The Economist on India 3

The Economist on India 3

India overheats

Feb 1st 2007
From The Economist print edition
India cannot run as fast as China without further reform

THE Indian tiger is on the prowl. This week, in an apt piece of symbolism, Tata Steel, which dates back to the days of the Raj, leapt into the league of top producers when it bought Britain's Corus, which includes the steelmaking remnants of the old imperial power. Nor is Tata alone: younger Indian companies such as Infosys and Wipro are storming international markets. Meanwhile, the world's business people and investors queue up to lavish money on India's talented engineers and computer scientists,

The roar from Delhi is echoing across Asia. After peevish years cast as China's underperforming neighbour, the huntress is now in hot pursuit. Over the past year the Indian economy has grown by an impressive 9.2%, not far behind China's 10.4%. At some point this year India's growth rate could even outpace China's; and if you measure things by purchasing power parity, India should soon overtake Japan and become the third-biggest economy, behind only America and China.

No wonder an increasing number of Indian businessmen, policymakers and economists are basking in the belief that their country is burning bright having at last broken free of its bureaucratic cage. An economy once famous for the “Hindu rate of growth”, of 3% a year, was opened up by the reforms of the 1990s, many of them pushed through by the man who is now prime minister, Manmohan Singh. His government's latest five-year plan assumes that India can sustain average growth of 9%. Who can doubt “Incredible India”, to borrow the slogan of its tourism campaign?
Tweaking the long tail

Fast growth is essential to pull millions of Indians out of poverty, so it is sad to pour cold water on this story. But that is precisely what is needed when there are so many alarming signs of overheating (see article). Across India prices are rising fast, factories are at full capacity, loans are piling up. Yes, the economic reforms of the early 1990s spurred competition, forced firms to become more productive and boosted India's trend—or sustainable—rate of growth. But the problem is that this new speed limit is almost certainly lower than the government's one. Historic data would suggest a figure not much above 7%—well below China's 9-10%.

When you mention overheating, many analysts point towards China. Yet India displays far more symptoms of the disease. Inflation has risen to 6-7% (compared with 2.8% in China); a record 99% of Indian firms report that they are operating above their optimal capacity; and credit is expanding at an annual rate of 30%, twice as fast as in China. Unlike China, India also has a widening current-account deficit—a classic sign of overheating, as domestic output fails to keep pace with surging demand. And if you are looking for a stockmarket bubble, Indian share prices have risen more than four-fold over the past four years, far more than in China. If something is not done, then a hard landing will become inevitable.

The Reserve Bank of India has been too timid in cooling down domestic demand: although one interest rate was raised this week by a quarter point, the overall rise in rates over the past two and a half years has not even kept up with consumer-price inflation. But the main focus of the government's attention should be on supply—and dismantling the many barriers that keep its speed limit below China's.

So far, reform in India has focused on setting its inventive private sector free from the world's most fearsome bureaucracy. This has unleashed entrepreneurial talent, but more change is needed. Now is the time to tackle the public sector itself. Infrastructure, such as roads and power, and public services, such as education and drinking water, are woefully inadequate and limit growth. Even as the economy has been booming, many public services have worsened. It seems incongruous that somebody can own a mobile phone, yet has to waste hours queuing for drinking water. India's top computer scientists are feted around the world, yet most children in rural areas lack the basic education needed to find more productive work. Around half of all Indian women are illiterate, compared with a ratio of around one in seven in China.
Singh's songsheet

India's rulers have two bad excuses for not dealing with those roads, schools and hospitals. The first is theoretical. Many Indian economic commentators say that further structural reforms, though desirable, are not essential to keep the economy growing at 8% or more because of the “demographic dividend”. A fast-growing working population and a falling dependency rate (thanks to a lower birth rate) will ensure more workers, more saving and hence more investment.

India's demographic structure is indeed starting to look more like that in East Asia when its growth took off. But this mechanistic view of growth assumes that demography is destiny and that economic policies do not matter. In fact, open markets, education and investment, especially in infrastructure, were the three chief ingredients of East Asia's success. Population growth by itself does not add to prosperity, unless young people are educated and new jobs are created. India needs to reform its absurdly restrictive labour laws which hold back the expansion of manufacturing particularly.

The second excuse for doing nothing is practical: there is little room to spend more on schools and hospitals. India already has one of the biggest budget deficits among the large emerging economies (as much as 8% of GDP going by the widest measure). In fact, plenty can be achieved by reform, rather than just spending. Private investors are hesitant about putting money in infrastructure, because the regulators are not independent enough of populist politicians to guarantee a decent return.

If these things can be tackled, India can indeed match China's growth. Mr Singh remains a reformer, but his government relies on the support of the communist parties and, with today's prosperity, there is no stomach to take them on. The worry is that today's overheating will need to boil over before that mindset changes.