Promoting India's inexorable ascent

By Martin Wolf

Financial Times

Published: March 2 2005

India lacks China's single-mindedness. Some would say this is a product of India's democracy. The opposite is closer to the truth: democracy is the only political system for a country of India's diversity. As I noted last week, the differences between the two colossi have shown themselves in their economic progress (Analysis, February 22). What is, nevertheless, remarkable is India's improvement.

What Palaniappan Chidambaram, the finance minister, needed to show on Tuesday, in the first full budget from the left-of-centre coalition elected last year, was that the improvement is safe in his hands. It is and he did. As Shankar Acharya, a former chief economic adviser, remarked: "This was a middle-of-the-road reformist budget." Optimists might have hoped for more. But realists must recognise the exigencies of coalition politics. The reforms of the past one and a half decades and particularly those of the early 1990s have already put this vast country in motion. The budget will, at the least, not slow this momentum. "First do no harm" is an excellent motto. The budget did, indeed, do no obvious harm. It even did some good.

Between 1960 and 1980 a moving average of the previous 10 years of economic growth oscillated between 3 per cent and 4 per cent a year (see chart). Since the early 1980s, however, these 10-year moving averages have been on a rising trend. In the most recent period (the 10 years that includes fiscal year 2003-04, April to March), growth of net national product per head has reached 4.4 per cent a year. At that rate, incomes per head will double every 16 years.

Source for charts: Indian Ministry of Finance.
Dates on all charts refer to Indian fiscal years starting in April of the year shown

The challenge is to sustain, if not accelerate, this growth. For a poor country, this is a necessary condition for eliminating mass poverty. Fortunately, the signs are good. Any country whose incomes (and so output) per head are far below those of the world's leaders enjoys a catch-up opportunity. The speed with which that opportunity is exploited depends on increases in the quality of "human capital" (above all through education), on the rate of capital accumulation, on the speed with which technology and other forms of knowhow are transferred from the more advanced economies and on the overall efficiency with which resources are used. On all these fronts, there is progress.

The literacy rate rose from 18 per cent in 1950-51 to 65 per cent in 2000-01 - not good enough but a substantial improvement all the same. In 2001, about 8 per cent of the population aged 25 to 34 had attained some form of tertiary education, against 5 per cent in China. Life expectancy rose from 33 for men and 32 for women in 1950-51 to 64 and 67 respectively in 2000-01.

A moving average of the previous 10 years' household savings has risen from 7 per cent of gross domestic product in 1959-60 to more than 20 per cent in the most recent period (see chart). Private corporate savings have also risen from below 2 per cent of GDP in the 10 years to 1990-91 to 4 per cent. Even though the public savings rate has deteriorated sharply, the overall gross domestic savings rate has risen to a 10-year moving average of 24 per cent, against 10 per cent in the years up to 1959-60. The actual savings rate in 2003-04 was 28 per cent of GDP.

The overall rate of investment has risen with the savings rate, from an average of 12 per cent of GDP in the 10 years up to 1960-61 to close to 25 per cent in the latest period. The return on capital has also been rising. A simple measure of this is the incremental capital output ratio (the ratio of the investment rate to the growth rate). The lower the ICOR, the less investment a country needs to attain a given rate of growth. Since 1989-90, the 10-year moving average of the ICOR has been running well below levels in earlier periods.

India has raised the quality of its labour force, substantially increased savings and investment and improved the efficiency with which these resources are being used. The latter, in turn, reflects the progressive liberalisation of the "licence raj", including in trade. The ratio of trade to GDP has jumped from 14.6 per cent in 1990-91 to 24.1 per cent in 2003-04.*

What then has Mr Chidambaram done - and not done - to move India forward? Suppose, for example, that the public sector could improve its contribution to gross savings from modestly negative, where it is now, to about 4 per cent of GDP, where it was two decades ago: that might raise the rate of growth by one percentage point a year. It was not to be. It is depressing, however, that Mr Chidambaram has even had to press the "pause button" on the far more modest reductions in the fiscal deficit required by India's own Fiscal Responsibility and Budget Management (FRBM) Act. Overall, the deficit of the central government and state governments is expected to remain close to 10 per cent of GDP.

Mr Chidambaram also had to plead with his own side for greater openness to inward direct investment. "On foreign direct investment", he remarked, "I would urge honourable members to take a pragmatic view. At the recent meeting of the finance ministers of the G7 countries . . . the finance minister of China looked in my direction and told the gathering that China had received $500bn worth of foreign investment since China opened its economy in 1980. Of this nearly $60bn came in calendar 2004." In contrast, India's net inward FDI in 2003-04 was only $3.4bn, according to its own figures.

Yet even if the budget offered no dramatic transformation, it contained valuable elements: reductions in peak tariffs on non-farm imports to 15 per cent; removal of 108 items from the list of products reserved for production by small-scale enterprises; a reduction in corporation tax; use of India's foreign currency reserves to fund investment in infrastructure, and increased spending on highways, rural infrastructure and primary healthcare.

How then are we to assess where India is going? First and foremost, there has been a big improvement in the underlying fundamentals. Second, there is a broad consensus on the direction of policy. Third, the government continues to find it almost impossible to control its own finances. Fourth, in a number of sensitive areas radical reform seems blocked. But India is moving. Growth at over 7 per cent is no longer inconceivable. India may not be China but it is set to be a powerful force in the decades ahead.

* Economic Survey 2004-05

martin.wolf@ft.com