India: Reforms are here to stay
The world’s largest exercise in democracy will soon be run once more, as Indian voters go to the polls in April and May. Around 900 million people are eligible to vote at one of the nation’s one million polling stations. As ever in politics, attention is focused on personalities, in this case even more so than usual. This is due to the strong personality of the current Prime Minister, Narendra Modi, and also because of the rapid rise of social media in India. The country already has over 400m internet users and 280m mobile broadband consumers. This focus on personalities is, in our view, exaggerated. Our recent visits support our view that the election result may not be as important as most observers seem to think.
This is because whoever is elected to run India for the next five years is likely to benefit from the reforms already undertaken. Analogies are inexact, but the economic reforms in Britain under Margaret Thatcher and continued by John Major were largely incorporated into the New Labour policies of their opponent, Tony Blair. Similarly, Bill Clinton, a Democrat, built on the liberal economic policies of the Republican Presidents Ronald Reagan and George Bush Snr. Despite the somewhat divisive nature of his leadership, there is a widespread consensus in India that Modi’s key policies are necessary to enable this vast country to catch up with other Asian economies, most notably China. These policies are simple but powerful:
- Installing a bankruptcy process and recognising bad loans.
- Introducing the GST (goods & services tax) which should lead to an improvement in tax collection.
- Connecting villages with roads and rail, providing power and toilets.
- Giving individuals a biometric identifier and bank account.
These policies have already led to growth rates which are higher than the longer term average, but not significantly so. Over the last five years, growth has averaged 7.3%, compared to a 30 year figure of 6.7%.
Crucially, this growth has mainly been focused in the poorer states, such as Bihar and Uttar Pradesh, where their GDP per capita has increased from under USD1000 towards the national average. This should have the effect of broadening the consensus that the reforms will prove to be durable.
A major acceleration in growth from richer states is yet to come. Overall, in some respects the achievements of the Modi administration so far appear modest:
- Real GDP growth hasn’t broken convincingly up above 7% despite a still low base, with GDP per capita at USD8,000, based on purchasing power parity. This is still low when compared to China’s USD20,000, the EU average of USD49,000 and the US at USD65,000.
- Despite this economic growth, nationwide industrial capacity utilisation has remained below 80% for at least the last five years despite a decline in gross fixed capital formation (to GDP) from 35% to 31%.
- Partly due to problems in public sector banks, the overall bank sector remains weak and undercapitalised, despite very low consumer finance penetration. For example, the ratio of mortgages to GDP remains below peers at 10%. This compares to 26% in the case of China.
- Transport is underdeveloped: logistics costs are high and rail freight market share is still only 20% of the total.
- India’s society has yet to make the great leap from the primary to the secondary, let alone, the tertiary sector. The early stages of China’s reforms under Deng Xiao Ping resulted in the agricultural sector becoming more efficient and jobs being created in manufacturing. Even now, agriculture still accounts for 49% of jobs in India, compared to 8% in China and only 2% in the USA. Manufacturing remains only 18% of GDP despite the government’s ‘Make in India’ programme.
A strong institutional framework is generally a precondition to durable economic success. Whilst the transition takes time, by some measures India is starting to evolve.
