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India should start matching China's GDP growth of around 8.5-9.5%, over the
next two years, barring another global financial crisis, according to Asian
economists at US investment bank Morgan Stanley. More importantly, they say
that, by 2013-15, India will start outpacing China's GDP growth notably. By
2020, the economists say that India will have the largest annual number of new
Morgan Stanley's Chief Economist for China, Qing Wang, believes that China's
growth will move towards a more sustainable rate of 8% by 2015, following the
remarkable 10% average over the past 30 years. Economists, Chetan Ahya, who is
based in Singapore and Tanvee Gupta, based in Mumbai, says that India's growth
will accelerate to a sustainable 9-10% by 2013-15, after an average of 7.3% over
the past 10 years. In other words, over the next 10 years, They expect India's
growth to outpace China's and India's per-capita income to reach China's 2009
levels of US$3,750 over the next 10-11 years. They see a further rise in
investments to GDP in India, particularly infrastructure, and a gradual rise in
consumption GDP in China.
India transitioning to higher sustainable
India's GDP growth has moved from a range of 6% in the early 2000s to 8-8.5%
currently. The economists say that this shift has been premised on three key
First, the improvement in demographics as measured by
declining age-dependency (the ratio of the dependent population size to the
working-age population size) has been the most important factor supporting this
acceleration in growth. The ratio of the number of elderly people and children
to the working-age (aged 15-64 years) population has declined from 68.6% in 1995
to 55.6% in 2010, according to United Nations (UN) estimates. In other words,
the working-age population has been growing faster than the dependent
population. This has helped support a structural rise in domestic savings.
Second, structural reforms have improved the utilization of
the working-age population, a key resource. Ahya and Gupta say a positive
demographic trend may be a necessary condition for strong growth, but it is not
sufficient alone. Favorable demographics need to be converted into a virtuous
cycle of acceleration in growth. A critical step in this process is the opening
up of productive job opportunities through reforms. Over the years, India's
government has been initiating reforms to encourage private sector investment,
which helps to create the platform of employment for the working-age population.
In this context, one of the long-standing challenges for India was acceleration
in infrastructure spending. The government has finally been able to address
The economists expect infrastructure spending to rise to 8% of GDP in 2010
from 7.5% in 2009 and 5.4% in 2005. Similarly, business capex has been
accelerating, except for during the recent period following the global credit
crisis. The corporate sector has evolved from infancy to be ready to grow in an
open global competitive environment. This rise in investment has created the
employment platform for the growing working age population and these reforms
have played a critical role in boosting productivity growth.
An Indian entrepreneur is
relaunching the East India Company after buying the remnants of the British
trading giant that once ruled much of the subcontinent. Sanjiv Mehta, CEO of
East India Company, spoke to CNBC about the company:
Third, globalization, as reflected in the steady rise in
exports to GDP and capital inflows to GDP, has also helped accelerate the pace
of growth. India has relied on both goods and service exports. India's
performance in services has been a key differentiating factor. Ahya and Gupta
say that services exports have higher value-added components and more potential
in terms of the impact on the rise in savings rate. India's share in global
services exports increased to 2.6% in 2009 from 1.1% in 2000. Also, they believe
that India has benefited significantly from a rise in capital inflows.
A combination of structural reforms (including reduction in import tariffs
and other protection), an increase in private corporate and infrastructure
investments and financial deepening, and changing corporate sector efficiency
has resulted in a steady increase in total factor productivity (TFP) growth. MS
estimates indicate that India's TFP growth accelerated from an average of 2.4%
in the 1990s to 4% in 2005-09.
This interplay of demographics, reforms and globalization is crucial for the
virtuous cycle of faster growth in productive job creation - income growth -
savings - investments - higher growth. Over the past 10 years, India's savings
to GDP has risen from 24-25% to 33-36%. Similarly, investment to GDP has risen
from 24-25% to 35-38% and GDP growth has accelerated to a trailing five-year
average of 8.5% in 2009 from 5.9% in 2000.
Factors behind the lag in India's performance versus China
Ahya and Gupta say China has managed to convert its advantage of a growing
working population into a virtuous loop of creating productive jobs for its
expanding workforce and translate this to higher savings, investment and growth
since the early 1980s. China's age dependency peaked in 1965 at 80.4%. Since
then, the country's working population has been rising sharply. Its age
dependency fell to 67.4% in 1980, 48.2% in 2000 and 39.1% in 2010. Concurrently,
China's government has been able to increase productive employment opportunities
and, in turn, generate higher savings. China's savings rate increased from about
25% in the mid-1960s to 35% in 1980, 37.5% in 1990 and 51.4% in 2009, supporting
a major rise in investments to GDP. Real GDP growth in China has averaged 10%
annually over the past 30 years, compared with 6.2% in India. During this
period, China's GDP grew 16 times to US$5trn whereas India's rose seven times to
US$1.2trn. China's exports (including services) surged 65 times over this period
to US$1,330bn while India's exports increased 22 times to US$250bn.
The lag in India's performance, in the view of the economists, was due to the
lower level of support from demographic, reform and globalization factors.
India's demographic cycle is trailing China's. Although the two had similar
age-dependency ratios in the late 1970s, China has far outpaced India in the
past 20 years. China was also well ahead of India in initiating structural
reforms, introducing them in the late 1970s versus in the 1990s in India. India
was also late in deciding to participate in globalization, as reflected in the
import tariff trend.
India's integration with the global economy started to accelerate in the
early 1990s while China's integration began in the early 1980s. For example,
India had import tariffs above 30% until the early 1990s. The economists say
that India is following the same path as China when their export-to-GDP ratios
are compared, keeping the starting points for both as the years in which the
countries initiated the liberalization that allowed their resources to interact
with those of the rest of the world.
However, India's GDP growth is now inching closer to China's. Over the past
three years, India has been narrowing the gap with China in terms of GDP growth.
In 2010, MS estimates India's GDP growth at 8.5% and China's at 10%.
There are a
variety of reasons investors should look to invest in India rather than China,
explains Niall Ferguson, professor at Harvard University. He share his thoughts
with CNBC's Matthew Taylor:
India to start outpacing China from 2013-15
Ahya and Gupta believe that, by 2012, India and China will likely achieve
similar growth rates of closer to 9% and from 2013-15 India will start outpacing
China's GDP growth notably. The demographic trend is likely to diverge in the
two countries. China is expected to reach an inflexion point in its
age-dependency ratio around 2015. The UN estimates that China's age-dependency
ratio will rise from 39.1% in 2010 to 40% in 2015 and 45.8% in 2025 whereas
India's will continue to improve from 55.6% in 2010 to 51.7% in 2015 and 47.2%
in 2025. This would be reflected in the median age in China, which by 2020 would
reach 37.1 compared with 28.1 for India. The economic impact of India's
demographic trends should improve further as age dependency declines.
India to emerge as the largest supplier of labour
Ahya and Gupta say India will account for almost 26% of the increase in
global working-age population over the next 10 years, according to UN estimates.
The large surplus in India's working population is forcing recognition in the
world economy of the country's role in global competition and output dynamics.
As mentioned, UN data show that, by 2020, India will contribute an additional
136 million people to the global labour pool.
In comparison, China and the US will contribute 23 million and 11 million,
respectively, while Japan's and Europe's working populations are estimated to
decline by 8 million and 21 million, respectively.
Demographics alone are not sufficient for acceleration in GDP growth and it
is important that the working population is educated. Over the past few years,
the trend in education in India has improved significantly. Ahya and Gupta say
that the quality mix of the fresh additions to the workforce over the next 10
years is likely to change dramatically. They estimate that only 7-9% of India's
population moving into the 15-plus age bracket is illiterate and that this could
dip well below 5% over the next 2-3 years.
Primary school enrollment rates have risen significantly in India over the
past few years - on a net and gross basis to 90% and 113%, respectively. Key
reasons for this have been the success of the government's Sarva Shiksha Abhiyan
(providing universal primary education) program and Midday Meal Scheme (under
which a free lunch is provided to students to encourage them to attend school).
The number of out-of-school children in the primary age group dropped to around
5.6 million in 2007 from 18 million in 2000, according to World Bank estimates.
Also, the drop-out ratio has improved significantly in recent years. According
to District Information System for Education (DISE) data, the retention rate
(the percentage of students who complete their education) at the primary level
improved to 73.7% in F2008 (12 months to March 2008) from 58% in F2005 and 53%
Ahya and Gupta estimate that, if current trends continue, the number of
students graduating from primary school each year (out-turn) could increase from
18 million in 2009 to 20.3 million in 2015 and 21.4 million in 2020. The impact
of higher enrollment would be felt on out-turn at the secondary level as well.
Indeed, secondary enrollment rates have already started to pick up. According to
World Bank data, the secondary school gross enrollment rate in India rose to 57%
in 2007 from 46.2% in 2000. In India, there are two key secondary education
levels - lower secondary (education up to Grade 10) and higher secondary
(education up to Grade 12). The economists estimate that lower secondary
out-turn could increase from 8.5 million in 2009 to 11.8 million by 2015 and
14.5 million by 2020, and that upper secondary out-turn could increase from 5.8
million in 2009 to 9.2 million by 2015 and 11.2 million by 2020.
This would also filter through to the tertiary level. Out-turn at the
tertiary level could increase from 3.7 million in 2009 to 5.7 million by 2015
and 7.2 million by 2020, MS estimates. This would imply an increase in India's
tertiary-educated workforce size from 50-52 million in 2009 to 114 million by
2020. The out-turn of tertiary graduates in China has been much larger than in
India because of a significantly larger delta in population in the 20-24 age
bracket. However, this trend is likely to change over the next few years, with
the delta in population in this age bracket becoming larger in India. By
2020, the economists say that India will have the largest annual out-turn of
tertiary graduates globally.
The availability of infrastructure and teachers will be key to ensure the
quality of education and supply of an educated workforce does not become
constrained with the rapid growth. For MS estimates of growth in the primary-,
secondary- and tertiary-educated population to materialize, there would need to
be adequate measures to increase the number of teachers and professors. India's
pupil-teacher ratio at all three levels is higher than those in other key
countries. Indeed, at the tertiary level, MS estimates that an additional 40,000
teachers/professors would be needed annually to maintain the current
pupil-teacher ratio. This compares with the outstanding stock of teachers at the
tertiary level of 540,000.
Steady implementation of structural reforms is important to create
the employment platform for rising supply of educated/skilled labor.
Ahya and Gupta say further reforms that help create the platform of productive
employment for the rising working-age population in India will be needed, in
theeir view. India's voting population demographics are changing rapidly, with a
rising bias towards younger people, who are literate and hungry for development.
Indeed, the positive outcome of a larger share of the seats in parliament for
the single-largest party in general elections held in May 2009 is allowing the
Congress Party-led coalition government to initiate some difficult reforms. For
example, over the past 12 months, the government has systematically focused on
reducing the subsidy burden on oil and gas. Also, infrastructure execution is
picking up gradually.
MD & co-head of Asian economics research at HSBC, believes India's central bank
needs to hike rates another 150bps in order to ward off rising inflationary
pressures. He shares his assessment of India's economy with CNBC's Martin Soong
and Sri Jegarajah:
Over the next 12-24 months,
Ahya and Gupta
expect the pace of reforms to pick up with the government initiating the
a) Further steady reduction in subsidies: For instance, the
government announced a 10% hike in urea (fertilizers) prices and a new
nutrient-based subsidy in February 2010. For gas, the government approved a
revision of administered gas prices effective June 2010. Also, the government
has increased domestic fuel prices twice so far in 2010 and has announced that
gasoline prices will be market-linked from now on. MS estimates that these
measures will effectively reduce subsidy expenditure for an annualized rate of
c.0.6% of GDP. The economists expect the government to maintain its path to
reduce subsidy burden.
b) Introduction of Goods and Services Tax (GST) system: A
transition to GST would be an important milestone from a macro perspective,
moving from the current system of different types of indirect taxes and multiple
rates of indirect taxes. The new system would cover a wider base, including all
goods and services. The current system taxes production, whereas the GST will
aim to tax consumption. Indeed, current law levies taxes on the movement of
goods from one state to other, effectively creating borders within borders. It
distorts the allocation of resources and inhibits productivity growth. India's
budget confirmed government plans to implement the consolidated nationwide GST
system from April 1, 2011.
c) Direct tax reforms: These reforms aim to broaden the tax
base and will minimize exemptions. The budget for F2011 has confirmed a plan to
implement direct tax reforms as recommended in the direct reforms code (DTC) in
The Ministry of Finance has issued a draft new code for direct taxation. The
thrust of the new code, as its foreword says, "is to improve efficiency and
equity in direct tax system by eliminating distortions in tax structure,
introducing moderate levels of taxation and expanding the tax base". For
broadening the tax base, the code will minimize exemptions. The removal of these
exemptions will improve the tax-to-GDP ratio and efficiency in allocation of
resources. The new code will also simplify the language and law to reduce
litigation and check tax evasion. Moreover, the new code aims to encourage
long-term savings. The tax incentives for savings will be rationalized. The code
aims to follow the Exempt Exempt Tax (EET) rule, under which initial savings
contributions and accrual of interest are exempt but withdrawals would be
subject to normal taxes.
d) Consolidation of the public sector deficit: The
government has accepted in principle the recommendation by the 13th Finance
Commission for a fiscal roadmap for fiscal deficit and revenue deficit for
F2010-15. The commission includes the following medium-term fiscal consolidation
plan: i) to cut the consolidated (centre plus state government) fiscal
deficit to 7.3% of GDP by F2012 and 5.4% in F2015. ii) This will enable the
government to reduce consolidated public debt to GDP to 76.6% by March 2012
and 67.8% by March 2015.
e) Meaningful steps towards divestment of the government's stakes in
SOEs (State owned enterprises): The government plans to initiate a
meaningful divestment program, targeting collection proceeds. The budget target
calls for raising Rs400bn (US$8.7bn, 0.6% of GDP) from divestments in F2011
compared with an estimated Rs250bn (US$5.5bn, 0.4%) in F2010. MS estimates the
value of the government's stakes in listed SOEs at US$300bn. If unlisted
companies are included, the value would be c.US$450bn.
f) Acceleration in infrastructure spending, particularly for roads
and power: The government plans to increase infrastructure spending to
8.4% of GDP in F2012 from 7.5% in F2009. The Planning Commission has estimated
that infrastructure investment in F2013-17 will rise to a cumulative US$1trn
compared with US$542bn in F2007-12. Key areas where infrastructure spending is
rising include power, roads and telecoms. The economists believe that this plan is realistic
g) FDI in retail marketing and distribution: Ahya and Gupta
say that by mid-2011 the government is likely to allow foreign direct investment
in multi-brand retail distribution with conditions attached for compulsory
contribution to back-end infrastructure investments and absorption of the rural
workforce. India, at present, allows FDI in single-brand retailing to the extent
of 51%, and 100% for cash-and-carry wholesale trading. If the government were to
allow FDI in the retailing sector for multi-brands, it would result in a
dramatic increase in retail sector growth, in MS' view, involving an increase in
input of capital, technology and new management practices, which could reform
the whole retail business chain. Ahya and Gupta say, this move of allowing FDI
for multi-brand retailing would restructure: a) retail distribution via higher
asset turnover and better inventory management; b) intermediary and logistics
management; and c) production management for agriculture and manufacturing.
Inefficiencies in the agriculture sector could be reduced significantly through
improvement in the supply chain triggered by retail sector growth. Similarly,
SME manufacturing would get a major demand boost and face pressure to increase
In addition to these positive trends in demographics/talent supply and
structural reforms, India should continue to benefit from globalization, which
should help to increase productive job opportunities for the country's skilled
labor force. MS expect India's exports to GDP to continue rising. The combined
effect of more favourable demographics and increased productive job
opportunities should boost India's private savings level and push aggregate
savings to 37-40% of GDP over the next 10 years, allowing the country to
maintain an investment/GDP ratio of 39-42%. This increase in savings and,
correspondingly, the investment/GDP ratio should ensure a shift in India's
growth to a sustained rate of 9-10% in this period.
Net capital inflows as a percentage of GDP in India have increased
sustainably to 4-5%, except for during the credit turmoil. Gross FDI in India
increased to 2.8% in 2009 from 0.9% in 2005. FDI as a percentage of GDP in
India is now higher than in China and Brazil. Capital inflows help India
fund its current account deficit and allow the country to accelerate investments
more than savings. Moreover, capital inflows into India tend to be in the nature
of high-risk capital. Indirectly, this large source of risk capital acts as a
catalyst to private corporate capex. The combined impact of the continued
structural reforms, financial deepening and rising investments should help to
boost productivity growth further over the next 10 years.
Qing Wang expects China's sustainable GDP growth to moderate to 8%
towards 2015. With a changing demographic trend, China is unlikely to
have a rise in the supply of cheap labour at the same pace as has been the case
in the past 20 years. Over the next 10 years, China will add only 23 million
people to its working-age population compared with 118 million people added over
the past 10 years, according to UN data, while India will add 136 million over
the next 10 years. The UN estimates that China's age-dependency ratio will start
rising from 39% in 2010 to 40% in 2015 and 43.7% in 2020.
In this context, MS expects China to initiate structural change in its growth
model, reducing the dependence on external demand, increasing consumption to
GDP, and narrowing the current account surplus. This rebalancing would primarily
be premised on lifting wages as a percentage of GDP and the re-pricing of
economic resources such as materials to reduce environmental costs. A corollary
to this trend will be the transition of the country's exports model from
low-value-added manufacturing to higher-value-added manufacturing. Similarly,
Ahya and Gupta say that China's share of consumption to GDP and services to GDP
will rise over the next 10 years.
India to offer best growth opportunity over next 25 years
Over the next 20-25 years, MS expects India to remain the highest growth
economy among large countries. India could have the advantage of maintaining its
high-growth phase for a longer period than East Asia did as UN data show that
India's age dependency will continue to decline until 2040.
UN projections show that India will be the only large country which will
still have favourable demographics after 2010. Japan, Europe and the US (in that
order) will have a significant rise in their aging populations. So, while in the
past 20 years, China has benefited ahead of India from a faster fall
(improvement) in age-dependency ratio, over the next 20-25 years India will have
Internal challenges to sustain strong growth story
Ahya and Gupta say that there are several challenges to India's high growth
story. First, the government needs to ensure that it delivers on execution of
infrastructure development. The trend in China over the past 25 years indicates
that, for 10% sustainable GDP growth, India would need to increase
infrastructure spending to 10% of GDP from the current 7.5%. The economists
believe that the government would need to focus on laying down the policy
framework and support to ensure a sustained increase in investment in key
sectors such as electricity, highways and railways.
Second, one of the key pillars of the MS strong outlook for India is a
structural rise in domestic savings and investments. In that context, reduction
of the government's revenue deficit would be critical. The government made a
move in that direction in February 2010 by targeting a lower fiscal and revenue
deficit, but such efforts would need to continue over the next few years.
Third, labour law reform would need to be prioritized. Ahya and Gupta believe
that sustained strong growth in SMEs will be an important driver of India's
growth. There are more than 40 labour-related laws from the central government
on such issues as compensation, retrenchment, industrial disputes and trade
unions. State governments also have several pieces of labour legislation. Most
of these laws are not in sync with the practical realities of a highly
competitive globalized world. The economists believe that labour law reforms
would be needed to support growth in labor-intensive industries.
Fourth, development of less-developed states. Rising income inequality and
high poverty levels in some states have increased the probability of social
instability. Already, a few states have faced insurgency from naxalites and the
internal security threat from this movement is a concern.
Fifth, as discussed, significant progress has been made in improving primary
and tertiary education. The success of primary education has meant that the
demand for secondary education infrastructure is beginning to rise rapidly. Ahya
and Gupta believe that measures to further improve secondary and tertiary
education infrastructure would be required to help sustain the strong growth