Search the Internet          Tips  Sites: Finance, Investment

Investment holds key to India's economic prospects

Ask any minister, banker or academic what India must do to fulfil its economic potential and the answer is usually the same -- invest more.

Their remedies for four years of stagnant investment may vary in detail, but a thread runs through them: unless the government engineers a massive shift in its spending away from subsidies, salaries and debt service to investment in roads, power, health and education, India will be condemned to being an underachiever.

"It is a matter of grave concern that no investment is taking place because India is an investment-led economy," said R Ravimohan, managing director of Credit Rating Information Services of India in Bombay. "Consumerism is never going to lead our economic growth at all. Investment is absolutely essential."

Investment equals savings. India might gradually lure a bit more money from abroad, while demographic factors might boost the already-high household savings rate of about 20 per cent.

But the heavy lifting must be done by the government reducing its swollen deficit, redirecting spending and following consistent policies that would give India's cautious businessmen the confidence to invest more.

"The issues are clear. The key to change is the public sector," said Shashanka Bhide, chief economist of the National Council of Applied Economic Research in New Delhi.

The scale of the required change is enormous.

The government's Planning Commission says the demonstrated growth potential of the economy in the past several years is only 6.5 per cent. Yet Prime Minister Atal Bihari Vajpayee has set a goal of doubling per capita income over the next decade, which would require average annual growth of 8.7 per cent.

Even assuming a pick-up in productivity growth to three percent a year from the two percent average of the past 20 years, Bhide said this would require a leap in gross fixed capital formation to around 35 per cent of GDP from near 24 per cent now.

Daunting challenge

Planning Commission member N K Singh, one of India's top officials, admitted the challenge was daunting. But he said he saw huge potential in sectors such as telecommunications as well as improving prospects for crucial fiscal and power reforms.

What's more, Singh said India's macro-economic fundamentals remain strong and the promise of a good crop thanks to favourable monsoons should be a pick-me-up for both sentiment and growth.

"There are enough positive features in the economy, which is why I think the present psychology and the present slowdown is transient," Singh said.

Not everybody agrees. Investment bank Goldman Sachs is forecasting a third year of slowing growth, to 4.5 per cent in the year ending next March from 5.2 per cent the year before.

But Mahesh Vyas, managing director of the Centre for Monitoring Indian Economy in Bombay, said he expected a rebound in farm output to lift GDP growth this year to 6.3 per cent.

Agriculture still accounts for 30 per cent of India's GDP and Vyas said three years of declining farm output helped explain why consumer spending had been subdued, dampening investment.

A revival in investment would depend on at least three straight years of good monsoons to fuel a steady rise in rural incomes, Vyas added.

But he said many industrialists were also worried about their ability to compete if the government keeps its promise and lowers India's import tariffs, now among the highest, by about two-thirds to reach average Asian levels by 2005.

"That is one of the factors that has stopped companies from investing enthusiastically," Vyas said. "They're not sure they have a sustainable model now. They want to think twice about it."

A senior financial diplomat in New Delhi agreed: "The concern is that some of these industries are just not competitive."

Policy confusion

All depends, of course, on the sector and the company. Shitin Desai, vice-chairman of DSP Merrill Lynch in Bombay, cited a string of multinational companies that had recently backed their bullish medium-term view by increasing their investment in India.

"There are pockets of business and industry which can be truly considered comparable on a global scale," he said.

Desai attributed the weakness in domestic investment to excess capacity but said speeding up the judicial process would help by encouraging banks to take more risks.

They are wary of lending now, Desai said, because it takes years for a case against defaulting borrowers to come to court.

M R Madhavan, head of research in Bombay for Bank of America, agreed. "We have a legal system that is perceived as fair and honest but it takes its own sweet time," he said.

This made bankers and investors wary because they knew that any dispute would take years to reach court, making it next to impossible to calculate a reasonable return on their money.

Arjun Sengupta of the Centre for Policy Research in New Delhi made a similar point. "The most important problem this government is facing is that, as an investor, I would not know what the risk-weighted value my project would be one year hence because I do not know what policies the government will follow," he said.

His advice to ministers in the fractious 19-party coalition? "Be consistent and do what you say you want to do."

Viewed through this prism, India's economic problems would seem to be the by-product of a vigorous democracy whose leaders are struggling to reconcile the myriad priorities of a rapidly evolving, billion-strong rainbow nation.

More mature, decisive leadership ought to be able to mitigate the compulsions of India's competitive politics. "Governance is something that can be learned," an optimistic Sengupta said.

But it is also tempting to conclude that an inward-looking, tariff-protected India could speed up its development by having the confidence to follow the lead of its hugely successful software industry and open up faster to trade and investment.

India has made huge strides since reforms launched a decade ago started to unpick the colonial legacy of semi-socialist state planning. But others are moving on, too, often more quickly. China's peasants are climbing out of poverty faster than India's.

"It's all very well India saying they've made progress, but the eventual goal of reform has to be judged against the competitiveness of others," said Frank Polman, head of the Asian Development Bank's office in New Delhi.

Tell us what you think of this report