Is India really the “New China”?

In vivid contrast to just a few years ago, when Jim O’Neill, who came up with the BRICs concept, wanted to drop the country from the acronym in favor of Indonesia, India has now emerged as the undisputed queen of the emerging markets.  Along with this development comes a new mantra: “India is the New China.”

But how true is this assertion?  Like everything else related to India, the answer is complicated and equivocal.

Given the stark economic problems in other major emerging markets, India is looking good in comparison.  It has now displaced China to assume the mantle of the world’s fastest-growing major economy.  The stock market is outperforming those in the other BRICS nations.  India also received $7.1 billion in private equity funding for the first half of this year, 38 percent more than the same period in 2014.  In volume terms, the number of deals jumped 62 percent vis-à-vis the corresponding period last year.

The CLSA brokerage and investment banking agency encouragingly reports that:

Our recent meetings with investors in Singapore and Hong Kong reveal that India continues to be a ‘favored’ market among regional investors.  While some investors have reduced India weight, most investors believe in sharp 2HFY16 earnings recovery and focus on the long-term structural positives, retaining their overweight.

And a number of foreign companies have recently shown their faith in India’s prospects by announcing major expansion plans. I’ll have more to say about these in the next issue of Datapoints, but the logic driving all of them was pretty much summed up by a Mumbai-based entrepreneur and investor quoted in the Financial Times: “India is the last billion-person market left.”


But because the politics of economic reform are much more challenging in New Delhi than in Beijing, India will never be able to replicate China’s meteoric economic rise over the last 30 years.  The past few weeks have offered ample illustration of this statement.

There is no denying that last summer’s hopes that Narendra Modi’s landslide election as prime minister would jump-start a quick economic renaissance have now faded.  The hype overlooked two key points: 1.) The country does not do rapid transformational change; and 2.) the “I” in India stands for “incremental.” 

Mr. Modi can claim that he brought about major changes in the northwestern state of Gujarat where he wielded unchallenged political authority during his long tenure as its chief minister.  The experience earned him accolades from the global business community and engendered a good deal of hubris on his part, such as when he confidently declared following his May 2014 election triumph that “ten years is all that is needed” to modernize the country.

But the dynamics of economic reform play out very differently on the national stage, given the growing fragmentation of the Indian political system.  And Modi has now run headlong into a truth that Montek Singh Alhuwalia, the distinguished economist and policy official, advanced many years ago:   The norm in India is “a halting process of change in which political parties which opposed particular reforms when in opposition actually pushed them forward when in office. The process can be aptly described as creating a strong consensus for weak reforms!”

This is an insight into the reform process that every entrepreneur and investor, not to mention prime minister and Cabinet official, should never cease bearing in mind.  Indeed, the just-concluded summer session of the Indian parliament demonstrated it in spades, as the Congress Party, the main opposition party, stalled progress on two key items on Modi’s economic reform agenda.

The first item is replacing the fragmented system of indirect taxes the central government and the states currently levy at different stages of the supply chain with a nationwide goods and services tax (GST), India’s version of the value-added tax.  The measure would help create a more unified market in India, increase productivity and enable higher GDP growth. UBS bank recently estimated that “The introduction of the GST is a key reform measure that could have immense macro implications for India’s growth potential.”

But consideration of the measure was shut down in the parliament’s upper chamber, which is controlled by the Congress Party and its political allies, even though the party supported the measure when it controlled the central government just a short time ago.  As ironically, Mr. Modi and his political party, the Bharatiya Janata Party (BJP), opposed the legislation when it was then out of power but now lines up foursquare behind it.

The BJP now decries the disruptive tactics employed by Congress though they are the same ones the BJP used when it was in the political wilderness.  Indeed, the feisty Sushma Swaraj, who is currently Mr. Modi’s foreign minister, was a major thorn in the side of the Congress Party when she led the BJP caucus in parliament’s lower house.

Another causality of the partisan bickering was Modi’s effort to simplify the lengthy and legally-convoluted process of acquiring farmland for much-need infrastructure projects and industrial projects.  The prime minister wants to amend the land acquisition act passed by the previous central government two years ago, which is widely judged to have substantially increased project development costs.

Political machinations surround this issue, too.  The BJP cynically supported the 2013 land legislation since it wanted to court India’s vast reservoir of rural voters in the run-up to last year’s parliamentary elections.  Once in office, however, Prime Minister Modi has expended much political capital on revising the legislation but so far to no avail.

I noted in a recent issue of Datapoints that Modi was close to abandoning the effort and this point appears now to have been validated.  Anxious to avoid being tagged as “anti-farmer” in the run-up to important state-level elections in Bihar, Tamil Nadu, West Bengal and Kerala, the prime minister and his BJP colleagues have punted on the issue.  Four months ago, Modi’s finance minister declared that the land reform bill would “determine a very large part of the progress India makes.”  Now he’s taken to encouraging individual state governments to move forward in lieu of action by the central government.

This is a tacit but clear acknowledgement that Modi’s momentum is dissipating.  The prime minister’s Independence Day address on August 15, delivered two days after the parliamentary session ended, said it all: Unlike last year’s speech, which brimmed with confidence and energy, his remarks last week were tepid and defensive.  Reuters quoted an unidentified member of the prime minister’s inner circle as saying that Modi was “upset about failing to further his reforms agenda and decided to ‘keep his head down’ and focus on improving performance.”

The GST reform is not dead, though if enacted in the next year or so it will likely be in a much diluted form that erodes the economic jolt it delivers.  The land reform effort, on the other hand, is in a deep coma.  At a minimum, it will take several years for the politics to line up with meaningful movement on this issue.

The past weeks underscore two key, reinforcing lessons about the politics of economic reform in India: 1.) The election season, and thus the political pandering to certain voter blocs, never ends; and 2.) There is no national consensus on the imperative of economic modernization.

In a report last month Moody’s Analytics pegged India’s true annual growth potential at near 10 percent.  It cautioned however that the “jury is still out on Prime Minister Modi, but the government’s failure to deliver on promised reforms is a major impediment to a broader economic growth momentum in the country.”  This week Moody’s warned that it might need to lower its growth forecast for India:

One main risk to our forecast is that the pace of reforms slows significantly as consensus behind the need for reform weakens once the least controversial aspects of the government’s plan have been implemented.

This analysis is cross-posted on the website of Geoskope, a business intelligence firm focused on key emerging markets, where I serve as chief knowledge officer.

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Repentant “Tax Terrorists” and Other Signs of Change in New Delhi

From senior government officials working longer hours and cutting back on their golf game, to the emphasis on Hindi in official documents, there are plenty of signs that a new order is descending on Delhi.  But perhaps the most poignant so far is the way Pranab K. Mukherjee, currently the president of India, has been forced into a public renunciation of the very tax policies he pursued just two years ago when he was finance minister.

The most significant consequence of the horrific November 2008 terrorist assault in Mumbai was actually self-inflicted.  The talented Palaniappan Chidambaram was shifted out of the finance ministry in order to whip the feckless home ministry into shape.  Mukherjee was appointed to fill the resulting vacancy, reprising an entirely unmemorable stint as finance minister in the early 1980s.  Significantly, while Chidambaram was an enthusiastic champion of the key economic reforms of the early 1990s when he was serving as commerce minister, Mukherjee was virtually invisible despite then heading up the Planning Commission, a key economic planning agency.

His second stint at the finance ministry, from early 2009 to mid-2012, was nothing short of disastrous.  He remained complacent as the global economic meltdown started to weigh in on India, preferring to emphasize expensive social welfare projects instead of productivity-enhancing structural reforms.  The budget he formulated in early 2011 was bereft of any serious commitment to rein in profligate spending and was laced with roseate assumptions that were quickly proved unfounded.  And the following year’s budget was so out of touch that a distinguished observer noted it was “shocking that a finance minister can ignore all the problems that he faces.”

Mukherjee’s tenure ended when he was kicked upstairs to the Indian presidency, the largely ceremonial head-of-state post.  By then India, hailed as the next China just a few years earlier, was being called the “first BRIC fallen angel,” the “Greece of Asia” and a “gasping elephant.”  The global ratings agency Standard & Poors was threatening to downgrade the country’s sovereign debt credit rating.  The announcement that economic growth in the first quarter of 2012 had declined to 5.3 percent, from over 8 percent just over a year earlier was so shocking that headlines in the Economic Times screamed “Goodbye 2020, Hello 1991!”  A Congress Party leader was even quoted as saying that “We have to rescue the economy from the ravages of Pranab Mukherjee.”

Most damagingly was the wrecking ball Mukherjee took to India’s reputation among global investors.  Searching for ways to pay for costly social spending, he devised exasperating tax policies directed at foreign companies doing business in India – this at the very moment when India should have been pulling out the stops to attract more overseas investment.  The most egregious case in point concerns Vodafone, the London-based telecommunications company, which in 2007 spent $11 billion to buy from a Hong Kong conglomerate majority ownership of what is now the second-largest telecommunications company in India.

Vodafone was subsequently hit with a $2.2 billion tax bill on its purchase.  The company resisted, arguing that the transaction was executed by offshore vehicles of the two principals and that in any case Vodafone was not the seller of the assets and so could not possibly be liable for a capital-gains tax.   After an extensive legal battle, the Indian supreme court in early 2012 agreed and reproached the government for overreaching its authority.

Having thus failed to prevail in the courts, Mukherjee attempted to re-write the law by proposing a retroactive tax on capital gains arising from cross-border purchases of Indian assets dating back 50 years, a piece of legislation that only furthered India’s reputation as an inhospitable investment destination.  According to Sanjaya Baru’s new book, Mukherjee gave Prime Minister Singh just one day’s notice that he was going to introduce the legislation.  The proposal provoked seven business associations from the US, the UK, Canada, Japan and Hong Kong to write a joint letter to Singh, warning that it “has called into question the very rule of law.”

The concept of retroactive taxation also drew criticism from the BJP, which labeled it “tax terrorism” in its recent election manifesto.   In its first official policy statement, Prime Minister Narendra Modi’s new government pledged to re-work the current tax regime so that it’s “non-adversarial and conducive to investment, enterprise and growth.”  It also promised to “create a policy environment which is predictable, transparent and fair.”

The irony is that this repudiation of the way Mukherjee approached things while at the finance ministry was issued not by Modi but by Mukherjee, who was discharging the traditional duty of the Indian president in outlining a new government’s agenda to a joint session of Parliament.  It’s an irony that many commentators overlooked, though it has much more import for the country’s prospects than the numerous stories in the press these days about miffed ministers and inconvenienced babus.

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Modi really will need to be a Miracle Worker

If Narendra Modi ends up as the new prime minister of India, his reputation as an economic miracle worker will be put to a herculean test.  As several news items make clear, the country’s economic problems go way beyond bureaucratic lassitude and policy indecisiveness to include major structural challenges.  Unfortunately, Mr. Modi appears to believe that speedier decision-making is enough to pull India out of its doldrums. Speaking the other month at a seminar on economic policy, he exclaimed that “good governance is more potent than policies.”

One of the dominant narratives in recent decades has been about how the spectacular growth of an urban middle class in countries like China and India would reshape the global economic landscape.  A 2007 report by the McKinsey Global Institute estimated that the size of the Indian middle class would swell to some 580 million people (41 percent of the population) by 2025.  Similarly, a 2010 report by the Asian Development Bank reckoned that the middle class would grow to over 600 million by 2020, and to over 1 billion by 2030 – at which point, it would outnumber that in China.

Such mind-boggling numbers helped spawn the ubiquitously cited “BRICs” epic propagated by Goldman Sachs as well as Fareed Zakaria’s “Rise of the Rest” saga positing a “post-Amer­ican” world.  And as the 2008 global financial crisis unfolded, the U.S. National Intelligence Council concluded that growing prosperity in China and India had catalyzed a “global shift in relative wealth and economic power … [that] is without precedent in modern history.”  There was even talk of “economic decoupling” – the notion that the Asian regional economy, with the two countries at its core, had achieved enough critical mass so it was no longer dependent upon developed markets in the West.

The sense that a new global order was dawning also led to a rash of high-lev­el corporate redeployments.  The head of the HSBC financial conglomerate relocated from London to Hong Kong, while Cisco Systems, one of Silicon Valley’s premier companies, decided to establish its eastern hemi­sphere headquarters in Bangalore.

But a series of reports in the Financial Times (here and here) this week argues that the growth of a solid middle class in Asia is less certain than widely assumed, since many who have risen out of poverty in recent decades could slide back into it during a prolonged period of slow growth.  This point is buttressed by new data from the National Council for Applied Economic Research, a widely-respected institute in New Delhi.  It finds that the annual income of the Indian middle class remains relatively low.(The ADB report cited above also made similar points.)

The International Monetary Fund warned last week that the world could face years of below-par growth, while some experts, like Ruchir Sharma (here and here), argue that developing economies like China and India are unlikely to achieve the high-flying growth rates they experienced in the last decade.

The Financial Times quotes Kaushik Basu, the World Bank’s chief economist and formerly the chief economic adviser to the Indian government, as saying that developing countries “need to do more, much more, in terms of structural reforms” in order to return to the kind of poverty-reduction gains seen in recent decades.

One fundamental reform India needs to carry through is the shifting of unskilled workers from the unproductive agricultural sector to labor-intensive manufacturing, something which should be a huge comparative advantage for the country.   Another key is spurring the urbanization process, something which Mr. Modi has promised to do by building 100 new technologically-advanced cities and expanding existing metropolitan centers in smarter ways.

Goldman Sachs reckons in a new report that the urbanization rate in India was about 20 percent in 1980, a figure higher than that of China at the time.  Since then, however, China’s rate has zoomed to over 50 percent, while India’s has only moved to just over 30 percent.  The investment bank calculates that urbanization contributes 2-3 percentage points to GDP growth in China and believes that accelerated urbanization would add some 1.8 percentage points to Indian growth.  Indeed, Foreign Policy magazine estimates that the top 35 metropolitan areas in China contributed just under half of its economic activity in 2013.  Premier Li Keqiang, who calls urbanization a “huge engine” for growth, has just launched a high-profile effort to speed along the process. The Economist magazine figures that nearly 70 percent of the Chinese population will reside in urban areas by 2030.

But according to a new report in the Wall Street Journal, the urbanization process in India has stalled due to an array of factors, including the lack of manufacturing jobs, persistent high inflation, and populist social welfare programs that discourage the rural poor from moving to cities.  A study released earlier this year by Crisil, a Mumbai-based company providing financial market intelligence, finds that some 37 million people exited the agricultural workforce in the 2005-2012 period, lured by better opportunities in the manufacturing and service sectors.  But it estimates (here and here) that these sectors will create 25 percent fewer jobs in the 2012-2019 period, thus trapping many rural youth in a life of agrarian poverty.  The marked economic slowdown in the past two years has already caused the rural labor pool to grow again and Crisil estimates that the under-employed agricultural workforce will expand by 12 million people in the 2012-2019 period.

The next prime minister will confront monumental economic challenges that cannot be resolved by greater injections of bureaucratic efficiency.  We will soon see how ready the Indian political system is to accept this truth and bite the bullet of fundamental reform.

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Reform is a Dirty Word in India: An Update

A previous post made the case that India’s difficulty in advancing serious economic reforms is ultimately due to the lack of a home-grown intellectual tradition that can undergird them.  As business leader turned public intellectual Gurcharan Das notes, the country is bereft of “a liberal party that openly trusts markets and focuses on economic and institutional reform.”

So does the likelihood of Narendra Modi becoming the next prime minister render this argument void? Continue reading

Reform is a Dirty Word in India

India’s difficulty in advancing serious economic reforms is ultimately due to the lack of a home-grown intellectual tradition that can underpin them.  The Congress Party, long a bastion of statist thinking, is proof of this proposition.  But fresh evidence comes courtesy of the Aam Aadmi (“Common Man”) party, the rising anti-establishment movement that oddly combines an emphasis on clean government with backward economic views.

In far too many quarters, the reforms adopted during the 1991 economic calamity are regarded as the modern equivalent of the British East India Company, something imposed on the country by overwhelming external forces.  Thus, no political leader of any note embraces reform as a concept and when it occurs nonetheless, it is usually the product of technocratic subterfuge.  As business leader turned public intellectual Gurcharan Das noted the other week, India is bereft of “a liberal party that openly trusts markets and focuses on economic and institutional reform.”

Read the rest of the article in The Diplomat.

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India Needs to Revisit 1991

Let’s hope that the specter of 1991 lingers around long enough to galvanize New Delhi elites – especially Congress Party leaders who are now in populist election mode – with the courage to implement game-changing reforms.  Taking a cue from the ADB, they can start with dismantling the anarchic laws governing labor markets and the acquisition of land for industrial projects which have stifled the growth of labor-intensive manufacturing.  This should be a huge comparative advantage though worrying signs are emerging of Indian manufacturers shifting to other countries.  But until some hard measures are enacted, all of New Delhi’s talk about building the country into a global manufacturing hub will continue to ring hollow.

Read the rest of the article at The Diplomat.

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India and the Long, Slow Walk toward Destiny

India exemplifies Adam Smith’s classic observation about there being “a great deal of ruin in a nation.”  Pessimism about the country’s prospects is now widespread, though it’s important to remember that India’s retains amazing potential.  Far-sighted leadership is in short supply, however.  As Indians gather to celebrate Independence Day, a re-dedication to the ideals Jawaharlal Nehru set forth in his “Tryst with Destiny” address is necessary.

Read the rest of my article in Fair Observer.

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