allows society to adapt to social pressures over time. Corruption in India is widespread, but its reach has been tempered by the gradual dismantling of the “licensing raj,” wherein bureaucrats had the power to withhold licenses from nearly any productive activity unless bribed or otherwise incentivized to participate.

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GEOPOLITICAL, DOMESTIC, AND ENVIRONMENTAL RISKS

India lives in a dangerous neighborhood. Three of its immediate or near neighbors (China, Pakistan, and Russia) are nuclear powers, and the likely addition of Iran to the nuclear club makes the security situation increasingly complex. Antagonistic to India, Pakistan holds nuclear arms and an ambivalent attitude toward Taliban fundamentalism, and its stability is a concern. India and Pakistan are engaged in an ongoing contest to control the Kashmir province in the north.

Domestically, political and religious strife presents risks. Though generally under control, a radical Maoist organization known as the Naxalites is widespread enough to pose a persistent threat. Violent flare-ups between India’s 100-million Muslim minority and other religious groups are not infrequent, and there is no guarantee that terrorist attacks of the sort that took place in Mumbai in 2008 are a thing of the past.

India is also ecologically vulnerable. More densely populated than China, and facing demands for water and petroleum that are outpacing supply, India is even more vulnerable than China to food and water shortages and epidemics. Imports currently compensate for its petroleum shortage, but increasing oil prices and competition with China for resources add risk factors to an otherwise rosy economic outlook.

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RECENT ECONOMIC PERFORMANCE

India’s GDP has grown fairly consistently from 1980 to 2010, as shown in Figure 1, which charts the growth of real GDP (in 2005 USD at purchasing power parity). In theory, India’s liberalization in 1992 should have resulted in a noticeable increase in growth, but a logarithmic plot of total GDP (not shown) reveals a relatively constant annual growth rate of around 5.5% since 1980, and a slight acceleration after 2002.

Figure 1: Evolution of India’s Real GDP

Evolution-India-Real-GDP
Source: Economist Intelligence Unit (accessed December 8, 2010).

A percentage breakdown of India’s GDP, presented in Figure 2, reveals much about the trends in GDP composition. Indian consumption, while growing in absolute terms, is shrinking as a share of GDP. Most of the difference is made up by increases in fixed investment. This is a positive sign because it suggests that—to the extent that it is deployed efficiently—the profits from GDP growth are being funneled back into the economy, and promises to generate greater productivity and labor utilization. At the same time, government spending has been relatively stable over time at around 12% of GDP. This too is encouraging, given the incentives to increase spending on populist projects as the economy grows.

Figure 2: Evolution of India’s GDP Composition

Evolution-India-GDP-Composition
Source: Economist Intelligence Unit (accessed December 8, 2010).

Figure 2 also indicates that exports are growing much faster than consumption, although the net effect of export growth is largely offset by comparable increases in imports. Overall, India runs a small but manageable trade deficit ranging between 3% and 6% of GDP. Indeed, the increase in Indian imports is the most apparent outcome of the liberalizations implemented in the early 1990s.

Figure 3: Sectoral Distribution of India’s GDP and Labor Force

Sectoral-Distribution-India-GDP-and-Labor-Force
Source: The CIA World Factbook (accessed December 8, 2010).

More than half of India’s GDP comes from service-sector activities. Similarly, just over half of its labor force is engaged in service provision, as shown in Figure 3. Of the balance, 34% is employed in agriculture, even when agriculture constitutes only 17% of GDP. The remaining 14% employed in industry produces roughly 28% of GDP, making it roughly twice as productive as the service sector and nearly four times as productive as agriculture. This data point puts the value of Indian industry in relief: it is not just the service sector that produces value in India; manufacturers such as Tata Motors are also key global players..

Figure 4: Interest Rates and Inflation in India

Interest-Rates-Inflation-and-GDP-Growth-India
Source: Economist Intelligence Unit (accessed December 8, 2010).

Over the last two decades, falling inflation and interest rates (see Figure 4) have created a favorable economic environment that has remained benign until fairly recently. Indeed, through most of the 2000s, Indian inflation fell from the low to mid-teens to around 4%, even as the economy ratcheted into high gear with between 8% and 10% real growth. In the last few years, however, inflation has crept up again, suggesting that India has experienced constraints in factor inputs, rising commodity prices (as seen in 2008), and, more recently, constraints in the supply of qualified labor.

The financial crisis of 2008 did slow the economy somewhat, but Indian growth never turned negative and indeed grew at a pace that would be considered quite respectable nearly anywhere else. It does seem likely that the central bank will raise interest rates in 2011 in an attempt to reduce inflation, but barring serious energy price increases, economic growth is likely to continue in the 6%–8% range for some time.

Part II of this article will cover the performance and likely trends of Indian asset markets.

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–Bruce P. Chadwick, PhD, CFA, is principal at Chadwick Consulting, an independent consulting firm specializing in macro strategy, including quantitative, emerging market, and SRI research.

 

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Comments

Hi Bruce, The Indian PPP GDP number is incorrect - should be around 4.5 Trillion.
-Pete

Thank you for this perfect article :) it has everything i needed for a project. Thanks again! :D

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