I should perhaps, before going too far, set out briefly my qualifications to write on this subject. I have visited India relatively frequently since 1989 and lived in Mumbai from 1995 to 1997. The qualifications are slim, and I therefore ask your indulgence for the frequent misunderstanding of India that now follows.

The story is a simple one and can be read daily in any newspaper, periodical or research report. India has shaken off the lumbering appearance of the elephant and has assumed its rightful position amongst the tigers of Asia, ironically at the same time that elephant numbers in India grow and the tigers struggle for survival. The growth rate, for so long stuck in the 3 to 4 % range, now regularly gets in the 6 to 7% range and threatens to move higher. The mighty services sector, spearheaded by the IT and telephony sectors, grows at a rate far faster than this and, unfettered by the heavy hand of government supervision, threatens to pull India from 50 years of being bogged down in a morass of semi-socialist sludge. Indians now live in the fourth largest economy in the world, as measured in terms of purchasing power parity.

You only need to look at the buildings in Delhi and Mumbai, or fly from one to the other in Jet Airways or be picked up by your car at the airport (what on earth happened to all those Ambassadors?) to see that the machine is rolling. But what exactly is happening in this economy? What is driving it and can it possibly be sustained? What are we going to see over the next five years and what are the risks that might derail the process?

If all goes well, and as with any country, this depends on the world as much as India, then the Indian economy will grow at somewhere between 7 and 8%. When I was in Beijing some years ago, I congratulated a senior government official on achieving yet another year of over 8% growth in the economy. ‘Ah,’ he said, ‘that is nothing to be proud of; we believe that 8% is the absolute minimum we can afford. Below that figure we cannot hope to improve the lot of the working class and, with 100 million itinerant workers, if that does not happen, we run a risk of severe civil disturbance.’

The equivalent problem in India is the ability of a government to be re-elected if the improvement does not happen. The Indian voters reaction to ‘India Shining’ was a statement of future intent. For the first time in this paper, but not the last, democracy makes its presence felt. It is difficult to think of a democracy that has achieved what India needs to achieve, in the time scale in which it needs to achieve it. The growth rate, therefore, has to improve, and this will only happen if the government gets out of the way, and this is a huge ‘if’.

For the last 50 years, it has been the government that has funded the growth in the economy. Funds have been directed, and indeed misdirected, where the powers that be thought fit and, somewhere in all this, there were sufficient consumer goods being produced, almost exclusively domestically and of extraordinarily low quality, to give the consumer the bare minimum of what was required. From 2005 to 2010 India will have a consumer-led economy. This will be a credit-driven economy, driven by 50 years of pent-up demand, with the household, not the state, in the driving seat. The state can step aside and concentrate on getting itself in better shape to help the consumer, which in itself would be a long overdue and welcome achievement.

 

This evolution brings with it new tastes and trends which will shape many changes over the coming years, most of which will be bought on by increasing urbanisation, not only the main cities, but also in the smaller cities and towns of India. The expansion plans of many of the large Indian Business Process Outsourcing companies can easily demonstrate this. These phenomena will increase the demand for private space as these cities grow. In any event, the demand for property and automobiles will continue to rise as more prosperous people seek, and can afford, some privacy. Likewise the leisure sector and tourism will blossom as the hard-working and well-paid worker seeks to relax where possible and, reverting to my last paragraph, this will be financed by debt as he or she gets more comfortable with the prospects for the company they work for and their position within it.

Now might be a good moment to review the main tool of this growth, the banking system, without which there will be no credit and precious little growth. India is fortunate in its banking sector, which has grown on average by some 13% in the 1990s. The fact that this is double that of the insurance sector demonstrates that it is reacting to demand. I suspect we will have a two-tier banking system developing as the excellent private banks grow much faster than their public sector cousins. But the great advantage India has is that the banks are by and large well, and indeed prudently, managed.

The recently published Moody’s financial strength index for banks gives India 24 out of 100, compared with China at 10, and Russia at 11. Importantly, great store was set by the level of non-performing loans in the bank’s total portfolios. Indian banks have 7% non-performing loans to total loans, as against 18% for China and 15% for Russia. The point of all these numbers is that India has the right machinery already in place to expand its banking system to meet the private sector’s need for growth. Credit discipline is being reinforced as Indian banks prepare for the new Basel II capital adequacy rules. Better management of risk is being backed up by big investments in technology.

 

As a result, India doesn’t run much risk of that potentially lethal interaction between liberalisation of domestic financial markets, liberalisation of foreign capital flows and structural weakness in the credit discipline of banks. This means India can afford further deregulation in the financial sector without compromising macro-economic objectives. Equally, if you look at it the other way round, capital flows could be liberalised further without undue risk of creating the conditions for a financial bubble.

I think another problem that might well solve itself over the next five years is India’s relationship with Pakistan. I say ‘solve itself’ deliberately for I do not believe that any government on either side will get it right as they look anxiously over their shoulders, wondering if the next move will be the one to upset their voter base. But the people of the region, given the opportunity, will provide the solution as trade across the border, once again driven by the 50 years of pent up demand, provides an economic framework for improved relations.

From this we might draw the conclusion that, world affairs notwithstanding, India is going to be looking pretty good over the next five years. Maybe it would be a good moment to look at some of the problems that could derail the process.

 

I do not really feel qualified to discuss in the pages of Seminar as to whether democracy, or at least the form of democracy practised, is India’s greatest asset. If it is, and it might well be, then we should also look at the other side of the balance sheet where, under current liabilities, I think we will spot democracy sandwiched in between hopeless government and raging corruption. Spare us from speakers (both Indian and foreign) who start their talk with ‘India’s greatest asset is democracy…’

The pace of change in a true democracy, particularly if it’s an increasingly regional party democracy, is painfully slow. It might get done better when it does get done, but by the time Bangalore’s new airport does get built, if it does, it might coincide neatly with a mass evacuation of businesses from Bangalore (if they can get out that is) on the ground of it being an impossible place to work, a la Calcutta in the seventies. An exaggeration I’m sure, but the government will have to find ways of delinking many parts of government from the process, we called it privatisation in the UK, and there is no example that I can think of in recent times where a democracy has pulled off a successful privatisation programme. Even the UK, when Lady Thatcher delivered one in the 1980s was not then, some say, a democracy!

It is impossible these days to attend a talk or lecture on India without the subject of China coming up, and I have tried to keep my references to China to a minimum in this piece. The comparison is fraught with difficulties not least because, by the time the ground rules of the discussion have been set to allow apples to be compared with apples, many hours have passed. There is, however, a statistic that I would like to quote to illustrate my next point. China spends 19% of its annual budget on infrastructure as against India’s 3%. It is infrastructure, or rather the lack of it, that is going to be the most likely cause of India failing to deliver over the next five years. Even Prime Minister Manmohan Singh estimates that US$150 billion needs to be spent on railways, airports and seaports over the next few years.

 

You only need to look at the projections for the rise in exports to wonder how these goods are going to get to the ports and if they do, how they will ever get through them. The government cannot provide the money, so the private sector must provide it; the Indian private sector can only provide a small potion of it, so foreign direct investment must provide it. This it can do, but agreeing terms has been too slow. The stark statistics on exports and what needs to be done are best illustrated by the following. The Fortune 500 companies in the US export 47% of their output; the figure for the top 300 Indian companies is 12%, unacceptable for an economy in the top four in the world. As this statistic swings, then the requirement for infrastructure spending will also grow.

China sucked in $55 billion in Foreign Direct Investment (FDI) last year compared with India’s $5 billion. This is disastrous, however you dress it up with arguments about imports and re-exports and overseas Chinese and whatever; it just is not good enough. Without these funds India cannot grow its infrastructure and without that, the much-promised trickle down effect will not occur and every five years the voters (the actual voters who will queue in the sun for hours, not the ones who think its just too damn hot to leave the house) will chuck the government out to give another one a chance to do just as badly. This is the real task that the government faces over the next fifty years. But, if it can get it right over the next five, India will thrive.

 

After money, the next most important commodity for the Indian economy is electricity, and here is another shambles. Consistently the central government has failed to invest in the system and the states have spent more time giving away electricity to get re-elected than they have in trying to provide a sufficiently secure supply that will make people feel happy in paying for it. In addition to this, as the electricity sales provide most states with their only secure income stream, most have sold these income streams forward. The funds from these sales having long since evaporated, the states (or rather the people governing the states) just have hopelessly insolvent electricity companies, with annual losses currently running at over Rs 21,000 crore, an extraordinary achievement.

This needs to be solved and the solution is not difficult, and here it is: securitize the debt over a twenty year period; pay the coupon and, ultimately, the principal through cutting losses, which should be achievable at the rate of 1% per annum and thereby recapitalise the State Electricity Boards (‘SEBs’). It is not acceptable that 61% of Indian manufacturing firms need to use captive generator sets compared with 20% in Malaysia, 27% in China, and 17% in Brazil.

The insolvency of the SEBs has one major knock-on effect; 47 out of the 55-odd privately funded power generation projects have not been finalised as they cannot get financially secure undertakings from the SEBs to purchase the electricity generated. And without the private sector, this problem will not be solved.

 

The next area of change on which we need to focus is the government itself. There have certainly been many countries over the last fifty years in which the people have been served worse than the Indian people have by their politicians, but there have been very few democracies with such a bad record. But this will change and, indeed, is changing. To the annoyance of many of my Indian friends over the years, I have always maintained that every time a foreign businessman steps off an aeroplane in India, a little bit of corruption dies.

This is not to say that many countries are not as corrupt as India, but rather that the globalisation of the way business is done will help solve this problem. So will rising prosperity, for with rising prosperity comes rising expectations and the new and growing middle class will, increasingly, not tolerate misbehaviour from their politicians. As the private sector grows, and as the people working in this sector increasingly understand why their companies are successful, they will increasingly understand the business of government and demand accountability from those they elect to conduct that business.

There does need to be some reassessment in India as to the purpose of government. In its simplest terms, government should be responsible for security, education and health. Why any government sees the owning of airlines, airports, hotels and power stations as being worthy of its time and energy is difficult to see. Prices can be regulated without ownership, as CESC will tell you. It will also have to tackle the thorny issue of the PSUs, before they drag the nascent service sector down with them.

 

There are some other pretty daunting tasks that will need to be focused on during the next five years. These are new challenges for this, and many other, governments. They are new for two reasons. First there are those challenges only recently invented, for example AIDS; second, there are those challenges that only come with prosperity. The provision of healthcare will be demanded, as will, increasingly, pension provision. In the latter, India would be wise to take a few lessons from the UK, which has made a spectacular mess of this sector in the last ten years. The time is right to do this now, when India has 40% of its population under 25. Japan is yet to grasp the problem and it has 60% of its population over 50. Watch this space for a massive financial crisis that will shake the world.

So, what will change in India over the next five years before 2010? I have attempted to put this question into perspective by trying to pinpoint phases in India’s history when there have been any material changes within a five year period that were not caused by events well outside India’s control; 1946 to 1950 is probably the only example. World wars, wars of independence and worldwide slumps are not, I hope, things that I am expected to address. India is too big to change, at least visibly, over a five year period. Certainly 90% of its landmass has not changed in any 50 year period, never mind five. So, my answer is that nothing material will change in India as a whole, over and above that which you would expect from an economy growing at 6% per annum.

But under the surface there will be tremendous change. This will, in my view, come from the minds of ordinary Indians. Not only as they are employed to grow the service sector with the massive reserves of intellectual capability that India has (there is India’s greatest asset, speakers of the world), but as they realise that they, the younger generation, can make a real difference, to themselves, to their country and to the world. When they realise that no country can be self- sufficient, particularly with regard to capital, in this world and that the providers are not part of a carefully disguised economic colonisation. When they realise that they do not want to run their country in the way that it been run for the last fifty years. When they realise that they do not want to be at loggerheads with all their neighbours, as has been the case for the last fifty years. When they realise that they expect better government and better politicians. And they do realise all this, and that time is upon us.

 

I would like to finish with a quote from a piece written on the future of democracy in India in the early 1980s by Nani Palkhivala, a man I was privileged to know in Mumbai. ‘Our republic would have a new lease of life when younger people, with well-equipped minds and with the ability to have a bright career outside politics, take to public life as a matter of national service.’ Written twenty five years ago, and has much changed since?

There is deep frustration that India does not move faster. But I fear that this will always be one of India’s defining qualities; it will always disappoint its supporters by its speed of change. On the other side of the coin, and of much more importance, it will always confound its critics.