By: Hari Sud
January 15, 2005

Growth of Indian economy is a bit shy of 8% mark. The latter is a key index, which the foreign investors checks before committing large sums of money for investment. Of its own, the Indian economy will find it difficult to reach this target, accept for an occasional burst of activity; like the one in 2003. To sustain it, outside help is needed and domestic house is to be placed under strict discipline. Democracy is a great buzzword, if it translates into order and political stability. Labor unrest, political opportunism and corporate irregularities are a few issues, which tarnish democracy and discourage outside investors. A politically dictatorial regime in China has avoided all the above and has attracted foreign investment. India is learning the Chinese model, painfully slowly, hence is finding it hard to attract foreign investment. Without the latter it is difficult to match the Chinese economic miracle.

What can India do of its own?

From 1951 (launch of First Five Year Plan) till 1991, the growth rate had been about 3.5%. The population grew at about 2.5%. With dismal growth and rapidly expanding population, poverty multiplied and unrest grew louder. Most plans fell short on their targets either due to missing investments or monies wasted on money gobbling heavy industry. Government-to-government loans from US, UK, Soviet Union and other donor countries managed to bridge some of the gaps. Other donor institutions like the World Bank and Overseas Development Agency were weary of India’s development model hence were stingy in providing assistance. Economic development model adopted by India never worked. Plan targets, although modest were never achieved. The country made dismal progress and nobody knew, how to do a better job.

There are two events, which are worth noting, midst this Indian failure. First, the US-China rapprochement and large-scale influx of capital from1980 onwards placed China on a higher growth path. Indians watched in dismay as year after year huge sums of money, reached China and none came their way. Second, in 1991 India ran out of money and had to mortgage its gold to borrow money to import the basics to keep even the dismal economy going.

The above two ended the internal lack luster debate on how to manage the Indian economy. The key question now arose as to who should be entrusted the task of managing the economy and how much political weight is placed behind the new economic managers. Noted economist and current Prime Minister Manmohan Singh’s services were requisitioned in 1992. As a Finance Minister, he further requisitioned the services of Montek Singh (another economist) and others. Together they set to put India’s finances in order.

Period 1991 to 1997

It was an adjustment period for the Indian economy. Badly needed fresh thought was brought into the management of the economy. Other equally able economists succeeded to turn Indian finances around and opened up the bottlenecks to growth. Concurrently China kept reaping the harvest of good governance with huge investment cash inflow. Its GDP grew at 8% a year. It was export lead boom for them. The latter is good but is not an ideal situation. The exports were priced low in order to pay for the monies received and allow huge profits for the American businesses. The Chinese were willing to go thru this sacrifice, as long the population stayed employed and more money kept coming their way. Even today, Chinese products are priced low with enterprise profitability, as least of their concern. In other words, China is simply a manufacturing bureau, where foreign investment is made to take advantage of artificially pegged low labor costs.

India does not subscribe to the Chinese model. Businesses in India have to operate to turn out a profit, pay taxes and employ people. Since Indian taxation is high, this together with restrictive trade practices and political turmoil from time to time made India as an unattractive place for foreign investment. But there was one silver lining. The US and the West, post 1998, needed English speaking, highly skilled IT and BPO consultants in large numbers. India had this necessary resource; hence this sector was ripe for investment. China was not in the running as it lacked the English speaking populace and the West did not wish to put all its eggs into one basket. Small investment in India placed this sector on a rapid growth. The other sectors of economy felt the benefits of this sudden boom and prospered.

Period 1998 to 2004

It is period of greatest improvement in the Indian economy and its perception abroad. The economy grew at 6.5% with an occasional burst of 8% in 2003. The foreign money managers started to look at India favorably. Political instability diminished a bit. Constrictions to the growth were slowly removed or reduced. That allowed the Foreign Direct Investment (FDI) to increase. A total of about $3.5 Billion in FDI has reached India in 2004. It compares unfavorably with China, which received $50 Billion, but it is three times higher than what India received in 1998.

The economy today is performing better than it has ever performed in last 50 years. Still it is not performing at its full potential. Additional outside investment is needed and needed now to reach its stated 8% growth potential.

What does India Need - FDI or FII

FDI usually is associated with export growth. It comes only when all the criteria to set up an export industry are met. That includes, reduced taxes, favorable labor law, freedom to move money in and out of country, government assistance to acquire land, full grown infrastructure, reduced bureaucratic involvement etc. IT, BPO, Auto Parts, Pharmaceuticals, unexplored service sectors including accounting; drug testing, medical care etc are key sectors for foreign investment. Manufacturing is a brick and mortar investment. It is permanent and stays in the country for a very long time. Huge investments are needed to set this industry. It provides employment potential to semi skilled and skilled labor. On the other hand the service sector requires fewer but highly skilled workers. Both are need in India. Conventional wisdom is that China will have an upper hand in manufacturing for a long time. If India plays its cards right India may be the hub for the service sector. Still high end manufacturing in auto parts and pharmaceuticals should be India’s target.

The FII (Foreign Institutional Investor) is monies, which chasses the stocks in the market place. It is not exactly brick and mortar money, but in the long run it may translate into brick and mortar. Sudden influx of this drives the stock market up as too much money chases too little stock. In last four months an influx of about $1.5 Billion has driven the Indian stock market 20% higher.

Where FDI is a bit of a permanent nature, the FII flies away at the shortest political or economical disturbance. The late nineties economic disaster of Asian Tigers is a key example of the latter. Once this money leaves, it leaves ruined economy and ruined lives behind. Hence FII is to be welcomed with strict political and economical discipline.

China receives mainly the FDI. They do not have instruments to receive the FII i.e. laws, institutions and political and judicial framework. On the contrary, India should welcome both and work hard to retain both.

Infrastructure Renewal

To keep the Indian economy growing the infrastructure sector like power, transport, mining & metallurgy, textiles, housing, retail, social welfare, medical etc. has to be upgraded. After the Enron fiasco, it is difficult to persuade anybody in the west to take interest in any of these sectors. Hence India is left to its own devices to raise money and build this sector. Borrowing abroad supplemented with Indian resources is the only way open to India. This upgrade is needed prior or in step with the industrial and service exports sector growth. It has to be placed on a higher priority. Only recently a suggestion to use a small portion of India’s foreign reserves met with howl of protests. The protestors in the Indian Parliament did not understand the proposal. Hence the government is stuck to steam roller its proposal through the legislative process or succumb to political pressure and do nothing. The latter is not acceptable.

If India finds its own $4 Billion a year for infrastructure then foreign investors will kick in another similar portion. The resulting money will very quickly rebuild the now cumbersome infrastructure.

Indian Agricultural Economy

India has burgeoning population and a huge poverty. To reduce poverty, population growth has to be controlled (in addition to economic progress). The agricultural output at the moment barely feeds the population. The caloric intake is low as compared to the West. Production of meat and milk has to increase significantly to increase the caloric intake and improve the health of the populace. The agricultural production, which has slowed down a bit in last 3 years, has to maintain a pace well above the population growth. To maintain 4% growth in agriculture sector, capital input in form of fertilizer, power, improved seeds, storage of floodwater and transferring surplus water to deficient areas has to be increased. Monsoon vagaries will have to be overcome with water resources management.

Agricultural capital input takes about ten years to mature and give result; hence this investment is to be made today to reap benefits in the future. This capital input has to be internally generated. World Bank and other long-term lending institutions could provide some help, but most monies have to come from within. About $10 Billion a year is to be invested in this enterprise. This has priority over all other enterprises.

Hence How much FDI and FII India Needs

Economist believe that additional $20 Billion a year for next ten years will drive up GDP growth additional 2 –3% from the current level of 6.5 –8%. If these monies arrive in form of FDI, it is good for the country. If it arrives in form of FII, it is still good, but it has to be controlled. Internal resources and withdrawal from foreign reserves, trade loans, long term financing from World Bank etc. will add additional luster to the investment plans.

All the above will happen, if the planned structural changes to the Indian economy are concurrently made and country’s bureaucratic structure is made investor friendly. Other legislative changes needed to ensure the safety of investor’s money are made concurrently. The recent changes in India’s patent rules and regulation are steps in the right direction.

All in all India has to become investor friendly. It is need of the hour. Left leaning politics has to be dumped. Opportunism in politics, which endangers the welfare of the people, is to be thoroughly discouraged.

Hari Sud