THE question at the start of the new year is whether India is in fact ‘shining’ (as Jaswant Singh’s Rs 50 crore advertising campaign tells us), and entering a new ‘golden age’ – as other finance ministry worthies have proclaimed – or whether the long-awaited revival of economic and business momentum is a product of little more than a near-perfect monsoon. In short, are we going to break out of the 5.5-6% average growth rate that the Indian economy has clocked since 1980, and get to the 6.5-7% range that will signal a shift in gears?

It’s a relief to be able to even debate the issue, for it underlines the change of tempo that had been awaited for two long and frustrating years, ever since the dotcom boom went bust in late 2000, and which is now the subject of government song. But the important issue is the answer to the question: is this a monsoon-induced blip, or a new growth curve?

To put the conclusion before the arguments, I see nothing to warrant a change in what I wrote for Seminar a year ago (in the January 2003 issue), namely: ‘Although there is no sign yet that the economy will break out of the 5.5% growth band that has characterised the past five years, the signs of a change in tempo are everywhere. And this time round, the recovery is likely to be more broad-based and more sustainable than was the case with the last two mini-recoveries, in 1997 and 2000. If the situation is managed well, we could even see the economy getting onto a 6% plus rate of growth.’

As they say in the television news, now for the details.

To understand the dynamics of what is happening, we need to separate the different colours in the rainbow that dominates some of the ‘shining’ ads, colours whose sequence school students memorise by using the acronym Vibgyor. So, here is our VIBGYOR for the economy:

V is for the Vote, in search of which the government might allow politics to come in the way of further economic reform;

I is for the International commodity price cycle, now in the upswing;

B is for the Business scene that has changed for the better;

G is for the Growth story in telecom, infotech, housing, automobiles and pharmaceuticals;

Y is for the Yellow Brick Road that our own Wizard of Oz, Atal Bihari Vajpayee, is laying across the country, and is a metaphor for investment in infrastructure;

O is for the Opening up of more sectors and markets through further reform; and

R is for the rain that came with the monsoon.

We need to understand these seven Vibgyor colours to figure out whether Jaswant Singh can do a Judy Garland and belt out a baritone version of ‘Over the rainbow’, or whether he will find, like Dorothy, that the whole sequence is but a passing dream before reality intrudes.

 

 

First, the facts. The recovery story that was outlined in Seminar a year ago has been confirmed. Corporate profits have soared, sales have done better than before, and industry is once again talking of investing in new capacity. Some sectors have enjoyed an outstanding year, like telecommunications, automobiles and housing. Others have seen renewed momentum, like software. Exports have borne up well, despite the strengthening rupee. Agriculture will have a bumper year, and the expected surge in rural demand is probably about to kick in, post-harvest. By the year-end, the signs of a boom environment are with us: you can’t get a seat on a plane into India, or a room in a hotel. They are all full up.

The recovery story has been recognised across the world, as India is once again the flavour of the season among those fund managers who focus on the emerging markets. The wall of money that has moved into India over the past year (a record seven billion dollars in portfolio investment) has driven up stock prices to levels not reached since the heady days of the dotcom era. And by all accounts (for you will have to search long and hard to find a market bear today), there is some momentum still left in the surge. Which means the wealth effect has kicked in and the feel-good factor has returned among investors.

 

 

As for the reasons, it’s best to start with the R factor in Vibgyor, or the rains. Do recall what the mood in the country was when the first monsoon forecast (in April-May) talked of a below-normal monsoon, how nerves were on edge when the monsoon arrived late, and how quickly the mood changed once it became clear that it was in fact going to be normal. To put this R factor in perspective though, it is no great achievement to clock 7% plus GDP growth in a year that follows a drought and which also has a good monsoon. For instance, we saw a much sharper economic recovery in 1988-89, the year following the last drought (in 1987).

So if agricultural growth dipped into negative territory last year (recording -3%), and this year records a positive 3% on the pre-drought year, then agriculture will have grown 6% on last year – contributing 1.5 percentage points to the GDP growth figure. Take that away, and this year’s GDP growth will be not much more than 5.5%, which is what it has been for over two decades. So the first point is easily established: the current forecasts for this year’s GDP numbers do not show a shift in gears by the economy; the growth acceleration is essentially (but not wholly) monsoon-driven.

If the R factor has been fortuitous, so has the I element: international commodity prices have been rising in a sharp upward curve that has spelt manna for commodity producers. Steel sold at less than $200 per tonne of hot rolled coils in the days when the industry was in crisis, and steel manufacturers used to hope and pray that prices would recover to at least $250; they are now reaching for $400 – driven largely by ratcheting Chinese demand. So, understandably, it is celebration time in steeltown. Aluminium, copper and most non-food agriculturals have also seen a price surge. The Economist’s index for non-food commodity prices shows a dramatic increase in prices: 23% over the past year. And since a good chunk of Indian industry is in fact commodity-based, even if we do not include oil – it has naturally been able to show a sharp profit recovery.

 

 

This has had two beneficial side effects. The banks and financial institutions, which had lent heavily to finance the creation of steel capacity, suddenly find their books becoming much healthier because all the sticky loans given to the steel companies now look good in the books. And second, the crisis-ridden Unit Trust of India, which has needed not one but two bailouts, suddenly finds its investment portfolio looking healthy enough for it to meet all its pay-out commitments. Which underlines the point that when the real (or physical) economy is doing well, the financial sector too will usually be healthy.

But it would be a mistake to conclude that the new tempo that has characterised most of 2003, and which promises to continue into the new year, is a result merely of the gods smiling on us. For there has been deeper change, below the surface, which will deliver long-lasting results, and this brings us to the B factor: the business scene. Through the difficult years from 1997 to 2002, when India’s manufacturing companies were besieged by a sense of crisis, many firms put their heads down and did exactly what they had to do: cut costs, improved efficiency, upgraded quality, modernised the technology in use, and reached for economies of scale. This, combined with consolidation of capacity in various product sectors (which gets rid of the price spoilers), has meant that the winners are now leaner, meaner and ready to take on the world.

 

 

I mentioned some examples of such companies in Seminar a year ago (Tata Steel, TVS Motors, Tata Motors, Ballarpur Industries, Bharat Forge and Bajaj Auto). And we learn quite a lot by looking at what has happened to the share prices of these very same companies, over the past year. While the Sensex has climbed by about 90% over the year (itself a comment on the year, since the index had fallen in the two previous years), three of our chosen six companies have doubled their stock prices, two have trebled, and one has quadrupled. All six manufacturing companies have done better than the benchmark stock market index. In other words, investors have recognised the change in India’s manufacturing story.

The revival of confidence in Indian manufacturing shows up also in the way export numbers have held up despite the strengthening rupee, and in the altogether new development of the year: Indian companies making acquisitions overseas. Thus, Bharat Forge has bought one of the two largest forging companies in Germany, Tata Motors is the frontrunner for acquiring the Daewoo truck company in South Korea, and Indian Rayon has bought a chemical firm in China, while Hindalco and Sterlite have bought mining companies in Australia and Zambia, respectively. There’s more, of course: Sundram Fasteners has bought an engineering firm in the UK, Ranbaxy has bought a pharmaceutical firm in France, and Asian Paints a unit in Fiji. These acquisitions speak of a new confidence and a willingness to go global in a way that simply did not exist before. It also underlines the point that future growth for these and other companies will not be limited by the constraints of the Indian market.

The question, though, is whether the change in the manufacturing story is confined to a handful of ‘poster-boy’ companies, or goes deeper and extends to the business sector as a whole. The aggregate numbers on corporate performance suggest the less exciting answer, because the increased profits this past year have been contributed more by savings on interest income and by ‘other income’ than by earnings from mainstream operations. In other words, operating margins have hardly improved; whereas, if operational efficiencies had been achieved across the board, the operating margins would logically have shown a healthy increase. The conclusion that one might draw from this is that Indian manufacturing has not seen change that is deep and wide, and that change is still confined to what one might call the upper crust.

 

 

However, the anecdotal evidence suggests otherwise. You can talk to almost any company today and listen to pretty dramatic stories of how costs have been cut, operations made more efficient, and staff trimmed. If one were to go by these tell-tale pointers, then the fact that there is only marginal change in operating margins has some other explanation. Perhaps the answer lies in the fact that markets have become more competitive, so that companies have to keep dropping prices in order to retain or win customers. Certainly, the anecdotal evidence points to this being the explanation, and this viewpoint is buttressed by the very low inflation that continues to be clocked for manufacturing products as a whole. In other words, companies have saved costs by becoming more efficient, but these benefits have mostly been passed on to consumers. The falling prices of everything from soaps to cars and from TV sets to newspapers tell their own story.

 

 

A wonderful case study for understanding this is provided by Maruti Udyog, which has set itself the seemingly impossible target of achieving a 50% improvement in productivity over three years. Mid-way through the three-year programme, the multiple charts tossed up by Jagdish Khattar, the company’s managing director, show stunning change in such key parameters as the number of man-hours used to turn out a car. The result is that Maruti is able to offer its customers cars with a lower price tag than before, and still make a handsome profit (compared to the losses of a couple of years ago). Once again, the stock market has responded by nearly trebling the company’s price within months of its initial share offering to the public. There are less dramatic but equally real stories dotting the country’s industrial landscape, whether it is Mahindra & Mahindra or tyre cord manufacturer SRF, Samtel (the TV picture tube company) or Apollo Tyres.

Yet, strangely, these very real changes do not show up in the aggregate numbers on industrial growth, which continue month after month to clock a modest 6%, give or take a little. Perhaps this is because the turnaround and growth stories are confined to a handful of sectors; perhaps industry is still dominated by the public sector giants where change has been patchy; and perhaps performance is held back by the sector-wide problems in broad-based industries like textiles and mining, sugar and capital goods/machinery, all of which incidentally have been crying out for reform.

In addition, what the numbers don’t catch is the distress almost across the board in small-scale industry, where significant numbers of entrepreneurs do not even expect to survive the next five years (going by an extensive survey of small-scale units). It doesn’t help that public debate on current economic issues does not touch on the subject of small-scale industry; and the danger is that, even if it does, the debate will be stuck in the rut of outmoded ideas that have long since outlived their utility (if they ever had any).

 

 

That should lead us into questions about the O factor, with regard to the further opening up of markets and sectors, but it is important before that to record the G factor which has in many ways provided the crucial thrust for the year’s change of mood. One might even call it G-force, because what we have seen is ‘take-off’ rates of growth in half a dozen areas. Housing, for instance, as interest rates have cascaded down and the banks have fallen over one another to hand out housing loans to anyone who strays into a bank branch.

The fall in interest rates was of course overdue, given the drop in inflation rates over the past few years. And considering how slow it was in coming, it has been doubly welcome. It has fuelled growth in not just housing but also in automobiles (which have seen G-force level growth in sales, reaching as much as 40% in some months). In telecom the fall in prices has been even greater than in interest rates – leading to China-style growth numbers when it comes to new connections (over 1.5 million a month). But even that pales into insignificance when one looks at what has happened on the stock market, where stock prices have surged by an unforecastable 90% or so (aided once again by the low interest rates, which have made equities preferable to debt).

 

 

Finally, we feel the G-force operating as the IT sector has acquired new thrust. The growing turbulence in other countries as the business process outsourcing rocket gathers momentum is one indicator of this; another is the fact that companies are stretching their operations into even hitherto neglected corners of the country and setting up outsize call centres in places like job-scarce Kolkata and the backwater of Bhubaneswar. In software itself, the leading companies are again pushing the throttle as the brief lull in tempo has come to an end, and as they re-work their business models to go beyond single-function contracts and take on the responsibility for providing that new buzzword: end-to-end solutions.

A fourth factor is the extension of outsourcing into novel areas like radiology (reading and analysing the results of various medical tests, whose results are zapped across the wires to India where radiologists cost a tenth of what they do in the US), equity research (as the big investment banks set up arm’s length shops in Mumbai, again at a tenth of the cost) and even hard-core applied engineering research – so that some of the biggest new research centres in traditionally tech-oriented Bangalore (the Indian Institute of Science, ISRO, Hindustan Aeronautics, and so on) are now private foreign-owned establishments like Intel, Honeywell, SAP and General Electric – with each of them employing hundreds if not thousands of staff, among whom a goodly number are Ph.Ds who are busy making a variety of breakthroughs and filing dozens of patents each year.

The R&D work now being done in India by foreign firms involves cutting edge product development, such as on the next generation of computer chips, or integrating with research in the home country so that it becomes a seamless whole. So, despite the public hullabaloo on the issue of job losses in the West, it is clear that the IT sector will continue to grow rapidly and may diversify even further. India’s resource endowments, the skills and abilities of its people and the institutional support mechanisms (the spread of engineering and other educational institutions, and now the plentiful supply of broadband connectivity) have converged to make the country the prime winner in a whole series of white collar activities.

 

 

This growth is generating many spin-off businesses. Real estate deve-lopment, for instance, since companies need acres of space for their expanding offices. In virtually all the big towns, new office space is now being counted in millions of square feet. Then there are the food and transport contracts for the 13,000 people employed in GE’s call centres, the 5,000 who will soon be employed by Honeywell, and by the many thousands more in the offices of Con-vergys, Daksh and Spectramind, not to mention Infosys, Wipro and TCS.

Add to that the downstream real estate activity that will be sparked off by these well-paid employees taking on housing loans and acquiring a roof over their heads – converting India into more of a home-ownership (and less of a rental) market. Without question, some of the buoyancy in automobile demand too is the result of this job creation, and when we look down the road, there will be greater demand for schools and hospitals, holiday homes and the expanding range of other needs of a thrusting middle class. All of these underline the G factor that we see all around us today.

 

 

This account would suggest that the Indian economy has in fact shifted gears and is now in top gear. After all, we have already been among the 10 fastest growing economies in the world since 1980, which was the transition year when the Indian economy shifted from its 3.5% ‘Hindu’ rate of growth to 5.5%. And while our performance has paled in comparison with our East Asian neighbours, including China, it is reasonable to believe that today we are poised for acceleration to a sustained growth rate of 6% and more. The question is whether we can do even better, and move from top gear into overdrive. That brings up the three remaining letters in VIBGYOR: the Yellow Brick Road, the Opening up of more sectors and markets (read: reform), and the forthcoming Vote. And it is here that the answers are not very flattering, and it is here that we need change, urgent change.

For all the successes of the prime minister’s road project (and the failures – as recent headlines have pointed out), and despite the improvements in port efficiency, the plain fact is that India’s economic infrastructure is not what it ought to be. We still have a poor power situation, and the pace of goods movement is pre-modern (one week to get a truckload of goods from Delhi to Mumbai, when it should take two days). Port turnaround time for ships, at 3.5 days, is better than the seven days of old, but nowhere near the inter- national norm of one or two days. Our airports are still a public embarrassment, even Kunming in the backward south-western corner of China has an infinitely better airport than either Delhi or Mumbai. The only infrastructure sector which is not a constraint is telecom, but here too the international rates for connections (vital for the call centres) are higher than in rival countries like the Philippines.

It could be argued that change is coming on all these fronts, but seeing is believing. The new electricity law has opened up the troubled power sector to a new set of rules, which if they work will make a real difference in two or three years’ time. But it is going to be a long haul to invest in the systems and processes that will cut power theft, reduce unmetered consumption, and achieve operational efficiencies so that consumers do not have to pay the outrageous sum of Rs 7 per unit (against a supply cost of less than Rs 3), as they do today in some of our cities.

 

 

The road sector is not short of funding, thanks to the cess on petrol and diesel, but implementation issues have cropped up all over the place and deadlines have begun to get pushed back – and we may find soon enough that the quality of work is variable too. In civil aviation, we are seeing some movement at long last to facilitate fresh investment in airlines and airports. But there is a time lag of three to five years between policy and market reality, so change that we can see and feel is still some distance away. And in the case of the railways, reform is still barely a gleam in the railway minister’s eye. Any action lies well beyond the visible horizon.

If one were to be optimistic about the scene, one could argue that in almost all these sectors corrective action has begun, and that we will have a different infrastructure story to tell in about five years’ time. But that brings us to virtually the end of the first decade of the new century, a decade that should rightly have been India’s. So these can only be counted as lost years.

 

 

As for opening up (the O factor), there are still many question marks. The big change since the Vajpayee government assumed office in 1998, is that many more Indians now see that the country gains more than it loses from such opening up. The lowering of tariffs and the end of import controls (forced on us by an American law-suit under the WTO’s dispute settlement mechanism) has not seen a flood of foreign goods, as had been feared; instead, we have had a surplus on our current account in the last couple of years, resulting in the flood of dollars that has sent foreign exchange reserves surging past the $100 billion mark.

The question, therefore, is whether the notion of India being a winner through globalisation is an idea with broad acceptance; broad enough, that is, to lend support to the new measures that are now required: further slashing of import tariffs, further opening up to foreign investment, further rolling back of domestic price controls and other forms of government intervention in markets, further privatisation (stalled at the moment because of the Supreme Court’s judge-ment on the oil companies’ sale).

Then there are all the issues that frustrated reformers have simply stopped talking about: laws that help create a more flexible labour market, an end to the counter-productive policy of small-scale reservations, raising user charges for government-provided services so that the fisc stops bleeding, sectoral reforms in areas like textiles (which at least saw changes in tax policy in the last budget) and sugar, reform of agricultural policies (price and movement controls, not to speak of wasteful state procurement arrange-ments), genuine price decontrol in oil… it’s a long list.

There is also the issue of budget deficits which have remained stubbornly high despite more than a decade of effort. The drop in interest rates provides some relief, since the cost of government borrowing has come down, and the past year saw the passage of a new law that mandates an end to revenue deficits in four years – an ambitious target. But it remains to be seen whether the government will in fact be able to trim the subsidy bill (now in a phase of runaway growth), slash the size and scope of government (frequently promised, never done), and improve tax compliance while finding effective and non-intrusive ways of taxing the under-taxed ser-vices sector.

 

 

There are also fundamental issues of governance that have become a matter of serious concern, since the delivery of basic services with a modicum of efficiency is now more than what the average citizen can ask for in states like Bihar and UP. No economy can move to 7% growth in the face of such reality. Indeed, the western and southern parts of the country are already doing 7 or 8% growth and more; so the national average is held back only by the perilous state of governance in the east and parts of the north. If these parts of the country do not get reformed, the national performance will continue to suffer – especially since much of the increase in population comes from these troubled states. So the government, indeed all governments, have to reform themselves before growth can truly accelerate. This is a more important and more fundamental, and more urgent, issue than most people seem to realise.

What is worth noting is that this large and daunting agenda has not changed very much in the past year, suggesting little reform activity. The biggest strides forward have been in the passage of the electricity and fiscal laws, beyond that there has been little action (especially after privati-sation got stalled). If this will be the speed at which we address the agenda, then acceleration to 7% GDP growth is going to be awhile coming.

 

 

For the immediate future, though, there is the V factor – or the vote. It now seems likely that the government will call a snap election by April, by which time the (bumper) rabi harvest will be in and the next monsoon will not have developed into a risk factor. Fortunately, four months is not enough time for the government to waste much money on populist announcements, and the BJP’s new-found confidence about winning the poll could well mean that it will not see the need for scorched-earth populism. The middle class’s feel-good sentiment, the farmer’s smile following successive good harvests, and the general buoyancy of an economy on the rebound could convince the government that it does not need to do anything other than underline the economic successes in order to win over key constituencies in society.

The more lasting issue, though, is whether the elections will deliver a stable government that can undertake the many challenges at hand. Experience has shown that the lead party in the ruling coalition (and a coalition is inevitable) must have dominant strength so that it is immune from blackmail by fringe groups. This probably means at least 180-190 seats. On present reckoning, that’s well within the realm of possibility.