Asia Study Report - Embrace the Dynamism of India

URATA Shujiro
Faculty Fellow, RIETI

With its huge population and continuing high economic growth, India is attracting the world's attention along with China. Affected by the global economic crisis, triggered by the Lehman collapse in September 2008, both India and China suffered a temporary slowdown but their growth rebounded in 2009. Now many are looking toward these countries to lead the world economy as their economies have recovered more quickly than advanced economies such as the United States, Europe, and Japan.

A research team at the Japan Center for Economic Research (JCER) has analyzed factors behind the high growth of the Indian economy, identified challenges in achieving further growth, explored ways to address such challenges, and compiled the findings into a report (I led the research team). In the course of this research, we also pondered how Japan can embrace the dynamism of the Indian economy to benefit its own.

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India's gross domestic product (GDP) for 2008 was 1.2175 trillion dollars, an amount equal to about 30% of China's GDP or 25% of Japan's. When adjusted for purchasing power parity, however, India is the world's fourth largest economic power, following the U.S., China, and Japan. With a population of 1.1 billion and a land area of about 3.28 million square meters, India is about nine times the size of Japan in both measures. The proportion of the youth population is relatively high and cultivated land accounts for a significant portion of the total land area of India.

Following its independence in 1947, India pursued protectionist policies under a socialistic, state-controlled economy. It promoted import substitution industrialization, a strategy seeking to expand domestic production as a substitute for imports. However, this did not result in efficient production and India failed to achieve its expected economic growth. Non-economic factors - including natural disasters and war with Pakistan - also hindered the growth of its economy. In the 1980s, India began to liberalize its economy in a gradual but systematic manner. While this helped India achieve higher economic growth, both the fiscal and current account deficits expanded significantly, throwing the nation into a serious economic crisis in 1991.

In response, India launched sweeping economic reforms under the leadership of then Finance Minister Manmohan Singh, now the Prime Minister of India. Specifically, the country pushed forward the liberalization of external economic policies such as those for trade and direct investments from abroad, the reform of the financial system, and the abolishment of the industrial licensing system. As a result, the principle of competition came into play, invigorating private-sector business activities. These reforms began producing tangible results from 2000 onward. From 2003 to 2007, India's real economic growth averaged well above 8% per year, compared to less than 6% from 1991 to 2003. The nation's economic growth since the 1990s has been driven by the service sector. And in the process, information technology (IT) industries have emerged as a fast-rising new star. With the IT revolution and globalization serving as a tail wind, IT industries developed rapidly in India where highly skilled IT human resources are abundantly available.

From 2000 and onward, people's income and purchasing power began to increase in a significant way on the back of rapid economic growth, leading to the rise of a sizable middle class; people with a certain degree of purchasing power. Setting their sights on the growing purchasing power, companies put their products - automobiles, motorcycles, home appliance, mobile phones, etc. - into the Indian market with tempting offerings to induce consumption. For instance, Tata Motors Ltd., which is India's largest company, has developed an ultra low price vehicle that costs only 100,000 rupees (approximately 220,000 yen) and aims to further expand sales. Meanwhile, fierce competition among mobile phone service companies led to a sharp decline in phone charges and hence a rapid increase in the number of subscribers, which has been growing at the pace of nearly 10 million per month during the past two years ( figure ). Furthermore, the retail market for the fast moving consumer goods (FMCGs) - i.e. everyday commodities such as shampoos, conditioners, and beverages - and related industries are fast expanding. Expanded consumption, in turn, prompted companies to make more investments, thus, creating a virtuous circle of economic growth.

Number of Telephone Service Subscribers in India Number of Telephone Service Subscribers in India

Source: Telecom Regulatory Authority of India (TRAI), 2009

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Thus, there are quite a few positive factors pointing to high growth, such as the increasing youth population, strong consumption demand, steady domestic investments, and expanding trade and direct investments from abroad. At the same time, however, India also has many challenges that need to be addressed.

First, key infrastructures have yet to be sufficiently developed. Infrastructure investments in the distribution and power sectors - such as those in roads, railroads, and ports - remain far from sufficient. This poses a very serious problem, impeding smooth economic activities and hindering the inflow of foreign capital that would contribute to the economic growth of India. The Indian government is fully aware of the importance of infrastructure development. However, coordination between the central government, which has authority over the procurement of resources for and regulations on infrastructure development, and local governments remains a problem.

Education is another serious challenge. The supply of competent human resources is indispensable to economic growth and it takes education and training to foster human resources. Education is not sufficiently given or received at all levels, i.e. primary, secondary, and higher levels. At the level of primary education, nearly one out of every three school-age children in India drops out to help with the family business or farming. The percentage of those continuing onto higher education is as low as about 10%. Enhancing higher education is essential to the development of knowledge-intensive industries, including the IT industry, which is counted on to become a growth engine in the future, as well as the medical service and biotechnology industries. The increasing youth population is a plus for economic growth when employment is secured. However, this same factor would work in reverse and suppress growth if employment opportunities became scarce and unemployment increased. In order to expand job opportunities for young people, it is necessary to enhance their capabilities through education and training.

Agriculture has a profound impact on the Indian economy. Agriculture's share of GDP has fallen year after year to about 17% in fiscal 2008. Nevertheless, about two thirds of the Indian population lives on agriculture or business associated with agriculture. Thus, a bad harvest would cause declines in family income and consumption in extensive rural areas, thereby dragging down the economic growth of the entire country. The majority of people living in the rural areas are poor and their circumstances can have a profound impact on the social and political environment. In addition to the lack of adequate agricultural infrastructure, such as irrigation and farm roads, the lack of investments and the delay in the introduction of technologies remain problems. The government has taken steps to expand bank loans to farmers but financial support alone cannot improve the situation. It is necessary to implement other, non-financial measures such as those to facilitate the introduction of technologies and help expand sales channels.

While economic reforms have made considerable progress, government policies as well as laws and regulations still need to be reformed in many aspects. Disturbing aspects include the following: India's labor laws remain extremely protective of workers; laws and regulations are not always followed; and the government continues to restrict foreign capital and protect domestic industries from imports. Today, farmers and people of the lower caste, who are discriminated against in India, are becoming increasingly politically aware, which has led to some politicians opposing reforms that would add to the suffering of farmers and workers.

Appropriate steps are also needed to address fiscal deficits, problems with the medical and healthcare systems, and energy and environmental issues. What is most important is to make self-help efforts. At the same time, however, India should make effective use of support from foreign countries including Japan.

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Japan, for its part, should seek to derive economic benefits by forging closer economic ties with India, a country with potential for high growth. Economic relationships between Japan and India have expanded significantly over the past several years, notably, in terms of direct investment and trade. However, the current levels of direct investment and trade are far too low, given the size of the two economies. In order to further expand Japan-India economic relations, it is important to work for an early conclusion of the ongoing negotiations on a free trade agreement (FTA), which would reduce trade and investment barriers between the two countries, and for the realization of the Comprehensive Economic Partnership for East Asia (CEPEA), which is still in a conceptual phase at the moment.

The largest of the recent Japan-India initiatives is the Delhi-Mumbai Industrial Corridor, a mega program that calls for turning the area stretching 1,483 kilometers between Delhi and Mumbai into an industrial zone similar to the industrial belt stretching from Tokyo to Osaka along the Pacific coast of Japan. This would contribute to the growth of the Indian economy and expand business opportunities for Japanese companies. However, there exist some requirements that must be satisfied to bring this project to a successful end. These include: ensuring sufficient investments by Japan; securing the Indian government's guarantees for bank loans made for specific construction projects that have been subject to prior assessment by Japan Bank for International Cooperation (JBIC), an international division of Japan Finance Corporation; coordinating industrial park plans in the relevant six provinces; and solving problems concerning infrastructure development.

Addressing environmental problems is a tough challenge that needs to be overcome as a prerequisite to sustainable economic development. Given the size of its economy, which is already large today and expected to further expand in years to come, India will have a significant role to play in tackling global environmental problems. In this regard, there will be ample room for Japanese companies to take advantage of their competitive edge in the environmental field.

The exchange of human resources is important to the strengthening of economic relationships. But people-to-people exchanges between Japan and India remain at an extremely low level. The key to changing this situation is to accept more specialists from India, such as those in the IT sector where Japan lacks human resources, and promote student exchanges between the two countries. According to Japan Student Services Organization (JASSO), only 543 students from India are studying in Japan in fiscal 2009 (April 2009 through March 2010). Not only is this nowhere near the number of students from China (79,082), Indian student numbers fall below even those from Nepal (1,628) and Sri Lanka (934), both of which have smaller populations than India. The main reason attributed to the small number of students from India is language but difficulty in finding a job in Japan is also thought to be a contributing factor. In order to attract more students from India, it is important to expand cooperation between Japanese and Indian universities and promote the employment of Indian graduates (from Japanese universities) by Japanese companies.

>> Original text in Japanese

* Translated by RIETI.

January 15, 2010 Nihon Keizai Shimbun

March 2, 2010