High growth not improbable, all India needs is critical reforms: HSBC
India's economic success since the 1980s has gone hand in hand with important economic reforms. India has the potential to grow even faster, but this requires further structural reforms and accelerated implementation.
India is a rising global economic power. Growth has increased steadily over the past few decades, more than doubling India's share in the global economy from around 2.5 per cent in 1980 (at purchasing power parity-adjusted exchange rates) to more than five per cent today. This has lifted India's gross domestic product per capita (in US dollar terms) five-fold over the same period.
Moreover, its economy has been among the fastest growing in the world in recent years, even in the last fiscal year when growth slowed to a multi-year low of 6.5 per cent.
India's economic success since the 1980s has gone hand in hand with important economic reforms. Key among these were steps to liberalise the industry and service sectors, gradually open up for foreign trade and investment and improve the fiscal position.
Looking ahead, India will continue to deliver strong growth, supported by rising income levels and favourable demographics. However, this should not allow room for complacency. India has the potential to grow even faster, but this requires further structural reforms and accelerated implementation.
In recent years, reform implementation has slowed down significantly, which has led to a supply-driven slowdown in growth. With supply struggling to keep pace with demand, inflation has remained persistently high despite the slowdown in growth.
In the absence of accelerated structural reforms, India will find it difficult to grow faster without seeing a build up of inflationary pressures. Relying on looser monetary policy to lift growth would be betting on the wrong horse.
A significant cut in monetary policy rates would primarily serve to tease up demand while doing little to pump up supply. In turn, this would run the risk of reigniting inflationary pressures. Moreover, India does not have the fiscal room to significantly stimulate growth.
Further structural reforms are, therefore, a must if growth is going to pick up notably over the next few years and if double-digit growth is ever to materialise. Moreover, the point here is not to achieve higher growth for just one or two years and then consider the job done. No, we are talking about being able to grow at a faster pace on a sustained basis.
To achieve this, reforms need to centre around:
(1) Tackling structural growth constraints such as infrastructure deficiencies, skill gaps, and rigid product and labour markets;
(2) Pushing the innovation frontier through more research and development;
(3) Further developing the financial sector to strengthen financial intermediation and resource allocation, and
(4) Continuing with fiscal consolidation to crowd in the private sector and make room for growth-enhancing spending on physical and social infrastructure. These policies will enhance India's growth potential by boosting productivity, investments, and human capital.
Now, will these reforms raise growth to double digits on a sustained basis?
The answer is yes, in our view, but not overnight. Most likely, we will have to wait for 10 to 15 years considering the scale of reforms still needed. However, under optimistic assumptions about reform quality as well as scale and speed of implementation, India could achieve double-digit growth on a sustained basis in five to 10 years.
These reforms will not just lift growth, but also help India rebalance its economy on both the supply and the demand side. On the supply side, India has relied on its service sector as the key growth engine instead of the manufacturing sector like China.
However, structural reforms should help India better utilise its comparative advantage in labour intensive and low-skilled manufacturing, which would fire up the manufacturing sector as a key engine of growth.
On the demand side, reforms will help strengthen India's competitiveness and ability to increasingly rely on external demand for growth. With China expected to go through the opposite in terms of rebalancing, this should leave the two economies' broad supply and demand side structures more similar over the long term.
In conclusion, the Indian economy will continue to be a growth star on the global economic stage in the coming decades as a gradual pick-up in reform momentum ensures a higher utilisation of growth potential.
We should, therefore, not get too caught up in the negativity surrounding the shorter term outlook, although it has temporarily taken some of the shine off the growth story. At the same time, of course, the growth story does not come automatically and it is contingent on policy makers rolling up their sleeves.
While we have not seen another big reform push yet we are getting more noises out of New Delhi. This does not guarantee a significant pick-up in reform momentum in the short term, but we could reasonably expect more traction over the next six to 12 months. This would also help to gradually improve the private investment cycle.
In this context, it is important to be realistic about how quickly structural reforms of this type and magnitude can be implemented. It is difficult to do it overnight both due to political constraints and because many of these reforms naturally take time to implement.
Moreover, their full impact on growth will take a while to materialise. Consequently, it will be a couple of years before we are back above eight per cent growth. We expect GDP growth of 6.2 per cent in 2012/13 and 7.4 per cent in 2013/14.
On a final note, it is worth emphasising that the debate in India, or anywhere else for that matter, should not just focus on the pace of growth. The quality of growth is equally important. This means achieving it through structural enhancements, which allows it to persist. It also means that it has to be sufficiently inclusive to be sustainable, but without constraining the growth dynamics of a more market-based economy. Environmental considerations are also a key from a sustainability perspective
The author is Chief Economist for India and ASEAN, HSBC
Moreover, its economy has been among the fastest growing in the world in recent years, even in the last fiscal year when growth slowed to a multi-year low of 6.5 per cent.
India's economic success since the 1980s has gone hand in hand with important economic reforms. Key among these were steps to liberalise the industry and service sectors, gradually open up for foreign trade and investment and improve the fiscal position.
Structural reforms are a must if growth is going to pick up notably over the next few years and if double-digit growth is ever to materialise: Leif Eskesen
In recent years, reform implementation has slowed down significantly, which has led to a supply-driven slowdown in growth. With supply struggling to keep pace with demand, inflation has remained persistently high despite the slowdown in growth.
In the absence of accelerated structural reforms, India will find it difficult to grow faster without seeing a build up of inflationary pressures. Relying on looser monetary policy to lift growth would be betting on the wrong horse.
A significant cut in monetary policy rates would primarily serve to tease up demand while doing little to pump up supply. In turn, this would run the risk of reigniting inflationary pressures. Moreover, India does not have the fiscal room to significantly stimulate growth.
Further structural reforms are, therefore, a must if growth is going to pick up notably over the next few years and if double-digit growth is ever to materialise. Moreover, the point here is not to achieve higher growth for just one or two years and then consider the job done. No, we are talking about being able to grow at a faster pace on a sustained basis.
To achieve this, reforms need to centre around:
(1) Tackling structural growth constraints such as infrastructure deficiencies, skill gaps, and rigid product and labour markets;
(2) Pushing the innovation frontier through more research and development;
(3) Further developing the financial sector to strengthen financial intermediation and resource allocation, and
(4) Continuing with fiscal consolidation to crowd in the private sector and make room for growth-enhancing spending on physical and social infrastructure. These policies will enhance India's growth potential by boosting productivity, investments, and human capital.
Now, will these reforms raise growth to double digits on a sustained basis?
The answer is yes, in our view, but not overnight. Most likely, we will have to wait for 10 to 15 years considering the scale of reforms still needed. However, under optimistic assumptions about reform quality as well as scale and speed of implementation, India could achieve double-digit growth on a sustained basis in five to 10 years.
These reforms will not just lift growth, but also help India rebalance its economy on both the supply and the demand side. On the supply side, India has relied on its service sector as the key growth engine instead of the manufacturing sector like China.
However, structural reforms should help India better utilise its comparative advantage in labour intensive and low-skilled manufacturing, which would fire up the manufacturing sector as a key engine of growth.
On the demand side, reforms will help strengthen India's competitiveness and ability to increasingly rely on external demand for growth. With China expected to go through the opposite in terms of rebalancing, this should leave the two economies' broad supply and demand side structures more similar over the long term.
In conclusion, the Indian economy will continue to be a growth star on the global economic stage in the coming decades as a gradual pick-up in reform momentum ensures a higher utilisation of growth potential.
We should, therefore, not get too caught up in the negativity surrounding the shorter term outlook, although it has temporarily taken some of the shine off the growth story. At the same time, of course, the growth story does not come automatically and it is contingent on policy makers rolling up their sleeves.
While we have not seen another big reform push yet we are getting more noises out of New Delhi. This does not guarantee a significant pick-up in reform momentum in the short term, but we could reasonably expect more traction over the next six to 12 months. This would also help to gradually improve the private investment cycle.
In this context, it is important to be realistic about how quickly structural reforms of this type and magnitude can be implemented. It is difficult to do it overnight both due to political constraints and because many of these reforms naturally take time to implement.
Moreover, their full impact on growth will take a while to materialise. Consequently, it will be a couple of years before we are back above eight per cent growth. We expect GDP growth of 6.2 per cent in 2012/13 and 7.4 per cent in 2013/14.
On a final note, it is worth emphasising that the debate in India, or anywhere else for that matter, should not just focus on the pace of growth. The quality of growth is equally important. This means achieving it through structural enhancements, which allows it to persist. It also means that it has to be sufficiently inclusive to be sustainable, but without constraining the growth dynamics of a more market-based economy. Environmental considerations are also a key from a sustainability perspective
The author is Chief Economist for India and ASEAN, HSBC
