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Is India going off track or staying on course?

Inflation is slowing the world's second-fastest growing economy. With recent evidence that millions are being pushed back into poverty, it'll take more than a good monsoon to sustain the new India. Samar Halarnkar and Gaurav Choudhury report. Five things India must do

business Updated: Jul 03, 2011 01:15 IST

"What slowdown?" asks Amit Kinariwala (46), smiling, as he reels off his recent destinations — Ethiopia, Nigeria, Lebanon and Egypt — and talks of three signed contracts. "There's a lot of business out there." As the Bangalore-based MD of Everett Middleware Consulting, a Dutch company specialising in identity and access management, Kinariwala believes there is much business to be wrung out of a global economic slowdown. "There's money abroad and in India, where we just won a big contract, but companies have to see value," he says, "Then they will spend."

Deepening global gloom does bring opportunities; the IT sector alone hopes to add some 225,000 jobs this year, and India reported its highest ever exports for the year ended March 2011. For millions of Indians not skilled enough, however, the last 12 months of high prices, particularly of food and manufactured products, have eroded incomes. That has slowed consumption and corporate spending and sparked a series of slowdown cycles.

On Wednesday, the Prime Minister emerged from his cocoon of silence to predict that inflation will slow to 6.5% by March 2012. Even if that happens — many warn of even higher prices instead — it is clear India needs radical changes beyond current challenges.

First, the immediate problems. At 7.8%, the growth of India's GDP from Jan to March 2011 was the lowest in five quarters. It could get worse. "Growth is expected to moderate to 7.5% in 2011-12," says Rajiv Malik, senior economist at Singapore broking and research firm CLSA. The manufacturing sector — it accounts for 80% of industrial output — grew at 5.5%, the slowest in 18 months. The latest data for factory output, for April, reveal that growth fell from last year by more than half, from 13.1% to 6.3%.

Slow manufacturing hurts corporate profits and employment prospects at India's 160,000-odd factories, employing about 110 million people. With such gloominess, the Bombay Stock Exchange's Sensex has fallen 9.8% so far this year, closing Friday at 18,763 points, shutting down a major avenue for raising money. Six companies have withdrawn plans for share offerings, three public sector companies (including giants ONGC and Steel Authority of India) have postponed disinvestments, and 42 companies are waiting for an opportune time to sell shares.

The RBI's strategy: Raise interest rates to mop up money, slow the economy and lower inflation. It's working — partially. But inflation is at its highest in 16 years. This is also undermining the poverty gains of the last decade. The 9.6% inflation (based on wholesale prices) of 2010-11, bad as it is, hides soaring food prices. Over the last year, milk has become costlier by 16%, prices of eggs, meat and fish by 20% and fruits by 22%.

In April, the Asian Development Bank warned that with poorer households spending up to a sixth of their income on food, a 10% increase in food prices can send 10 million Indians (three-fourths from rural areas) into poverty; a 20% rise could increase the rural poor by 45.6 million and urban poor by 13.3 million.

Exacerbating these problems are petrol, diesel, cooking gas and kerosene hikes, enough to boost inflation by 1%. "Due to these hikes, inflation could be close to 10% by July," says C Rangarajan, Chairman of the PM's Economic Advisory Council.

For some weeks, inflation in non-food articles, such as cotton textiles and minerals, has been 20%-25%. Higher fuel prices won't help. Without tax cuts for petroleum products last month, things may have been worse, but this sets off another vicious cycle that will leave the government poorer by Rs 49,000 crore for 2011-12. So, less money for the things India needs to reduce poverty-social-welfare and infrastructure. India lauds itself for escaping the worst effects of the economic meltdown in 2008, but figures quoted by Planning Commission Deputy Chairman Montek Ahluwalia in a journal article in May showed that 33 million people were added to the ranks of the poor within two years.

There is no current data available, but inflation is likely pushing millions who had just climbed out of poverty (measured at the ability to spend $1.25 a day) back in, worsening India's worry under — and unemployment. So far, the government has made no progress with major policy reforms, stalled since 2004.

This picture reveals, according to data released by the government 10 days ago, that even during the rosiest years of growth, between 2004-05 to 2009-10, when growth averaged 8.43%, the economy generated no more than 2 million jobs for the 55 million people who joined the workforce. This low employment comes at a time when every sector is short of skilled workers — from masons to teachers to waiters to engineers — a reflection of an education system that is not imparting skills the economy needs.

"Deeper social disparities should never be viewed as the inevitable price of rapid growth, and more egalitarian outcomes in education, health, and gender should not be considered "second-stage" reforms," writes Ejaz Ghani, economic advisor to the World Bank and author of The Poor Half Billion in South Asia, in a new blog post. Or, as the newly revealed ravages of the meltdown indicate, growth alone can't create and sustain a new India. So, companies and the middle-class are asking tough questions of the present reform-less business environment.

"Business confidence has seen a decline since September 2010, not surprising, given the corruption, environmental and governance issues that stalled all policy action during the winter session of Parliament, which is reflected in (declining) corporate fixed capital spends," says Anand Mahindra Managing Director of the Rs 57,000-crore Mahindra Group, spread across 18 industries. Mahindra says he intends to launch new models "to generate excitement" despite a sharp fall in auto sales.

The invisible army
Mahindra and India Inc are the visible, aggressively global, flag-bearers of an emerging nation, but they are, in a sense, incidental to its future, which appears to lie in the dank tanneries of Mumbai's Dharavi slum township, in the room-sized waste-recycling units of outer Delhi, in 30 million small, micro and medium enterprises. Put together, these grubby factories contribute to half of India's factory output, 45% of exports and employ more than 60 million people (India's high-profile service sector employs no more than 33 million). "Their investments, collectively, are more than that of the government as well as that of the private corporate sector," economist and former J&K Bank Chairman Haseeb Drabu wrote this month in Mint.

Least recognised is the ailing agriculture sector, which employs half of India's population, about 600 million people, produces no more than 15% of GDP and lives from monsoon to monsoon. A good monsoon this year may reduce food prices and keep the economy stable, but India's agriculture will remain one of the least productive in the emerging world — about 64% of the world average. In 1977, Indian and Chinese farmers harvested about the same amount of wheat. By 2009, wheat yields in China were 1.7 times more than India, according to UN data.

Galloping food prices are linked to agricultural problems. Uncertain agriculture and rising prices are a global issue, but India's small, failing farms can't keep pace with growing demand.

With reforms stalled, these unheralded engines of entrepreneurship and employment bear the brunt of corruption, crumbling infrastructure and discrimination (small, medium units get less than a tenth of commercial credit).

The push for new reform comes most recently from India's ally, itself under economic strain.

"India is at the point now where future growth will depend on the success of the next wave of reform," US Treasury Secretary Timothy Geithner said this week in Washington D.C., particularly seeking finance-sector reform. In response, finance minister Pranab Mukherjee said reforms of banking, insurance and pension-fund sectors were now in Parliament, awaiting consensus.

These reforms are vital to finance the $1 trillion — the value of the national GDP — India will require over the next five years to overhaul its collapsing infrastructure, which, if built, could potentially catalyse every sector, from farm to factory.

As our top 5 reforms sheet indicates (alongside), India needs not just reforms in diverse areas but a governance makeover. Unless that begins, a cycle of upturns and slowdowns will continue — with more of new India's people sliding back to the old.

Jairam kanojia (50) laundry man (Delhi)

"Whatever I earn is spent on food and essentials"

Jairam Kanojia, 50, earns his keep as a laundry man in a local society in west Delhi's Paschim Vihar. For the past two decades, his daily routine has more or less followed a set pattern: fire the charcoal, heat the iron and "press" clothes for residents of the Meera Bagh Housing Society.

But the last year-and-a-half has been different and difficult.

Pummelled by soaring prices of most food items, Kanojia is struggling to make both ends meet for a family of eight. "Whatever I earn is spent on food,

household items, school fees and other expenses. I have two young daughters and I end up saving nothing for their marriage."

The earnings from ironing clothes alone do not suffice. Till about 18 months ago, Kanojia used to earn about Rs 5,000 a month. Today he earns more, but is poorer. Skyrocketing food prices have forced him to dabble in odd jobs.

Untrained in any other skill, Kanojia now-a-days cleans vehicles in the same society to earn an extra buck, which still leaves him with a deficit at the end of the month. Costlier essential items leave him with no extra money to fulfil life’s bigger aspirations: educating his children for a better life. "I also dream of giving the best education to my children," he says in a choked voice.
— Himani Chandna Gurtoo

Dilip Mark Mendens, 41 Entrepreneur (Bangalore)

"I'd love to have a driver, two cars"

Mendens is momentarily rueful. He had a full-time staff of 45, worked all day, locking up the office every night and lived it up in pubs and restaurants, as his annual turnover reached Rs 4 crore by 2007. A former courier boy, Mendens embodied the opportunities of the flat world.

His human resource consultancy, Ascro Transatlantic Pvt Ltd, provided staff, entry level to senior management, to 40 clients, including multinationals. When the world economy melted down in 2008, his turnover tumbled 99.8% to Rs 5 lakh.

Mendens had to give up his office, and "settle" his 45 employees in other jobs. This time, as Bangalore grows jittery again, he’s prepared. "I foresee a bust, no way India will escape," he says.

He works out of his father's home and is happy with five clients — one markets holistic healing, another trade fairs. "What I do now is very satisfying," says Mendens, who now begins his work day leisurely after a game of squash and ends at home with his children or a drink at the local Catholic Club. He doesn't miss the expensive nightlife, but it would be nice to have that driver.

— Samar Halarnkar

Gopal Gupta (28) Public Relations executive (Mumbai)

"With rising EMIs, I don't have money to get married"

He has drastically reduced socialising, postponed his vacation plans and even shelved matrimony.

Seven hikes in his equated monthly installment (EMI) over the last one year have hit public relations executive Gopal Gupta hard.

Over the last year, Gupta, 28, employed with a public relations firm in Mumbai, has seen his EMI rise from Rs 12,500 to Rs 15,800 (a hike of 26%).

These days Gupta resides with his mother and younger brother at Bandra. Last year, when the going wasn't as tough, he had purchased a house on Mira Road and was thinking of moving in there. But that looks like a distant dream now. "My plans have gone for a toss. Another hike in the EMI will leave me with no option but to sell the home I bought last year as I won't be able to service it from my current salary," says a dejected Gupta.

He cannot even contemplate changing jobs for a better compensation package, as a new job will bring with it, its own set of uncertainties.

In the last two months, owing to rising EMIs and expenses, Gupta has stopped going to clubs with friends and even quietly excused himself from joining his friends on a Lonavala and Khandala trip.

Worse, the quagmire of EMIs and rising inflation has forced him to defer his marriage plans at least for this year and also affected his higher education dreams.

"Under family pressure, I was thinking of getting married this year, but now I can't plan marriage because of rising

outflows. I have also not been able to save for my higher studies," adds Gupta.

"My salary has been revised only once in a year but the expenses and EMIs have seen several revisions."
— Sandeep Singh

Answers beyond fighting inflation

We asked 5 people with varied experience of India's growth story to make sense of the present jitters. The bottom line: the economy will come through, but sweeping, new reforms are essential.

C Rangarajan Chairman, PM's Economic Advisory Council

Use all policy tools to tame inflation

Controlling inflation is a priority concern of the government. What started as food inflation has become more generalised. However, food inflation is coming down. More particularly, the rise in the prices of foodgrains has been modest in the current year.

We must use all policy instruments —interventions in the foodgrains market and fiscal and monetary policies — to bring down inflation to a more acceptable level.

The fuel price hike has become inevitable. Crude prices have risen sharply. Domestic prices of petroleum products must reflect this. Subsidies on petroleum products must also be contained to prevent the fiscal deficit from rising. The fuel hike may add to inflation by a little over half a percentage point.

India's growth rate in 2011-12 will be in the range of 8 to 8.5 %. This is due to a variety of circumstances. The process of recovery in the advanced economies is slow. Domestically, the investment sentiment is weak. Nevertheless, a growth rate above 8 % must be considered respectable and high in the current world situation. Revenue targets are in nominal terms. The nominal income may still grow at the rate implicit in the budget estimates.

Even as revenue targets are achieved, we need to keep a watch on expenditures so that the fiscal deficit is contained at the budgeted level. This will also help in taming inflation.

Anand Mhaindra Vice Chairman, Mahindra Group

Strike a labour, income security balance

The economy is likely to see slower growth (this year), but this will be more in the nature of a moderation (7.5%-7.7% GDP growth) rather than a slump. Prevailing inflation rates, to my mind, are the bigger threat at present. To increase supply capacities, we need higher investment rates, but instead what we saw last year was a sharp decline in capital expenditure — public and private.

Private consumer expend, by the way, was fairly robust last year right through Q4 (January to March, 2011). Business confidence has seen a decline since September 2010. However, we're a noisy democracy, and the noise always signals the first step towards resolution. The issues raised in the last few months are important, and I now see steps being taken towards resolution, which makes me hopeful. Note, the government has submitted 32 bills for enactment or amendment this (coming) session (of Parliament). The three things government must do to keep growth on track and reinfuse confidence into business are the Land Acquisition Bill — stalling many infrastructure and industry projects; rationalise environmental clearances; and labour regulation reforms. We need to make a beginning in labour reforms. We have one of the most restrictive labour security regulations in the world, and this is limiting both labour employment and industrial growth. We need reforms here that strike the right balance between income security and flexibility in labour hours employed.

Rajiv Kumar Secretary General, Ficci

Time to implement structural reforms

The slowdown in the economy is now evident. It is reflected in the steep decline in investment growth rate, which slowed down to 0.4% in March 2011 as compared to more than 15% in March 2010.

If that was not enough evidence, there is a downturn in the investment cycle, which had driven Indian economic growth since 2003-04.

Private consumption is also beginning to be affected by higher costs of borrowing. The slowdown should not be a surprise as it has been policy induced. The Reserve Bank of India, in its pursuit of lower inflation, has raised interest rates by 275 basis points in 10 steps during the last 12 months.

But monetary policy on its own will not suffice to achieve macro stability along with rapid growth and fiscal policy will also have to play its due role. Moreover, given that inflation is largely a result of supply shortages, it is imperative that structural reforms are implemented to remove supply-side bottlenecks and expand production capacity.

The current policy regime appears to be based on the assumption that increasing consumption demand through large scale transfer payments will suffice for rapid growth.

With lack of private corporate investment, production capacities are not keeping pace with demand, thereby resulting in persistent inflation.

Ajay Shah Professor, National Institute for Public Finance and Policy

Need to restore confidence of investors
Firm databases, which are the most reliable element of Indian statistics, show a mixed picture. On one hand, the Jan-Feb-March 2011 quarter showed moderately good performance for sales and profit. But the CMIE 'Capex' data, where we measure new project announcements, has been reporting difficult times from mid 2010 onwards. New project announcements by foreigners and by the government have dropped sharply. New project announcements by the Indian private sector have also dropped a bit.

The behaviour of the private sector may reflect reduced optimism about the future. The behaviour of the government directly influences investment in the economy. In either event, these patterns are likely to give a slowdown in investment.

In one element, difficulty is already visible: capital goods imports have not had robust and sustained growth after the crisis. Investment makes up a large slice of Indian GDP.

These two factors (public investment and the optimism that shapes private investment) thus have a strong impact upon business cycle conditions. Monetary policy is, and should be, absorbed in the fight against inflation.

Fiscal policy has little room to manoeuvre given India's chronic fiscal crisis. Finding a way out of this dark situation thus rests on only one lever: economic and governance reforms, that will restore confidence of domestic and foreign investors.

Bharat Ramaswamy, Economist

Reform agriculture and invest in R&D

When you talk of long-term reform, there is a very simple fact: Over the last 20 years, except for one year, the amount of grain the government buys is larger than the amount it dispenses through the public-distribution system (PDS), which was never reformed. So, you build mountains of grain, then you try and get rid off them through targeted subsidies. This kind of regime is no longer stabilising foodgrain prices, as it was meant to.

At the same time, our agricultural productivity is one of the lowest in emerging markets. Our R&D system, one of the largest in the world, has failed. We have fallen so far behind, it's shameful.

Market reforms — agricultural pricing, opening of retail — are very important, but there is a lot of basic R&D to be done, which the private sector will not do. Agricultural extension has collapsed, and the Centre has shown no leadership. Mr (Sharad) Pawar (Union agriculture minister), keeps telling us agriculture is a state subject, but R&D is completely in central hands. Innumerable experts have reviewed this and all have said almost exactly the same thing. Similarly, the Kaushik Basu committee on inflation has recommended reforms in agricultural markets in opening of retail. The Vaidyanathan committee told us what to do to about irrigation productivity. We know what needs to be done. But there is no strategic thinking, no urgency. The Vajpayee government did a lot to reform agriculture, but there's been nothing since.

First Published: Jul 02, 2011 22:19 IST