Commentary: India: – The “Hindu Rate” or a Pause Before the Next Lap?

Following nearly double-digit economic growth for the latter part of the last decade, India’s economy has slowed sharply, with the IMF recently lowering its growth forecasts for 2012 to slightly below 5%. This slowdown has raised the question whether the “India Story” is effectively over. A closer look at the underlying reasons for the slowdown reveals that India has hit a macroscopic crisis at the intersection of economics and politics which is increasingly laying bare the country’s underlying structural challenges. India clearly needs to take several immediate fiscal and monetary steps in order to step back from the brink, and recent announcements from the government provide encouraging signs of its commitment to do so. However, while failure carries the risk of India suffering a “lost decade” of sorts, the successful implementation of emergency measures alone will not suffice to bring India back on track to meet its long term development challenges.

After averaging 8.5% over the previous five fiscal years (FY07-FY11), India’s economic growth has slowed sharply to 5.3% and 5.5% in the first and second quarters of 2012, respectively, and to 6.5% for the fiscal year ended Mar-2012 . Despite expectations of a moderate growth turnaround in the next 12-18 months, commentators in India and globally have been speculating whether the country, despite the quality of its entrepreneurs and potential, mired in structural problems, is heading back towards what was derisively called the “Hindu Rate” of growth (of 3-4%) the country achieved for decades before economic reforms in the 1990s. However, looking at the drivers of the slowdown and their origin in India’s structural challenges tells a more nuanced story about India’s growth prospects.

First, let us take a brief look at some of the key issues. India’s economic fundamentals have clearly deteriorated and the proximate causes of the slowdown can be attributed to the following:

  1. Political Deadlocks and Declining Business Confidence. The policy stasis of the last 18 months has resulted in a sharp drop in business and investor confidence which can directly be attributed to widespread policy bottlenecks which are impacting, among other things, the availability of coal, land acquisition, environmental and mining clearances, and agricultural supply chains. This uncertainty, combined with declining consumer confidence, has adversely impacted new investments which have declined from c.US$120bn a year ago, to under US$60bn in the quarter ending June 2012 (see chart), sharply impacting industrial growth.
  2. Persistent Economic Deficits. India continues to suffer persistent “economic deficits” including high inflation, a widening budget deficit and an ongoing shortfall in public sector investment. Inflation has been stubborn at close to double digits for the last 24 months – driven in large part by the acceleration in prices of primary articles (food and fuel) which comprise a relatively larger share of India’s consumption “basket”. This has prevented the Reserve Bank of India from reducing interest rates meaningfully from their current high levels; many investors who borrowed with the assumption of rapid growth are showing severe strain. India’s budget deficit continues to widen and is approaching 6% of GDP in the current fiscal year, and almost 10% when accounting for off-budget expenditure and state government deficits. Investment in infrastructure remains far below its target of 10% of GDP increasing the infrastructure shortfall that is holding back India’s development.
  3. Weak External Environment and High Exposure to Oil Prices. India’s net oil imports increased fourfold from 2004 to c.US$85bn in 2011, and are expected to reach c.US$100bn in the current year. Simultaneously, the sharp slowdown in industrial production and weakening external demand has resulted in a slowdown in export growth with India’s exports to China growing at 17% in FY2012 (vs. 33% in FY2011) and exports to the EU growing at 14% (vs. 28% in the previous fiscal year) driving India’s annualised trade deficit to a record 8-9% of GDP. With domestic savings slowing, this has created a large current account deficit which reached c. 4% of GDP in June 2012 and a large external financing requirement of c.US$75bn in 2012 at a time that foreign investors’ confidence in India has waned. The Rupee accordingly has come under significant pressure – depreciating 17% since the beginning of 2012, and resulted in continued inflationary pressure.

The Need for Structural Reform

Following the initial stages of the slowdown earlier in 2012, where India’s government sought to defend the country’s slump by pointing to the weak global macro environment, it has become increasingly clear that India faces significant underlying structural issues responsible for its sharp decline. As the Sign has argued in February (see our “India Wide Open” paper), there are areas where the cracks in the system are beginning to show. Our top three are:

  1. Governance and Accountability. By most measures, India’s government appears to have lost the ability to govern effectively. Its coalition is besieged by unwieldy allies who have effectively blocked all attempts at reform. Further, a string of high-profile corruption scandals have empowered an increasingly hostile Opposition, while making the bureaucracy more risk averse and afraid of taking decisions on critical projects. This is not to say that the government has not attempted to enact reforms in the face of opposition, and Prime Minister Manmohan Singh seems to have had enough, declaring in a recent cabinet meeting: “If we go down, let’s go down fighting.” While this determination is being commended, former supporters are now observers waiting for the rhetoric to translate into results. Further, with regards to its sprawling bureaucracy, India has yet to demonstrate that there is accountability for results and that the institutions are empowered to bring to account inefficiency, wasteful expenditure and corruption; all of which are required to move past the public trust impasse.
  2. Entrepreneurial Bottlenecks. India ranks 132 out of 183 countries in the most recent World Bank Ease of Doing Business rankings which is the lowest ranking among South Asian countries, the lowest among the BRICS and behind numerous other emerging markets like South Africa and Vietnam (see table). It is a credit to India’s entrepreneurs that they have continued to build companies that are generating c.15% aggregate revenue growth, c.13% aggregate earnings growth, c.16% average return on equity in the last three years (2008-2011) despite this stifling climate. Indeed, the top eight sectors in India deliver growth of 23% which ranks well against even China’s top eight at 21% despite of the lack of supportive top-down industrial policies supporting Chinese industries. Onerous regulations in place today include the remnants of the “License Raj” which require companies to receive a series of licences to do business, archaic and completely ineffective labour laws, and a complex and unwieldy state and federal taxation framework. In order to enable the next generation of entrepreneurs to come through faster, India needs to remove antiquated restrictions and create a fair and well-enforced set of rules that allows competition to thrive. In order to generate employment on the scale which India needs to sustain its development, it has to enable new industries – as it did the IT services sector – largely by providing a clear and rational framework, and then getting out of the way. To add impetus, the government’s holdings and influence over public sector companies, particularly the nationalised banks controlling 72%% of India’s deposit base of US$1.2 trillion , would need to be reduced significantly.
  3. Infrastructure. Despite coming a long way from where it was at the turn of century, adding 870m new mobile connections, over 100GW of power generation capacity, and 13,250km of roads since 2000, India’s infrastructure growth is simply not fast enough. Most urban areas continue to be badly strained with insufficient basic infrastructure to deal with their growing populations. More importantly, the delivery mechanisms need repairing and focus needs to be put on not only fixed asset investment but also operating efficiency. Power plants have been built, but there is insufficient coal being supplied despite sufficient reserves, while transmission and distribution remains largely in the hands of inefficient state electricity boards. Policy planners will need to think out-of-the box if they are to cope with the near doubling of India’s urban population expected in the next decade. The task of rethinking how existing cities will function better and smart new cities are built seems a tough one.

Back to the Past?

India’s ruling Congress Party is clearly alive to the stark reality facing the country and has appointed new leadership in the Finance Ministry that at recognises the immediate task at hand. The ministry has recently taken several common sense steps to (a) revive investor sentiment and ease bottlenecks for both foreign and domestic investment in the country, (b) reduce diesel subsidies, an unpopular and politically challenged reform, in order to demonstrate its commitment to reducing the fiscal deficit, and (c) radically clarify or remove changes to the tax code that recently unsettled foreign investors.

Our analysis suggests that India’s growth rate is highly sensitive to policy unblocking entrepreneurial action. The effect of simple actions makes a significant impact and more concerted effort revives the country back to its previous trajectory. The key findings are:

  1. Back to the Past (<5%). If India continues to undergo the current political uncertainty which prevents the ruling government from implementing basic economic policy, India’s recovery remains in doubt and the economy could languish at or below 5% p.a. over the medium term, hampered by high inflation, high interest rates, a weak currency and widening deficits.
  2. Good Economic Housekeeping (6-7%). If sound policy implementation contains the fiscal deficit and inflation, and revives the investment rate back to c.35% of GDP (the level in 2011) in the medium-term, India can return to a 6-7% growth path as soon as 2013. However, any additional political uncertainty or ill-advised election year fiscal profligacy could also delay this rebound until after the election, currently expected in 2014.
  3. Policy Throughput (8-9%). If the government can implement meaningful policies which improve the business and investment environment to a similar level as the period from 2000 to 2009 (see graph), India could see its investment rate climb to the 38-40% levels it was at during that period and the growth rate could improve to 8-9% - similar to the pace during the latter part of the decade.

  1. Structural Change (>10%). To get to 10% or above, policy implementation would need to deal with India’s larger structural issues. Our paper on “India Wide Open” explored the necessity and dimensions of this given India’s population growth by 2050. The changes required are radical.

Clearly, the fourth scenario is the critical one for Indian policy makers if India is to avoid the downside risk that India’s good housekeeping and policy throughput are thrown off course by exogenous factors outside of their influence. Regarding the third scenario, it remains clear that the political leadership to implement this has not yet fully galvanised. The recent loosening of FDI norms in the retail, aviation, insurance, and pension industries triggered coalition allies to desert the Prime Minister, and the Opposition (which in the past has supported some of the same reforms) to call for a general strike. This uncertainty about the country’s leadership and the will in India to accept reforms has cast doubt on its ability to deal with its deeper structural issues at a critical stage in the country’s development.

Signs of Hope

Under the surface though, there are signs of potentially significant positive change underway in India. Some notable examples include:

  1. Regional Development - India’s Laggard Becomes its Poster Boy. With more than 100m people, Bihar is the 3rd largest state in India; of these almost 60m are Biharis under the age of 25, the highest proportion in India. For many years, Bihar was compared to the least developed regions of Africa and written off based on economic and social development indicators, with the lowest per capita income in India. Fast-forwarding to 2011, the state government has taken significant strides to improve governance and is now identified as India’s “least corrupt state” , has made significant tax and judicial reforms, established rule-of-law, made significant progress in female empowerment, and its economic revival is considered no less than miraculous (see table). Clearly, the lessons from Bihar matter greatly for India’s future as a model of what India’s young workforce can accomplish when supported by effective government policies.

  1. Building Infrastructure - Delhi's New Transport System. Until the first decade of the 2000’s, the capital’s transport infrastructure consisted primarily of state-operated buses, there was no metro and Delhi’s was ranked as one of the world’s worst airports. Since then a combination of the central and Delhi’s state government delivered a greenfield international airport: a, 200km metro system carrying over 2m passengers daily and a number of eight-lane expressways to adjoining urban areas. This in turn has enabled the creation of both affordable housing in previously distant locations, helped boost the city state’s internationally-connected employment hubs (e.g. Gurgaon, Noida), and Delhi has been one of the fastest growing regions in India in the period FY04-FY12 (see table above). Delhi’s success can appear like the exception that proves the rule of the country’s inability to execute. However, it also demonstrates that the challenges which most projects in India fail to overcome are in fact surmountable given proper leadership, widespread support and well-planned execution.
  2. Smart Governance - An Identity for Every Indian. The Unique Identification (UID) project to provide India’s population with digital identification led by former Infosys CEO Nandan Nilekani (now a cabinet minister) has managed to receive broad-based political and industry buy-in, enrolling 209m citizen to date and launching its next phase to double usage to 400m. The UID program is a landmark project for India, expected to significantly streamline delivery of public services and help address widespread embezzlement of funds earmarked for subsidies and poverty alleviation . Promisingly, there are a number of similar high impact projects underway which “hold the promise of changing the way India works, banks, communicates, transacts, and engages.” Prominent among these are the National Skills Development Council (NSDC), granting financial support to private sector companies providing education and training, with a goal of making 150m Indian youth employable by 2022; Bharat Broadband to roll out optic fibre connectivity to 250,000 villages; and the Delhi-Mumbai Industrial Corridor Development Corporation tasked with building seven new smart cities on the high-traffic route. The progress to date of these initiatives demonstrates improving government efficiency and the quality of services that it provides is an achievable goal across a wide range of activity.
  3. Creating Global Industries – One of the 21st Century Detroits. Chennai (in the southern Indian state of Tamil Nadu) is quietly “set to emerge as one of the top five auto clusters globally.” The cluster of vehicle and components manufacturing facilities around the city account for 60% of India’s auto exports and have made it an automotive manufacturing hub for the country as the largest producer of passenger cars, bicycles, 2-wheeler, 3-wheelers, tractors, earth moving equipment, and even tanks. Manufacturing capacity is expected to double by 2015 in order to meet domestic demand as the country becomes an export hub for global auto manufacturers. Various domestic and international large auto components companies have set up capacity in the area, and combined with the rapidly-growing Western and Northern auto clusters, should help India become a global auto manufacturing hub.

In today’s India, for every Bihar, though, there is an Uttar Pradesh which is struggling. For every visionary state leader, there are many more that practice cynical and divisive politics. For every infrastructure success story, there are others with disappointing results. If India achieves only our middle scenario, a 6-7% growth trajectory in the next couple of years, the mould will not have been broken for a new India to emerge that is ready for the challenge of population growth of 400 million more people by 2050.

Conclusions and Implications for Investors

It is difficult to ignore a country of 1.2 billion people growing to 1.6 billion soon, with GDP growth rates of over 5%, a democracy too, in a Greater Pacific region with China as a growing power across one border and Pakistan teetering on the brink of chaos on another. The world’s major political and economic forces are necessarily drawn to the country despite its failings. From the perspective of international investors, whether India grows at 6% or 10%, it will continue to expand at three to five times the pace of most of the best case scenarios for the US and Europe in the near term. However, given the structural challenges that the country faces and the high growth variance between the highest and lowest regions and industries, investors will require a highly selective investment strategy. In India’s uncertain macro environment, successful investing requires focusing on the micro. In identifying opportunities investors need to carefully select the risks they are willing to take on. The reward for that risk can be considerably superior to most in the world based on our analysis and experience. The dimensions of that opportunity are:

  1. Invest in High Growth Regions. There are five large high-growth regions in India that are delivering GDP growth rates between 10% and 12% (rates comparable to China) which represent 24% of the population and more than 40% of the country’s GDP. The per capita income in these regions is almost twice the national average, and they represent a different India from the whole in terms of ease of operation (90% of our India investments are in these regions).
  2. Find High Growth Sectors. There are eight sectors growing at nearly 20% per annum and within these several large sub-sectors which are growing at 30+%, all of which offer opportunities to outperform nearly every major international and domestic market.
  3. Focus on People. In India, as in many rapidly developing markets, the focus on people that one can work with is critical. The question that is constant and becoming more evident is that although there are plenty of people who are delivering results, how many of these can one solve issues with.

Despite its current troubles, India will continue to grow at a reasonably rapid rate. The weakening of the global macroeconomic environment coupled with a series of exposes at home, has exposed the complexity of India and demonstrated that the India story has likely gone as far as it can go based on the current policies. India still offers the potential to be one of the most attractive economies in the world, but this requires a revolution, demonstrating visionary leadership, building a broad national consensus and passing a series of ambitious reforms. Is all this possible? Man’s first reaction is often to write-off the very difficult as the impossible. Fortunately for India, the seeds of its revolution are already in place if it looks in the right places and to the right examples. It now needs to grow these seeds and plant them all over the country.


1 : India’s national accounts use a financial year ending March 31 – all GDP growth numbers refer to year-on-year change in real GDP at factor cost (unless otherwise noted)2 :Source: Department of Commerce, Government of India3 : Aggregate for companies on the BSE-500 index which represents c. 95% of the market capitalization of the Bombay Stock Exchange (source: CapitalIQ)4 : Source: Reserve Bank of India Bulletin (as of August 2012)5 : The current draft of the XIIth Plan which runs from 2012-2017 envisions an average investment rate of 38.7% for a 9.0% growth scenario, and 41.4% for a 9.5% growth scenario; Source: Planning Commission of the Government of India, Faster, Sustainable, and More Inclusive Growth: An Approach to the Twelfth Five Year Plan6 : Source: Bibek Debroy and Laveesh Bhandari7 : Or latest available (FY12 state GDP growth figures for Maharashtra and Gujarat are not publicly available)8 : Source: New York Times, India Undertakes Ambitious ID Card Plan, by Vikas Bajaj, Jun-20099 : Source: Economic Times10 : Source: Hindu Business Line (

11 : Source: Frost & Sullivan

12 : Does not include Bihar, Chattisgarh, and Delhi which are also growing at 10+%