Medium Term Outlook for the Indian Economy

Rakesh Mohan

In these days of feel good, feel better and feel best I thought I could put the current economic situation in the country in perspective. There has been some calculation of GDP of national economies starting 300 years ago. Three hundred years ago the share of India, China and rest of the world were roughly equal. At that time USA as an economic entity was non-existent. With the advent of industrial revolution in the 18th century and the triumph of knowledge and reason or unreason began the long ascendancy of Europe. The Asian resurgence started with Japan in the 1950's, although it had started 100 years earlier the real resurgence started after the World War and later China in the 1980's. In the 21st century it is our turn now. What we have done after independence? Many of us born after Independence are very impatient with what we have done and often we are very critical of what we have not done. At the time of Independence an average Indian could look forward to die at the age of 32 years. Life expectancy at birth was 32 years. On a different note, the total installed power capacity was 1362 MW. Fewer than 10 percent of the females were literate, ofcourse, poverty was rampant.

As China turned the corner in 1980's so did we, but at a lower rate. We have come a long way but still we have a longer way to go. Despite some of the achievements we have talked about our economy was stagnant during the 1950's and 1980's with per capita income growth not more than one percent a year. With that kind of growth we never felt growth at all even after 10 years. However, the seeds of the economic growth were indeed planted. A number of economic institutions, the banking system and the Planning Commission and the Planning System were started. It is fashionable to talk ill of the Planning System but I for one believe that there is nothing wrong in the Planning system but we did not change it in time. The institutions that are in the news for the wrong reasons but are now known well around the world, the IIT's, IIM's were all started in the first ten years after Independence. Our research labs, steel industry except TISCO were all founded during this period. It is a fact that we did not grow fast enough but 100 years preceding the per capita income was going down, the GDP growth was zero. Despite the fact that many of us are impatient with what we have not done in the 1960's and 1970's the foundation for some of the growth in 1980's and 1990's hope fully for the next 25 years were laid in the 60's and 70's. The sea change that has taken place in 1980's and 1990's is that from around one percent per capita GDP growth we have moved to 3.5-4 percent GDP growth annually. 3.5 percent to 4 percent GDP compounded GDP growth starts piling up quickly. Therefore our per capita income has roughly doubled between 1980 and 2000. This is so palpable and can be felt across the country. With the GDP doubling we were able to move from one percent growth from 1950-80 to 3.5-4 percent in the 1980-2000 period. The question is when we make the leap to 6 percent per capita income growth which means 7-8 percent GDP growth in the next 10 years or 20 years. If per capita income grows at 7.5 percent we will double per capital income in 10 years. Doubling per capita income in 10 years will make a lot of difference and change will be grappled faster than doubling in 50 years. But what we should recognise in terms of understanding where we are and be impatient about is that even if we grow at 8.5 percent GDP growth annually we need 6-6.5 percent per capita growth. Even if we double in 10 years time in 2014 or after we will be where Thailand was in the 1980's. We are fifty years behind Thailand even if we grow at a rate of 8 percent or more. So there is no reason for complacency. All of us need to feel impatient, all of us need to act whatever we do. India suffered a setback in 1991 and there after we are subject to a wide range of reforms despite the changes in government at the Center and states.

Inflation: When we take stock, some major changes indeed have taken place in the last ten years. The greatest achievement in the last ten years and some thing that really affects all of us is that inflation has come down. From the late 1950's to mid-1990s we had almost normal inflation rate of 7-7.5 percent a year. Price level doubled every ten years. Last 6-7 years inflation has come down to 4-6 percent, actual rate would be 4.5 percent. We have made a significant change from 7.5-8 percent to 4.5-6 percent inflation. This change is also happening internationally, not just in India. Globally also there has been a major change in 1990's. It has taken a very long time after World War II and before that the depression of the 1930s for inflation to come down.

After the World War the whole world got used to inflation. Once you disturb something in the economy both domestically and internationally it takes a long time to settle down. So you need to be very cautious of disturbing things in the macro-economic sphere. Internationally, inflation is around two percent now. So we are still higher than the international level. But it is a big change that has taken place. Lower inflation is good for investment, stability and importantly good for reduction of poverty because inflation really affects the poor more than the rich people and the better off because they can bargain away in terms of income and wages ahead of inflation. Therefore, reduction in inflation is extremely important for poverty reduction.

Forex Reserves: We had the shock of 1991, the forex reserves came to almost zero. We had forex reserves for only two weeks of imports and after that shock the quality of our economy, polity and political economy as a whole took this to heart and policies were changed so that now we have more than $ 100 bn worth foreign exchange reserves. The major observation about India is that when we get a big shock we act. The last big shock before 1991 was the drought of 1960--late 1960's. That was when the United States put us to `Ship to Mouth' existence with the PL 480 shipments of food. The consequence of that shock resulted in the green revolution. The consequence is that now we have higher food stock. The same thing we had in 1990-91--our external debt went up, reserves went down and our external stability came into question-- we had taken the IMF loan, the World Bank loan some how our system has responded. So we do now have a manageable external debt. The recent changes in external commercial borrowings is connected to this and we are able to liberalise norms for ECB. The observation is that we now have control over our external debt.

Let me take you through the other snapshots of the 1990's after the reforms were undertaken. Earlier you had to have queues for everything. To get licences, to buy cement to build a house, you had to have licence to import anything, the average tariffs were 110 percent till 1991. Today there are no import restrictions, the average tariff has come down to below 20 percent. Foreign investment was a dirty word today it is open, portfolio investments have been permitted. In broadcasting we had only one channel, now we have 100s of channels, the quality is better and there is great deal of competition. Or look at the telecom sector- long back when I was in the Planning Commission I couldn't get a telephone so I had to find some one with a telephone. And my wife to be had a telephone under a special quota so I had to marry her for the telephone and she married me because I had the gas cylinder!

In Indian Airlines, one had to have influence to get a seat, today seats are going vacant. We could never dream that we could go from Mumbai to Pune in two-and-a-half hours. The key point point behind all these is that higher growth and higher incomes feed on each other. The engine for growth is both a consequence and a cause.

Changes in Consumption Pattern:

Since 1985 at National Council of Applied Economic Research (NCAER), we used to survey 300,000 households every year, both urban and rural to observe what households buy. We have a list of 50 consumer items half of them consumer durables and the rest non-durables. There has been a dramatic change in the pattern of household income in 1990's. If we classify household as Low Income, Middle Income and Low Income, since the reforms started in early 1990's the percentage of LIH has come down from 60 percent to 30 percent and that of HIH has gone from two to seven percent. In 1997 we had predicted the household consumption for 2001-02 based on previous data and it was quite correct. We now expect the percentage of LIH to come down to less than 20 percent in the next five years. In the next ten years the percentage of LIH and HIH will almost be the same. We have thought of ourselves as a very poor country, we have thought of ourselves as very poor people. What will happen in the next 10 years. This thinking will provoke a change in the urban areas-- the percentage of LIH and HIH have crossed each other. This is partly the feel good factor that is being talked about. Politics is also changing. No attention is being paid to what the middle class wants because the economic demographics is changing. The proportion of HIH have tripled from five to 15 percent in urban areas. Huge change in incomes in urban areas. The kind of change that has taken place in 10 years-- from early 1990's to early 2000- similar change in magnitude is taking place between 2001 and 2006. This trend may be seen in some cities more than in some other parts of the county. Similar movement is there in the rural areas with in 5-6 years seven percent of households becoming high income groups. Even in rural areas ther eis a huge change in incomes, the middle income households have risen from 33 percent to 70 percent. What earlier used to happen in 10-12 years is happening now in 5-6 years. As incomes grow savings also grows. When the proportion of LIH is 60 percent the savings is negligible. When that proportion came to 30 percent savings is also increasing. Some may be saving less, some may be saving more. Banks will get more and more deposits in the forseeable future. Therefore, there is no shortage of resources and that is very important for growth. Six hundred million people are climbers or consuming classes in the rural areas and 300 mn in urban areas so total combined is 900 mn who are buying something and this is a huge market. By 2006-07 there will be 25 m household in the HIH category which means the group will constitute 100 mn people which is a huge market. The MIH will rise to 40 mn which means a total number of 700 mn people in this category. The LIH will have 35 mn and the number of people in that category would be would be 200 mn. As Low Income Households (LIH) becomes a minority there will be a great temptation to ignore them completely because their votes become much smaller.

We have been growing stronger and stronger. This can be seen in the sort of explosion of interest shown by international magazines to carry a story about India in the cover itself. People like Narayana Murthy, Azim Premji, and Ambanis all of them have contributed to a stronger image of India. It is for the technocrats not politicians to see that we do not forget what the poor needs.

Product Consumption Patterns

Group I-- Pressure cookers, wrist watches, iron boxes, radio transistors, ceiling fans, cheaper things that are brought by climbers.

Group II-- items are brought by drivers--they more expensive things.

Group III-- These goods are brought by the consuming classes.

After 1990's for Group II and III goods the growth rate has been much faster. The number of people in the HIH went from 5-15 percent in 10 yeas, the growth has been very fast. It is therefore, from a very low base the kind of goods that richer people buy grow faster but volumes may be greater in the lower categories, ie. Group I and II goods. But Group III and IV goods will grow faster in the next 5-7 years or 10 years.

Fall in penetration levels

The highest penetration of consumer goods is seen in wrist-watches. Penetration means ownership of a consumer item per thousand households. Highest penetration is seen in wrist watches. It is the first thing that people buy when they earn money. It is interesting to me because people always talk of India being timeless. But first thing with people who have a little bit of money is buy a watch. Atleast one watch will be there per household and there could be 4-9 watches in a household or none at all. Other goods-- pressure cooker, radio, black and white TVs the penetration is 500 per thousand households and washing machines, refrigerators, color TVs and expensive goods much less. The growth is higher for group III goods.

Rural market.

One way to look at the future is to look at the share of the rural market. Rural market constitutes more than 50 percent for many products. The growth of rich households and middle income households is larger than in urban one. Given ofcourse that more than two-thirds live in rural areas if the income distribution is same in rural area as well as urban area the share of the market in rural areas will be much higher. But that is not the case. The rural are the share of the market for many of the products is more than 50 percent. Over time as more and more products are sold in the rural market more than half the goods sold will be in the rural area. Associated with RBI I see all these trends as interesting. An important point is that we have not been serving the rural areas well because we see it is a small market. In rural areas along with higher consumption there is higher savings. The question is how fair we are as bankers to server rural areas in getting the savings and investing them for productive purposes to give them adequate returns, adequate safety. What is happening to rural incomes? Politically it has been recognised therefore you find more attention been given to them these days in the last 5-7 years as to what should be done to small scale industries and rural lendings. Things that economists, bankers, planners need to think about what is going to happen in rural areas. Despite the same income levels we have lower levels of consumption in rural areas. And the main reason is lack of power, lack of electricity. Without power there is no point buying a TV or an electrical appliance. This brings us to the importance of investment in infrastructure in rural areas. The investment required for different kind of distribution channels which means investment in roads, of course education. I have given a snapshot of what is emerging in the rural market for next 5-7 years. Growth in volumes in the next five years will be much more than last 10 years. The size of the domestic market will be of international strength. I have taken off from three articles written by Arun Shourie a couple of months back in Indian Express. In the post reform period in 1991 the industry was saying that the government is trying to kill them and that they will not be able to compete. This got worse in the late 1990's when the growth of the industry, slow down and infact there is a certain amount of enthusiasm in the early 1990's when industrial growth went up. In 1997-2000 the industrial growth was down to 4.5 percent. Suddenly in last two years we have seen a new confidence. People in every business are speaking the language of confidence we see new emphasis on R&D, new emphasis on innovation, new emphasis on financial management, new emphasis on investor management, shop floor management in industry. The overall business process has been restructured in the late 1990's, now we are beginning to see the fruits. Many people decry what was done to steel in second and third Five year plans. But between TISCO and SAIL we are among the low cost producers of steel in the world. In aluminium, between NALCO, a public sector unit, Hindalco, a private sector and Balco (Sterlite) a foreign company-- India has emerged as a competitive producer of aluminium. It is remarkable because aluminium is one of the capital intensive industries. It is also power consuming, biggest input is power. Even petrochemicals where we never thought we would be competitive we have become competitive although protection is still high in petrochemicals. Other very different industries--Moser Baer is one of the largest exporters of compact disks, high technology. Another industry-- Hero Honda, largest producer of motor cycles produces two million motor cycles annually. Thous three years ago they were crying of the Chinese threat. Most amazingly in automobiles more than 100,000 units were exported in 2003 calendar year. Just go back to 1981, just 25,000 cars were produced totally. Quite amazingly a number of small companies like Brakes India, Mahindra and Mahindra, Rane Brakes, Sona Steering all got awards for exporting as also Crompton Greaves. Hindustan Lever is the most profitable of the Unilever companies. There is something in the air in term of national confidence. There is a great deal of entrepreneurship that is alive and well. But the point is it is very broad based. I as an economist find it very interesting to look at the most competitive companies. They have very little in common-- ranging from steel, aluminium, petrochemicals, heavy industries and capital intensive industries. Paints, CD-Roms belong to the low capital intensive category. In auto components we have made a mark, in pharmaceuticals-- Wockhardt, Ranbaxy have all become globally competitive.

In 1995-96 when the agreement with WTO was signed and IPR issues came every one was screaming mad that it will kill our pharma industry. But look at the consequence. The companies realized that they cannot be protected they went out and start doing work. Now the pharmaceutical industry says we are the best in the world. Quite amazing.

The major point here is competitiveness is visible in very different industries. Second we have complaints about the complex tax regime, different tax collections, corruption, customs and excise procedures, huge infrastructure handicaps, but despite all these we have 20 to 30 companies which have actually done well. What is common among them? All are based on technical competence not based on a government favor, all based on international competitiveness. All approaching world class scales. It is very important that we cannot achieve international competitiveness with out a world class scale. But world class scales are different in different industries. For eg. In machine tools, it is small scale the world over but it is smaller in India. Auto companies are large world wide, the point is we need to be of world class scales to be competitive.

What lies ahead?

I will mention the BRIC's report which refers to the prospects of Brazil, Russia, India and China and is prepared by Goldman Sachs. What they have pointed out is that these four countries as a whole will overtake the largest current G-6 countries--USA, UK, Japan, France, Germany, Canada or Italy in terms of total share in world economy by 2040. This is interesting to me. I began this lecture by stating what we were 300 years ago. By 2040, we will come back to what we were 300 years ago in terms of economic weight. We will overtake European countries by 2025 and Japan by 2035. We will have higher growth among the BRIC countries because of our economic demographics. The working age population as a proportion of our total population will continue to rise till 2025.

As other countries age and the aged population-- children and aged non-working combined keeps on increasing therefore the scalings will come down. Therefore, our proportion of working age population will keep increasing. The downside is we have to be thinking of employment. That will only be a boon if economic growth is such that it creates employment. If we don't produce employment our working age population will not be working and they will be a burden. And because this age group is very energetic they will create a lot of noise and social problems. Lot of emphasis has to be on employment generation.
If you examine the NCAER projections, within another 10 years the people below the poverty line will be less than 10 percent from the present 25 percent. Economic issues start to become more important. A great deal of attention need to be paid to growth, power generation, schools, health and so on. All of this will have great importance in rural areas.

Some changes in agriculture --we need to understand and observe and make appropriate changes because it requires a great deal of change in our attitude to agriculture. As number of people below the poverty line declines, it will require more food to eat. The biggest change is the total food expenditure as a share of expenditure on cereals is falling. As income increases more money is spent on items like milk, milk products, poultry, fish processed foods, meat etc. What this means is huge business opportunities, huge economic opportunities that will arise in rural areas. This is necessitated by the changes required in production, processing, consumption and marketing of goods. This will not take place unless a great deal of attention is paid to rural infrastructure.

What we have seen in Southern states like Kerala, Tamil Nadu, Karnataka, Goa and some Northern states of Haryana and Punjab they did their roads long ago. Other states have to catch up in this regard. Housing demand will be great in the coming years. When we build a house, we have to fill it- it cannot remain empty. Urbanization and housing will lead to higher demand for consumer goods. An example of Dominos Pizzas will be enlightening. At the backend there is a large supply chain and the owner has to be ensure -- supply of tomato, supply of onion, each ingredient that goes into the making of pizza. These items have to be brought to where pizza is made.People have to be trained. His company's philosophy is zero defect. So right from supply chain quality upradation is taking place in human capital up to the farm.
I am fascinated by the Dominos Pizzas example. This kind of change will take place at a much wider fashion. Higher consumption and higher saving will lead to changes in life style, food habits, and higher investment. The other aspect of globalisation is greater scope for innovation, R &D and education. In 1990, if you asked me which are the cities that will grow , I would have said-- Bangalore, Hyderabad, Chennai, Pune, Gurgaon, Pune, Chandigarh. There is something common to these places. One is first class education opportunities, second the instituitions established long time ago, each one of them have research labs built by government in the early 1960's. Each has a good concentration of machine tools.
One thing we need to recognise is that Kerala has a good record in education but not perhaps in higher education.

Urbanisation needs lot of reform, land markets and more efficient rural infrastructure. There is no shortage of resources we have to gather the resources. But there is shortage of management experience in urban management. We don't have very good answers to some of our problems in this area, but where we know the answers we don't know the way to reach them. The total employment in organised sector in the country is less than 10 million. Remember the point I made earlier about the changing economic demographics which means more opportunities for employment should come in the organised sector. China has atleast 80-100 million employed in organised sector. Unless we are going to focus much on manufacturing more employment cannot be created as services cannot created much employment. Small scale industry was supposed to create employment but we cannot produce labour-intensive goods reserved for SSI in India unless it is done on a world scale. For eg. Toys, buckets, clothing, hand tools are labor intensive but cannot succeed unless done on a large scale. Small scale dereservation has to be done immediately otherwise we are going to pay a heavy price.

Social security is an important issue, but labor flexibility is also equally important as our Finance Minister said three years ago. Rural transformation is taking place, we have come a long way. But we still have longer way to go. We have to fulfill the dreams we have for the betterment of all of us. We are no longer afraid of doing different things, differently.