India – Future Fast Forward

“Life can only be understood backwards; but it must be lived forwards.” ― Søren Kierkegaard

The Indian economy when the bricks of the regulatory wall started being brought down one by one in 1990s altered trend growth to a measly 3.9% over the next decade. It is only from 2000 with the significant increase in capital expenditure on factories and infrastructure did the growth levels change dramatically to 13.6%. This was aided in great measure by a benign environment globally till 2008. But then not only the world turned bad but the corruption in natural resource allocations destroyed business confidence and impacted the banking sectors’ ability to create new credit. While capex dipped below levels seen in the 1990-2000 period the household sector driven by new aspirations continued to spend although the pace was impacted by the slow-down in rate of income creation.

In Current US$	1990	2000	2010	2015	Gr 1990- 2000	Gr 2000 – 2010	Gr 2010 – 2015
GDP	327	477	1,708	2,074	3.9%	13.6%	3.9%
Gross Capital Formation (% of GDP)	24.9%	24.1%	36.5%	35.0%	3.5%	18.4%	3.1%
Adjusted National Per Capita Income	322	390	1,177	1,420	1.9%	11.7%	3.8%
Household Final Consumption Expenditure (% of GDP)	68.0%	64.6%	56.0%	58.0%	3.3%	12.0%	4.7%

Source: World Bank

Our view of the future is usually a linear extrapolation of the past. For example, if GDP were to grow at 5-7% over the next 10 years the following outcomes are reasonably certain:

• Our GDP would be $3.4 – 4.0 trillion, 4^th largest in the world after US, China and Japan. We would be a third of China today and lower than even Japan which had 25 years of zero-growth!!;


• We would likely be the 3^rd or 4^th largest consumer market in the world with per capita income in the $2,500 range substantially below Western European or US levels of $40,000+;


• The redistribution of income driven by this growth would result in a bulging middle-class – shown by the “Seekers” in the chart below:

	Income Levels (Rs)	2015	2025
Deprived	<0.09 million	35%	22%
Aspirers	0.09-0.2 million	43%	36%
Seekers	0.2-0.5 million	19%	32%
Strivers	0.5-1.0 million	1%	9%
Globals	>1.0 million	1%	2%

Source: Mckinsey

But the future is an uneven path with potentially surprising outcomes -  no one in the mid-19^th century imagined America emerging as the foremost economic power in the world and everyone in the early 1980s thought that Japan will become the largest economic power, and till a few years back most people thought China will take over the world.

China (which swung the other way into state-pumped manufacturing and infrastructure build) is seeking to rebalance its economy with consumption to GDP moving from 36% of GDP to say at least 50% to reduce reliance on investments and exports and get this to levels closer in the developed countries like US, Japan, Germany or UK which are in excess of 50%. At current level it is company of countries like Saudi Arabia, Algeria Iraq or small countries like Singapore. Also, it wants to continue to grow rapidly at 7% to continue to provide employment opportunities as for centralised government a young angry population would be threaten stability, especially a single party regime. This would imply consumption growth in excess of 10% but investment and credit which is inordinately high proportion of GDP continues to grow at 4% and 10% plus respectively. This is an impossible equation over ten years with credit to GDP already at 260% and very low productivity of incremental capex spend. A good rebalancing means GDP growth below 3% with consumption growing at ~5% and investment growing below zero. But this means negotiating the multiple vested interests built over last 30 years which create their own uncertainties. (http://poleconomyindia.blogspot.in/2015/08/china-everything-overdone.html)

Coming to India - there are many imponderables in the linear extrapolation theory as it negotiates the next 10 years:

• It is given the substantial global over-capacity across industries and the shape of our banking sector, low investment growth is baked in over the next few years. The pace of investment growth may recover to high single digits later part of the decade as these issues get resolved. Plus, given the low level of capital formation in India, any buildout of factory or roads or ports drives productivity improvements. But in another scenario, if the government is able to lift the infrastructure related investments or even get large scale investments in defence related platforms to India (i.e. shifting F-16s manufacturing to India), it can potentially improve growth trend by ~2% for the horizon. This can change GDP outcome by almost $1 trillion.


• While the projections of the super-normal growth of the Indian middle class sound promising - it is unlikely in this age of technology we will see such a massive re-distribution of income over a such a short horizon. The advent of robotics (with a combination of our complex labour laws) could reduce employment across segments – automatic harvesters in agriculture, precision arms in manufacturing or robots for customer service at a bank. Further, technology creates significant winners for successful ideas, look at Facebook, Apple, Google or Uber. The other implication of this is potential unrest which consequently results in a political response in income redistribution plans which could hold back growth potential. The more positive implication of continued population growth (even China turns negative by somewhere around the early 2020s with significantly aged population) would be India providing a qualified labour force to a world of declining population. But nonetheless a larger middle class would mean greater pressure on governance – October 2013 I had said, “The citizens are demanding better services (infrastructure, policing etc) and higher accountability of the elected officials / bureaucracy. This can be only met by more decentralized but accountable system otherwise the edges will fray.”


• We will surely have a very large consumption base:
• Our taste patterns while currently less homogenous will become more homogenous as population is more mobile providing scale in individual market segments like food and clothing;


• Education, Health and Consumer Durables will see great demand but innovation will drive down costs leading to widespread adoption. For example, MOOCs or their participants may replicate content on a global scale and thereby reducing the pricing of content. Consumer durables may reduce cost by transferring all the functionality onto a wearable or a mobile;


• Ecommerce on which billions have already been spent by angels and VCs will need to innovate on their business models to produce profitability. A viable product pricing will continue to be high as customer acquisition cost (at least Rs.250), logistics (at least Rs.80 including returns) and overhead (say Rs.30) means Rs.360 has to be recovered at optimized business model levels. If the product is sold at a commission of 20%, average ticket sold needs to in the Rs. 2,500 range for new businesses. For the likes of Amazon, of course break-evens are much lower. This makes the lower end of the market inaccessible and most business models will be created to tap into “Seekers”, “Strivers” and “Globals” which comprise only 20% of the population today. Models where delivery is based on the internet like tax services or travel advice or movie tickets the break-even pricing will be much lower allowing them to access a deeper market;


• Consumption of financial services will increase but with massive competition and therefore pricing compression from tech disruptors, which traditional players will be forced follow. Given the convergence of financial needs, as businesses get access to financial intelligence they will cross-sell - insurance to mutual funds to foreign exchange to bank deposits to payments.
• The linear model also assumes that the current economies will retain their place and there will be no event that unravels any of the economies including India getting into a potential war with Pakistan. Pakistan and China, despite their internal weakness, realise that India is going through a phase of defence build-up which once completed in the next 5-7 years will make adventurism much more difficult (i.e. multiple missile programs, new forward bases in Arunachal Pradesh, acquisition of new age aircrafts and UAVs, naval carrier development). Then again India may in 2019 elect a motley government. I had written in April this year (http://poleconomyindia.blogspot.in/2016/04/power-shortage.html) how practically all of the principal areas of Eurasia – fragmentation in Middle East, economic and political crises in Europe, multiple challenges for (oil price, dependence on Putin and rapid population decline) Russia and stresses on the economic model of China - are in the phase of destabilization. For example, it is very likely that the EU will face a break-up or become a much reduced body in the next 8-10 years or the Chinese economy may go into recession as the rebalancing program unhinges under the weight of global slowdown and banking crises. It is very difficult to chart the implication of these “non-linear” events on the growth of India - impact will be deep but finally relative equations are all that matter.

Having said this, GDP growth is simply a function of population and productivity. That India will continue to see population growth 1+% is a certainty. We have a very low stock of capital investments (infrastructure, education, healthcare) and consequently investments will have meaningful impact on productivity is again certain. India will continue to grow at a fairly high rate in a struggling world – our growth is very attractive with an ability to pay reasonably for capital in world drowning in negative rates. Looking at it another way, India a 7% growth results in global GDP expanding by $140bn which the entire EU with $16trn GDP base is struggling to do!! However, higher levels of coupling and connectivity also mean easy transmission of global issues to India. Finally, in an always uncertain world, velocity (speed and direction) of change and evaluation of risk are the only two elements that matter.

Beyond what is at play

Beyond the current elements at play for India what is crucial is putting in place a legal and enforcement architecture:

• Land laws – the point at which it should reach is man in a city buying a piece and being able to build a house without the myriad of laws and requiring bribes to be paid. Industry or state being able to procure land to build infrastructure or factories;


• Labour laws allowing free hiring with protection for labour against exploitation, fair wages and pension;


• Build the bankruptcy architecture and enable banks to take quick decisions to enable the free hand of market forces take over;


• Allow private education with a regulator to boot;


• Build water transport related infrastructure and rules – it is much cheaper always to use sea transport versus land;


• Independent enforcement by agencies like police, anti-corruption bureau or the Central Bureau of Investigation;


• Courts architecture expanded to enable quick dispensation of justice.

These measures can expand growth potential while allowing a growing population an infrastructure to remedy their grievances.

And, there is hope in the new generation which has the courage to experiment and do new things. There is beyond the well-publicized e-commerce related start-ups, there is technological innovation in the areas of product / hardware (defence, nano-tech or new age chemicals) and business services which has the potential to revolutionize select industry verticals.

To be hopeful in bad times is not just foolishly romantic. It is based on the fact that human history is a history not only of cruelty, but also of compassion, sacrifice, courage, kindness. What we choose to emphasize in this complex history will determine our lives. If we see only the worst, it destroys our capacity to do something. If we remember those times and places -- and there are so many -- where people have behaved magnificently, this gives us the energy to act, and at least the possibility of sending this spinning top of a world in a different direction. And if we do act, in however small a way, we don’t have to wait for some grand utopian future. The future is an infinite succession of presents, and to live now as we think human beings should live, in defiance of all that is bad around us, is itself a marvellous victory. - Howard Zinn