Wednesday, June 17, 2009

Top 10 challenges for India to achieve 2050 potential

Various studies have shown that India could be 40 times bigger by 2050. To achieve this potential, however, the nation needs to implement many changes.

In one of its latest papers, Goldman Sachs outlines ten crucial steps that India must take in order to achieve its full potential.

“In our latest annual update to our Growth Environment Scores (GES), India scores below the other three BRIC nations, and is currently ranked 110 out of a set of 181 countries assigned GES scores. If India were able to undertake the necessary reforms, it could raise its growth potential by as much as 2.8% per annum, placing it in a very strong position to deliver the impressive growth we outlined,” it says.

Here are the 10 things for India, as outlined by Goldman Sachs, to achieve its 2050 potential:

India’s governance problems overarch all its other problems. Without better governance, delivery systems and effective implementation, however, India will find it difficult to educate its citizens, build infrastructure, increase agricultural productivity, and ensure that the fruits of economic growth are well-distributed.

Governance problems stem from the increasing inability of the government and public institutions to deliver public services in the face of rising expectations. A large gap between physical access to services and the quality of services provided is leading to a citizen satisfaction gap.

Some observers attribute India’s governance problems to its democracy. Goldman Sachs thinks it is the malpractice of democracy—or the ‘democracy deficit’—that is the cause of the problem.

A well-functioning democracy should allow citizens to have more voice in evaluating the quality of services they receive, for governments and service providers to be accountable, and for citizens to pay directly for services received.

Many international observers tend to see education as one of India’s biggest advantages. This is primarily because they tend to meet only the best and the brightest.

It is the case that India has a large number of highly educated people. But it has a population of 1.1bn and probably the highest absolute numbers anywhere globally receiving hardly any education.

There is evidence that the amount of time spent receiving secondary education is important for economic growth and productivity. India scores poorly relative to the other BRICs, and even below the average of all emerging market countries.

The actual amount spent on education is low, and its efficiency is weak. It is important that India improves the amount and quantity of money spent, and that the quality is improved.

There is also significant need for better higher education. The likely numbers seeking higher education can be expected to grow by three of four times by 2020 from the current number of around 10mn.

The National Knowledge Commission has proposed an increase in the number of universities from 350 today to 1,500 by 2016. It has also proposed an increase in the 18-24 age group — to be educated to university level from 7% to 15%.

India plans to quadruple the number of its universities in the next ten years—an admirable goal and a huge challenge. Its goal should also probably be that at least 20 of these are the world’s best. Shanghai University has become recognised as the authoritative voice on leading universities.

Its latest ranking does not show a single Indian university in the top 300. China itself has six. In order to achieve this kind of ambition, just as in other spheres of life, India’s leadership needs to have strong and imaginative goals. Perhaps India can share ‘best practices’ with leading universities from elsewhere around the world.

Although India has not suffered particularly from dramatic inflation, it is currently experiencing a rise in inflation similar to that seen in a number of emerging economies.

Goldman Sachs thinks a formal adoption of Inflation Targeting (IT) would be a very sensible move to help India persuade its huge population of the (permanent) benefits of price stability. It also recommends greater independence for the Reserve Bank of India and the abolishment of all FX controls.

“We are well aware of some of the difficulties, both real and perceived, for India to adopt these choices, but we think it is in India’s best long-term interests to undertake these steps. IT has given major benefits to a broad variety of countries, ranging from ‘developed’ countries (such as New Zealand, Sweden and the UK) to ‘developing’ ones (such as Brazil, Korea and South Africa). For India, there are probably broader powerful benefits,” it says.

India’s gross fiscal deficit remains one of the highest in the world and, recently, government liabilities have been increasing at an alarming rate.

Goldman Sachs estimates that the overall government deficit stood at just under 6% in FY2008. In FY2009, this may accelerate to above 7%, due to a large debt-waiver for farmers, a big wage hike for civil servants, increasing fertiliser and oil subsidies, and higher exemptions on income tax.

At such high levels, government borrowing crowds out private-sector credit, keeps interest rates high, adds to already high government debt, and becomes a key source of macro vulnerability.

Therefore, a medium-term strategy for fiscal policy, which reduces the overall deficit to a sustainable level, is critical for India.

India’s financial sector remains small and underdeveloped. The state still dominates the sector, holding 70% of banking assets, a majority of insurance funds and the entire pension sector.

Additionally, markets are lacking in corporate debt, currency and derivatives. This leads to a lack of credit and low financial savings. Total credit, at 50% of GDP (although increasing rapidly in recent years), remains well below that of its Asian neighbours (an average of over 100% of GDP) and especially compared with China (111% of GDP).

Within this, consumer credit remains abysmally low (at 11% of GDP) compared with an Asian average of over 40% of GDP. Household savings tend to be in physical assets and gold, and risk diversification channels are not available.

To meet its growth potential, India needs to pursue financial reforms to channel savings effectively into investment, meet funding requirements for infrastructure and enhance financial stability.

Savers need to have access to a broad range of financial instruments, while borrowers should be able to access local debt and equity.

In the past decade or so, Indian trade with the rest of the world has ballooned. Lower tariff barriers encouraged by Indian authorities have been key, as has booming world trade. This impressive development needs to be kept in perspective, however, as it has come from an exceptionally low base. India currently accounts for no more than 1.5% of global trade.

On Goldman Sachs’ GES scoring system, India still ranks below the average of all developing countries. India’s trade with China is rising sharply, and China now ties with the US as India’s biggest trading partner.

Again, however, it is important to recognise that trade with China remains very low. India takes just 1.93% of China’s exports and provides just 1.46% of its imports. Total trade with the US in 2007 was just $42bn. For comparison, total US trade with China in 2007 was $405bn. Similarly, total Indian trade with China was just $37bn.

Thus, in terms of international trade, India continues to be much less ‘open’ than many of its other large emerging nation colleagues, especially China. Given the significant number of nations with large populations on its borders, Goldman Sachs recommends that India target a major increase in trade with China, Pakistan and Bangladesh.

Increasing agricultural growth is critical not only for India to sustain high growth rates, but also to move millions out of poverty. Currently, 60% of the labour force is employed in agriculture, which contributes less than 1% of overall growth.

India’s agricultural yields are a fraction of those of its more dynamic Asian neighbours. For instance, rice yields are a third of China’s and half of Vietnam’s.

Agriculture will have to contend with two other problems. First, the loss of arable land for non-agricultural uses as India industrialises and urbanises.

Second, soil erosion due to intensive farming and environmental degradation. Since there are limits to enhancing area under cultivation, as forest cover is already dwindling, raising agricultural productivity will be key.

India’s constraints in infrastructure are obvious to first-time visitors or long-term residents. The problems of clogged airports, poor roads, inadequate power, delays in ports have been well-recognised as impeding growth. Indian companies on average lose 30 days in obtaining an electricity connection, 15 days in clearing exports through customs, and lose 7% of the value of their sales due to power outages.

Incremental demand for infrastructure will continue to increase due to economic growth and urbanisation. Thus, there is both a stock and a flow problem. If India’s economic growth were to continue, it will fuel demand for energy, transport, logistics and communication.

The success stories in the past few years need to be replicated. India has built more than 3,600 miles of highways for the Golden Quadrilateral Highway project, whereas in the previous 50 years it had built 300 miles; the New Delhi metro was completed earlier than envisaged; and the privatisation of the telecom sector, and its rapid growth and penetration, are all success stories that demonstrate that India can build infrastructure.

The ability to continue to do so will be critical for the growth of the economy.

India’s high population density, extreme climate and economic dependence on its natural resource base make environmental sustainability critical in maintaining its development path.

History is replete with instances of societies that have depleted their natural resources in the course of their development, thereby leading to severe loss of growth, and in some spectacular cases (e.g., Easter Island) a complete collapse of the civilization. Although such dire prognostications are premature, urbanisation, industrialisation and ongoing global climate change will take a heavy toll on India’s environment, if not managed better.

India is well-placed to deal with environmental issues. It has a strong policy and institutional framework—including a separate ministry for environment and forests; state and local pollution control boards; a vocal media; and of late a very active judiciary.

The political commitment to a sustainable environment is, however, still lukewarm, and significant segments of the population may profess to have other, more pressing priorities. If not given the right priority, environmental sustainability has the potential to become India’s greatest challenge.

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