India: The next 10 years

Global Finance, Apr 1997 by Sumit Mitra

The biggest challenge is to create a better life for all. But few

are sure if the government's pro growth program can deliver.

India, the land of 320 million poor, will observe the 50th anniversary of its independence from British rule later this year. The irony is, if the poor do not have the strength to dance through Independence Eve night, many of the 200 million people in the middle class will have enough resources to be happy anyway. That's because India has two economies rolled into one. One falls lower than that of the World Bank's classification for low income economies. The other is comparable to the second tier of Southeast Asian economies, such as Thailand and Malaysia. Independent India's first rulers, led by Jawaharlal Nehru and his daughter Indira Gandhi, walked the tightrope between the two extremes and preached the philosophy of "balanced growth." Both growth and equality suffered as a result. But, since the beginning of the government's economic reform program in 1991, growth has won out over equality.

Does this hold out a more promising future for India over the long term? Nobody is sure. Western firms are putting steadily rising amounts of foreign direct investment into India-amounts that reached about $2 billion in each of the past two years. That's a big jump from the slender $10-150 million annually that used to trickle in some years ago.

But the present levels are insignificant in comparison with the $38 billion plowed each year into China. Truth be told, the West has yet to make up its mind about India. Its heart is willing, but its purse is not.

The willingness of the heart shows in the steady rise in FDI inflows: from $586 million in 1993-1994 to $1.3 billion in 1994-1995, and $2.1 billion in 1995-1996. But there is still a big gap between FDI "approvals" and the actual inflows. For every hundred dollars approved, the actual investment is no more than $18.

However, the longterm outlook for a nation of one billion people shouldn't be confused with the bargain hunter's survey of the shop shelves. The assessments of some of the Fortune 500 firms with long experience in India present a promising picture. To Scott Bayman, chief executive of GE India, the country "is poised to combine a vast market with a large production base." Keki Dadiseth, chief of Hindustan Lever Limited, the Indian operation of Anglo-Dutch food giant Unilever, has forecast that his company, which now brings in 5% of the parent firm's global turnover, will push that to 10% by the year 2000. Citibank, which leads among credit card issuers in India, is increasing the range of its customer services at a frenetic pace. Procter & Gamble has for the past few years been heading the pack of multinational corporations in hiring fresh-minted business school graduates-at world-class salaries. Bill Gates of Microsoft, who paid a well-publicized visit to India in March, calls India a "software superpower." This tandems with management guru Tom Peters's prophecy that the Indian city of Bangalore will become the world's software capital in a few decades.

Pretty words? Perhaps. But India has lately taken a lot of bold new steps that make bullish projections look quite credible. And surprisingly, the economy is changing course regardless of the country's notoriously fractious politics. The government of the republic is now headed by a coalition of 13 parties, including communists and socialists. But it has presented an annual budget that makes Margaret Thatcher look like a socialist. The highlights of finance minister P. Chidambaram's 1997 budget, described as the most liberal since India's independence, are:

cuts in the top income tax rate from 40% to 30%, and the marginal tax rate from 15% to 10%;

declaration of a tax amnesty under which all undeclared assets can be regularized by paying a 30% taxwithout any questions asked about how such assets were acquired;

cuts of top import tariffs from 50% to 40% and reductions in excise duties;

partial opening up of the insurance sector to allow competition in health insurance and pension funds (though foreigner participants are still barred);

allowing venture capital funds to invest up to 20% of their funds in a single company, up from 5%.

Years ago economist Arthur Laffer sketched his famous curve on a napkin at Wall Street's Michael I restaurant, to the glee of the assorted supply-siders. Two decades later, and on a different continent, Chidambaram is testing his theory, betting that if the tax rates are lowered, India will see lower prices, higher output, and therefore, higher government revenue. The new budget has only one paragraph devoted to the usual homilies on the fiscal deficit. Chidambaram says he will contain price rises by liberalizing imports, not by jamming the brakes on growth. He also promises to hold the gross fiscal deficit down to 4.5% of GDP, an optimistic forecast that is founded on his growth expectations for the economy.

With its new economic plan, India has finally taken the plunge toward supply-side management. It now expects supply to create demand. The lower income tax rate is supposed to induce people to work rather than to stay at home, and create more incentive for firms to increase production in the United States. All this has a familiar ringsounding much like the Reagan years in the United States. In Southeast Asia too, most of the growth sagas were written by unhindering supply. But for India, a country which spent 44 of its first 50 years as an independent nation entangled in licensing and permits, nothing could be more invigorating than the current policy turnabout.