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Friday, October 17, 2003

Reliance buys Flag

Reliance Industries, India's largest private sector firm, announced its acquisition of Flag, an ailing fiber-optics firm which had only recently come out of Chapter 11 proceedings, for about $207 million (at its peak, Flag was worth $7 billion). This is Reliance's largest overseas purchase and second only to Tata's purchase of Tetley Tea in terms of overseas acquisitions by Indian firms.

Interestingly, Tata-owned VSNL is a reseller of Flag bandwidth in India. Wonder what this acquisition will do to that arrangement.

Flag currently has about 10 GBps of bandwidth coming into India via submarine cable. I suspect that with the acquisition of Flag, Reliance will be able to provide dirt-cheap rates on International long-distance calls. Watch this space.
Car sales grow 13%

The latest numbers for September indicate that car sales in India have gone up 13% over the same period last year, with 56,764 units being sold. This would mean approx 650,000 to 700,000 cars for the year. Buses and Trucks grew by about 44% during the same time. The successful completion of the Golden Quadrilateral project is said to be behind the boom.

Though I know the infrastructure in the country is improving, I suspect that infrastructure growth is not/will not keep pace with the growth in automobile sales, especially in the cities. Clearly, urban planners have to rapidly improve the state of the transportation infrastructure if they want to avoid gridlock in the cities.

PS: By way of comparison, the U.S. sells about 16 million cars every year and China sells about 3.25 million cars every year. Perhaps we should bet on when the Indian car market will break the 1 million mark. I would bet on about end-2004 to mid-2005. Any takers?
Test Post

Hi everyone. Just wanted to make a test post before posting anything substantial. If anyone needs more information about me, surf here for a brief bio.
Are You a Credit Risk?

Oooh, self abuse is taxing on the brain. I hope you will forgive me for coming back again. Especially since I have a horrible feeling Reuben is going to 'hit us with his rhythmn stick' some time this afternoon. I think Vivek is taking us in the right direction: What we need are some numbers up on the scoreboard, then we can do some calculations. (Incidentally there is no truth in the vilely slanderous rumour that I am only doing Indian blogging as an excuse to get back into cricket!). This time it's Morgan Stanley who have the lead. (and after this, I promise, I'm off with Uncle Vanya for a weekend in the country). In the meantime, c'mon folks, this can go a little further, bank retail loans to GDP at 3.5% is not the end of the world. In fact it's just the begining. Why this is the case I will explain, as they say, as time goes by.

ndian banks are rushing to entice the next household consumer to borrow for spending. In fact, it is not unusual for an eligible consumer to receive five telephone calls in a day from sales personnel trying to sell either a low-cost credit card, inexpensive housing loan product, car loan or an unsecured personal loan. There has also been a shift in the behavior of the Indian consumer. He is now more willing to borrow to spend unlike in the past. This has caused a consumer loan revolution, which had been evolving for a while now but is now gaining significant momentum (see our previous notes, Leverage Effect Driving Private Consumption, dated June 3, 2002, and What Is Driving Strong Retail Loan Growth, dated August 28, 2002).Even though the corporate credit growth has been decelerating over the last three years, retail loans continue to grow at a very high rate. Retail loans are estimated to have grown at the rate of around 45% in F2003 and 47% in F1H04. This compares with an average annual growth of 27% in three-year period of F2000-F02. Retail loans as a proportion of the GDP are estimated to rise to 7.1% by end March 2004 from 2.6% as of March 1999.What is driving this strong retail loan growth? We believe that there are two set of drivers: (1) on the supply side, the banks are getting aggressive in lending to consumers; and (2) on the demand side, consumers are shedding their inhibition against borrowing............

On the demand side, the culture of increasing consumerism and shortening consumer product life cycles is encouraging Indian households to leverage their balance sheets. Indian household balance sheets, which have traditionally been extremely underleveraged, are finally being geared up. The trend in credit-financed, two-wheeler purchases also reflects this change in consumer attitude. About 55% of the two-wheeler purchases are now financed through loans, compared with just 30% in F1999.This boom in retail loans is lending strong support to the overall growth environment. Incremental retail loans to incremental GDP is estimated to rise to 25% in F2004 compared with 3.5% in F1999. Incremental retail loans as a proportion of incremental private consumption are estimated to have risen to 11.8% in F2003 from 3.1% in F1999. Is this trend sustainable? Comparing India’s retail loan-to-GDP ratio with that of other Asian countries reveals that there may still be scope to increase the penetration of retail loans. For instance, the retail loan penetration for China is at around 12.5% and for other Asian countries in the range of 30-60%. We estimate that bank retail loans to household wealth is only about 3.5%. Banks could therefore still tap “able and willing” borrowers before they move down the income curve aggressively and raise a systemic concern about credit quality. However, the key challenge, we believe, is a possible revival in the corporate capex cycle. Combined central and state government borrowing has already reaching new highs as consolidated fiscal deficit is approaching 11% of GDP. Now even consumers are borrowing. A confluence of demand for funds from these three areas could mean pressure on liquidity and a possible rise in interest rates. This in turn could slow down retail loan growth. We believe that as long as interest rates do not back up more than 150-200 basis points over the next two-three years, retail loan growth should still be sustained at least at 20-25%.
Source: Morgan Stanley Global Economic Forum

In the 'hot-seat'

Tamal Bandyopadhyay is worried abot the so-called hot-money. The difficulty is in deciding what here constitutes 'hot money'. The dollar is embarking on a secular (historic) decline. The Rupee (and later the Renminbi) are embarking on a secular (historic) rise. The general tendency will be up. There will of course be 'corrections' and this is where the flow of funds in-and-out which Tamal affectionately calls 'hot money' becomes important. India needs free currency markets. Long-term it can only gain from this. Short-term it needs to remove the distorting restrictions which, in the final analysis, give rise to the problem. Meantime, the time honoured solution to a rising currency is a reduction in interest rates. Internationally we are in a disinflationary - not an inflationary - environment.

On Monday, the value of the October 31 dollar was Rs 45.25 while the October 15 dollar was trading at Rs 45.40. In other words, if a bank entered into a sell-buy swap with another entity (that is, selling spot dollar - giving delivery on October 15 - and buying the October 31 forward dollar), it would have made a net gain of 15 paise or 7.53 per cent annually. If this money was deployed in the overnight market or put in the Reserve Bank of India's (RBI's) repurchase (repo) window, the bank would have earned 4.5 per cent on this money. So the bank would have gained a cool 12.03 per cent interest on a 15-day dollar kitty. Unprecedented gains of this kind have become possible because the rupee premium on the forward dollar has vanished - the greenback in the forwards market is now traded at a discount. On Monday, in actual terms, October-end forwards were sold at a discount of 15 paise, November 14 paise, December 12 paise, January 10 paise and so on.

The September 2004 forwards were traded at a one paise discount. This means the rupee value of dollar in September-end 2004 is Rs 45.39 while the spot dollar was trading at Rs 45.40! This marks the first time since the liberalisation of the Indian financial sector that the forward dollar is trading at a discount. This defies all financial logic. Traditionally, the currency with a higher interest rate is always traded at a discount in the forwards market vis-a-vis the currency with a lower interest rate. Forward premiums reflect the interest rate differential between the US and India. If that is the case, since US interest rates are lower than that prevailing in India, forward dollars should always command a rupee premium.

Why are forwards crashing and trading at a discount? This is because, apart from the interest rate differential, forwards also factor in domestic money market conditions and the outlook on the dollar. There is all-round bullishness on the rupee. Foreign institutional investors (FIIs) are pouring in money as if there is no tomorrow; the outlook for foreign direct investment (FDI) is also bullish given the signs of an economic turnaround. Many positive factors have pushed high oil prices, the burgeoning fiscal deficit and rising inflation into the background.

So what are we seeing? Exporters are in a mad rush to bring back their export proceeds and sell them to banks because they feel if they delay, the value of the dollar will drop in rupee terms. Importers think the same way, so they do not feel the need to cover their position by booking forward contracts. Even companies that have raised foreign currency loans overseas or taken dollars from banks through the foreign currency non-resident (bank) or FCNR(B) accounts are selling dollars in the market because they are confident that they can buy dollars by spending fewer rupees to clear their future dollar liabilities.

These dollars are being sold to banks. However, banks or authorised dealers (or ADs) cannot build dollar positions because the entire banking industry's open position on dollar is capped between $ 1.5 billion and $ 2 billion. So the banks in turn sell these dollars to the RBI. The net result of this is manifold. First, the RBI's dollar kitty is swelling. The country's foreign currency assets stood at $ 87.73 billion as on October 3. This is after the redemption of the Resurgent India Bonds.

Banks are feverishly buying in the spot market and selling forwards fearing a drying up of cash dollars because of the RBI's dollar mop-up. Finally, as supply outstrips demand, forward dollars are being traded at a discount instead of at a premium. The rise of the rupee is not an aberration since all global currencies are rising against the dollar. But the trend of forwards trading at a discount is an anomaly and needs to be corrected. To do that, the RBI may need to look into some structural issues. One way of tackling this could have been through creation of a dollar liquidity adjustment facility (LAF) like the existing rupee LAF whereby banks can borrow rupee resources if they need and, conversely, RBI can suck out excess rupee to ward off a liquidity overhang in the system. The liquidity corridor works through the repo and reverse repo route. The same mechanism can be extended for dollar liquidity. However, the central bank has reservations about this and has written to the Foreign Exchange Dealers Association of India (Fedai) that this in not in tune with international best practice.

The second step could be directing exporters to stop selling forwards for the time being. This may be interpreted as a retrograde step. But in the past the RBI had forced exporters to bring back exports proceeds in a hurry to pump more dollars into the system when there was a shortage. When we don't need dollars, RBI can as well tell exporters to wait and watch. Similarly, it can also put temporary restrictions on exporters' cancellations and rebooking of forwards contracts. In the past, the RBI has done so for importers. The RBI can also made it mandatory for corporations to hedge their foreign currency exposure. This will pep up the demand for the forward dollar. Another way of increasing supplies in the cash dollar market could be raising the banks' overseas borrowing limit. At present, it is capped at 25 per cent of the unimpaired tier I capital (that is, capital and free reserves) or $ 10 million, whichever is higher. If that is done, fears over a cash dollar shortage will recede and sanity will return to the market.

It can also pump in cash dollars by entering sell-buy swaps to meet the demand for dollars in the cash market. This essentially means the RBI will sell spot dollars and buy forwards. This way, it can pump in dollars to meet present demands and buy at a future date to balance forwards selling by other players. Finally, it can allow the rupee to appreciate without any intervention. This route will put an end to the expectations game. But exporters may feel that there is a limit to which the rupee can appreciate and once it reaches that level, the trend has to be reversed. They may wait to sell forwards at that juncture.

If the anomaly in the forward markets is not corrected, the RBI will not be able to check the flow of hot money into the system. It has already brought down the interest rates on FCNR(B) and NRE accounts to ward off the interest rate arbitrage opportunity. But when the forwards premiums are traded at a discount, foreign institutional investors and non-resident Indians get to earn a risk-free income in India on hot money. That is why the RBI is left with no choice: it must address the structural issues in the forwards market if it wants to shut the door on hot money.
Source: Business Standrad

Finally some good news from the Power Sector

But can these reforms be sustained?

To disinvest or not to disinvest

Kaushik talked about disinvestment a few days back. I have a question, why is Ram Naik so opposed to disinvestment?

The standard answer is minister's oppose privatization because they want to protect their turf/ milk the PSUs for personal gain. Perhaps...

But if that is the case, then there should plenty of moolah involved for the party and Ram Naik himself. As far I know no one has so far suggested that Ram Naik is on the take (you are welcome to correct me).

Ram Naik is taking a lot of political risk opposing privatization. Both his bosses (Vajpayee and Advani), the chattering classes, the financial markets and a determined minister are gunning for him now. Add it all up and it is a pretty strong lobby. Please don't tell me he is risking so much just to use the HPCL guest house in Bombay.

But then again never under estimate the power of pettiness!

Ram Naik represents North Mumbai Lok Sabha. He has a track record of getting elected successively five times.

Perhaps he needs HPCL/ BPCL to dole out jobs and sundry favours for his constituents?

I really dunno, but I'm sure we'll get back to the disinvestment debate. Watch this space.

BTW, here is a tit-bit (pun not intended), as private member Ram Naik introduced a Bill for "Promotion of Breast feeding and Ban on advertisement of Baby Foods". The Bill was subsequently adopted by the Government and became an Act.

Thursday, October 16, 2003

Welcome to Reuben

As you will see the team at IEW is growing. Today I would like to welcome Reuben Abraham on board. Perhaps the best introduction to Reuben I can offer are his comments on some points I made to him in a mail. Basically we were talking about why it is that India is so strong in IT and China is so strong in manufacturing. This, I think, is going to be one of the key areas of investigation and research her at IEW. My hunch is that there is something deep in Indian culture that is being expressed here. But perhaps at this stage, if I said more I would only reveal my own ignorance. So I'll let Reuben reply:

You talk about wondering about Indian affinity to IT. Let me introduce you to some more of my theories.

If you look at Indian and Chinese contributions to the world, you'll see one big difference -- The Chinese have always made tangible contributions (gunpowder, rocketry etc) whereas the Indians have always made intangible contributions, be it the zero, base 10 maths and so on. And this pattern sort-of holds at a general level right across the centuries. If you were to extend this argument into the current scenario, is it any surprise then that the Chinese have been extraordinarily competent in manufacturing and hardware while the Indians have been fantastic is services and software. Of course, if Indian manufacturing starts to explode, I am proven wrong.

But, I suspect Indians will never be able to compete globally (except for niches) with the Chinese in manufacturing, though the domestic markets will sustain the manufacturing sector.

You have always talked about demography and you touch upon it briefly here as well. One thing most long run projections, including the BRIC projections seem to ignore is that India will overtake China in terms of population in about 25-35 years. Does that also mean the Indian economy will eventually grow to be larger than the Chinese economy? I dont know the answer, but I have seldom heard this question being asked.

Secondly, if one were to look at the influence that an economy wields over the world -- the way the U.S. does today -- I suspect that the Indian economy might actually wield greater influence for one reason soft power. The Chinese have nothing in the same ballpark as the Indians when it comes to wielding soft power.

Well, those are my theories du jour.

Well, if these are only Reuben's theories of the day, and there are as we say here in Catalonia 'more days than sausages', then I guess we're in for an interesting ride. Rajesh, who never seems to be far away when these debates are going on, immediately came across with an interesting link:

Chetan Parikh: On behalf of Capitalideasonline and Oxford Bookstore I would like to welcome all of you to a talk on "Economic Development in China and East Asia -- Lessons for India". This is to be given by the distinguished speaker, who has taken time out to be with us -- Professor Leslie Young.

Professor Young: Next thing I want to talk about which has an impact on modern governance is the religion, the philosophy and we can trace the differences -- I am sure you have some deep knowledge of Indian religion and philosophy and you have some knowledge that China is very different. And I say firstly that we can understand this difference and we ought to look at its impact on modern China.

First of all it seems to me that what happened in India was that you had a 1000 years in which you had a period of old culture -- the Vedic period in which you developed a certain kind of philosophy which was -basically it said that there was inside your self was the whole universe. So this was a deep philosophy which then had to deal with another issue which arose when you started writing and writing kind of separates you from the world.. And so you had a tension between two philosophies.

I mention this because in the very long term had an impact on China and on Japan.
But by contrast in China what you had is the following. You had a different writing system, which was a pictorial and videographic writing system that mixed up pictures with abstract symbols and therefore Chinese philosophy developed in quite a different path. What it did was to view the world not in transcendental terms, that is in terms of there is some abstract world up there and there is a real world down here, but the Chinese view is that the real world is all that there is but it has an internal structure and this view of the world meant that on one hand you had Taoism which was looking for the structure of the world and this inside the world itself not above it and this led to ideas like free markets, spontaneous order of society. The view was that society orders itself. It wasn't a God given order -- it was a society that ordered itself. This is the first viewpoint.

The second point was Confucianism, which basically took the family as a metaphor for government. So it used -- the metaphor for politics was an extended family you might say.

And the last thing, the least positive aspect of it is something that you probably even haven't heard of, called legalism. Which was a very tough minded ruthless philosophy of control. That a large state was held together by very tight government and these three philosophies kind of supported each other. The legalism was too tough and the first empire that tried it, the Qin empire, which gave China its name lasted only two emperors, then got kicked out. It was too harsh an area and then the next dynasty, the Han dynasty learned from that and installed Confucianism to come and soften it. To impose obligations on the rulers, to make the emperor, the father of the people to soften harshness of legalism.

And the third that point is that Taoism then lead to the notion that the classic experiment is you should rule an empire like you cook a small fish. That is you leave at alone. You leave it alone. So the notion was that the administrators, the rulers of China should really let the market work and stand back. So this I emphasize is an idea that originated in China and one can find in Chinese history and text that spoke the idea of invisible hand 2000 years ago.

So these three things if you see complemented each other. The notion of a tough harsh government, top down government, nevertheless which took responsibility for the people -- and took responsibility, but left them alone as much as possible. So these three things balanced each other..............

One another thing -- this shows Chinese leadership were strangely enough, you must think of them as liberal arts graduates, they specialized in the essay writing, in poetry, in calligraphy -- these were the rulers of China. However this was balanced by the duty -- the books that they studied were the Confucian classics and they imposed on the social leaders, the elite, the duty to look after everyone else. And this meant -- and this is something that I noticed when I come to India that it seems to me that the elite of India don't feel the duty to provide practical leadership. They have the duty to provide theoretical leadership but not practical leadership. I will give you an example.
In the campus of the Indian School of Business there are lots of women who sweep the streets, sweep the roads, sweep the paths and they have a little broom made of twigs and the broom is this long. And they spend their lives sweeping the path. Now why can't somebody tell them to put a stick in the middle and then they could stand up and sweep the path. Then their lives will be transformed if only somebody would take the trouble to do that. Once you put the stick in the middle -- you can find a stick anywhere -- right? And this to me is amazing.

Now contrast that with the invention that you know about. The Chinese -- it was the Chinese who invented the wheelbarrow. I don't see wheelbarrows in India. People carry baskets of dirt on their heads. So this is - now anyone in this room is capable of inventing a wheelbarrow -- there is no question of that -- right? But no one has done it for these guys moving dirt around.

So that's what I mean by a duty to provide practical leadership which seems to me that the leaders in India provide intellectual, philosophical, religious, something leadership but they don't feel the duty to provide practical leadership.

And there are whole provinces in China that were made fertile because some engineer came and designed an irrigation system and he was a scholar. He started out as a scholar but being put in charge of a province he said why don't I fix this problem. So this is I think one of these historical traditions that are very important for explaining, for understanding what's happening in China today.
Source: Economic Development in China - Lessons for India, Lecture by Professor Lesie Young

Wednesday, October 15, 2003

Should we worry about the fiscal deficit?

Sudhir Mulji, a columnist at the Business Standard, has been arguing for many months that India should not worry about the fiscal deficit. I couldn't agree more. In a developing country like India, output is held in check by the lack of demand. The government should stimulate demand by a massive public works program to build basic infrastructure. The concerns about inflation are, I think, a bit over blown. The productivity growth industry in India and the world has seen in the last few years should be able handle a surge in demand (if we reduce import duties). Besides, a public works program will give jobs to the millions of underemployed poor. With a record foodgrain output forecast and 100bn dollars in RBI vaults, there has never been a better time to think bold. Yesterday Omkar Goswami, Chief Economist, Confederation of Indian Industry wrote something similar in the Financial Express:

On Infrastructure And Deficits

For seven per cent plus growth, is there a case for slightly more deficits to finance infrastructure investments?


Unlike many Bengalis, Ashok Lahiri, the Chief Economic Advisor at the ministry of finance, is not known for hyperbole. If anything, just the opposite. So, when he, as the government of India's premier economist, informs scribes that India could well attain 8 per cent GDP growth in 2003-04, I had to sit up and read his prognosis very carefully indeed.

Basically, Mr Lahiri's prediction is based on this year's excellent monsoon. Barring very few regions, not only have the rains been plentiful but also there has been no major floods in September. Rainfall data from 1 June to end September 2003 show that it has been by far the best monsoon in the last fifteen years. Typically, good years translate to 80 per cent of the meteorological districts having 'excess' or 'normal' rainfall. This season, 92 per cent of the districts have been so blessed, which is in sharp contrast to the drought of last year.

Given this and the fact that there was a 4 per cent fall in agricultural output last year, Mr Lahiri is betting on something between 9 and 10 per cent growth in agricultural sector income. This isn't overtly optimistic, especially if we consider the smaller base of 2002-03. Since agriculture - more specifically, the primary sector - accounts for 24 per cent of India's GDP, this translates to anything between 2.16 to 2.4 per cent of GDP growth. Add to this an easily attainable 6 per cent growth of industry (which accounts for 26 per cent of our GDP), and an often achieved 8 per cent growth in services (accounting for the remaining 50 per cent of GDP), and you get to Mr Lahiri's estimate of 8 per cent GDP growth in 2003-04.

I am not going to quibble with this number. At worst, Mr Lahiri may be off by half a percentage point. But for an economy that crawled at 4.7 per cent GDP growth in 2002-03, a 7.5 per cent growth in the very next year will be a damn good show. That will make India the second fastest - if not the fastest - growing continental economy in the world.

This brings me to crux of the article: How do we sustain this growth? After all, there is no reason to believe that the rain gods will be as kind next year. So, how can we ensure that India keeps on clocking 7 per cent plus growth over a rising base for the next decade - the kind of growth needed to substantially eradicate poverty and make us a meaningful economic power in Asia and in the world?

The answer: Infrastructure, infrastructure, and even more infrastructure. Let me say it bluntly: You cannot sustain 7 per cent plus growth year on year with the current state of railways, power, ports, airports, IT and telecom backbone, and even roads. It's as simple as that.

To be sure, roads have improved thanks to the Rs 1.5 per litre cess that is financing the work on the Golden Quadrilateral and village roads. I recently drove to Manali, and throughout Kulu district, there were ubiquitous signs proclaiming village roadwork under the Pradhan Mantri Gram Sadak Yojana. There is definite progress. Even so, the 7,200 km North South-East West corridor is still at a nascent stage; and there are 195,231 km of national and state highways, most of which are in pitiable state. We have miles to go before we can claim to have roads like the ones that exist in Thailand, Malaysia or the southern and eastern parts of China.

While roads may be the beginnings of a success story, power is most definitely not. Even last year, there was an average unmet gap of 12 per cent between peak demand and supply. A recent CII-World Bank survey of 1,856 manufacturing companies across 12 states shows that, on average, 9 per cent of the value of production is lost due to power outages. Moreover, 62 per cent of these firms are forced to own generators, which supply, on average, 31 per cent of their electricity needs. In China, production loss due to power cuts is less than 2 per cent; and only 30 per cent of the firms need to own gensets. As far as railways are concerned, the less said the better. And while much is being proclaimed about modernising our airports, one only needs to compare Sahar or Delhi airport with Singapore, or even Bangkok airport, to know how much more we need to do.

Now for some fiscal heresy, which will certainly be frowned upon by Mr Lahiri. Experience of the past decade has shown that there is inadequate private sector appetite for all manner of infrastructure. And yet, without investing in it, we can't sustain 7 per cent plus growth. So, can we marginally increasing the quantum of deficit, provided we can 'ring fence' every additional rupee, and target it for greater infrastructure spending? For instance, it should be possible to convince the Railways minister to levy a flat 5 per cent surcharge on all passenger fares - to be matched by budget support - as a railway development fund. As in roads, this can be used as a fund to modernise Indian Railways and create an integrated supply chain. Similarly, we should be able to allocate a larger amount for development of ports and airports, provided the money is spent on that and nothing else, and spent well.

This strategy won't help all infrastructure. For instance, the power situation requires rapid reform of state electricity boards and a political willingness of chief ministers to raise tariffs to at least cover marginal cost. I am also aware of treading a dangerous path. It's all very well to speak of 'ring fencing'; in reality, there is a serious risk of the additional outlays being siphoned off to feed the insatiable appetite of government consumption. Moreover, increasing the deficit to fund infrastructure assumes managerial and execution skills which are not necessarily in abundance in the bureaucracy.

Even so, I'd say that it is worth a try. We can't sustain over 7 per cent GDP growth without better infrastructure. That isn't going to happen only with private sector participation. It will need dollops of public funding, at least for the next five years. Instead of being fiscal purists and running the risk of choking off future growth, let's experiment with raising the quantum of the Centre's deficit to fund infrastructure to fuel more growth. Let's bet on the denominator (nominal GDP) growing faster than the numerator (the deficit) - which should reduce the deficit as a percentage of GDP. And, as far as managerial talent is concerned, let's get the likes of Narayana Murthy to dedicate their next few years to major infrastructure. For a country of over a billion people, I refuse to believe that there aren't enough managers who can get our infrastructure going.

Hi Guys,

I just joined Kaushik and Edward at the India Economy Watch. This is a test post.

My interest is mostly public policy, so I'll try and link to that sort of stuff.

Where are All the US Manufacturing Jobs Going?

Well the answer seems to be 'nowhere', and fast, if you accept the arguments Caroline Baum advances in this article. And I'm sure in one sense she's right. Global employment in manufacturing is probably on the way down. There is more: one point she doesn't note about the China syndrome, is that as areas like Guandong grow, wages rise, and the really labour intensive, low, low wage stuff migrates, either to other regions, or out to Vietnam, Cambodia etc. This process is now evident where I live - in Spain, one of the countries mentioned as having gained jobs via the EU. Most of the talk in the business community now is about the displacement of this manufactuing work out to the new EU candidate countries. On the other hand, don't miss her 'optimistic' conclusion: "one day human beings will be redundant in manufacturing production. (Hey, that will free up more of them to man customer and technical support hotlines)". Obviously she hasn't noticed what must now be obvious to India Economy Watch readers: these jobs are migrating too. The bottom line here is that no-one knows what is going to happen. We haven't been here before, and all historical analogies can only have limited value. I really can't get all this straight yet. But cheer up, at least it's going to be an exciting ride!

You know all those U.S. manufacturing jobs that have been high-tailing it to China? China sure is doing a lousy job of holding on to them. China lost 16 million manufacturing jobs, a decline of 15 percent, between 1995 and 2002, according to a study of manufacturing jobs in the 20 largest economies by Joe Carson, director of economic research at Alliance Capital Management. In that same time, U.S. factory employment shrank by 2 million, or 11 percent. In fact, in the seven years ended 2002, the number of China's manufacturing jobs fell at more than double the rate --15 percent versus 7 percent -- of the other countries in the study. (Two of the top 20 economies, Mexico and Brazil, report manufacturing employment in index form, not as actual headcount, and weren't incorporated into Carson's analysis. The payroll changes in that time period weren't large enough to alter the conclusions.) Despite China's addition of nearly 2 million factory jobs in 2002, ``the level of factory jobs (last year) was below 1998's and far below 1995's,'' Carson says.

So who's stealing China's manufacturing jobs? It seems that China's advantage as a low-cost producer hasn't halted the insatiable drive worldwide to replace even dirt- cheap labor with productivity-enhancing equipment. Some 22 million manufacturing jobs were lost globally between 1995 and 2002 as industrial output soared 30 percent, Carson says. It seems that devilish productivity is wreaking havoc with jobs both at home and abroad. Carson's investigation found that only five of the 20 countries increased manufacturing jobs between 1995 and 2002. Three of the five -- Canada, Mexico and Spain -- ``seem to have benefited from regional trade pacts or currency agreements,'' he says. The other two, Taiwan and the Philippines, showed a net 300,000 seven-year gain, large for those economies but small on a global scale. Put in a global evolutionary context, the loss of 2.6 million manufacturing jobs in the U.S. since the start of 2001 looks far less ominous -- at least to folks not seeking elective office. Facts about the extent of the decline in global manufacturing jobs would demolish the economic (not the political) argument for protectionist measures. Both houses of Congress have proposed legislation that would impose stiff tariffs on Chinese imports.

Facts about human capital's decreasing relevance in the manufacturing process would expose the silliness of appointing a manufacturing czar, an initiative announced recently by President George W. Bush. They would upend the misplaced notion that China's undervalued currency -- the yuan has been pegged at 8.3 to the dollar for almost a decade -- is giving the country's manufacturers' a competitive edge and ballooning its trade surplus with the U.S. to $103 billion in 2002. No reasonable degree of yuan appreciation could offset the labor-cost differential between the two countries. U.S. manufacturing workers make about 25 times what an average Chinese factory worker earns, according to statistical agencies in the U.S. and China.

The fact that China is losing factory jobs at a faster rate than the countries from which it is supposedly stealing them just might put to rest the notion of China, job thievery nation. The angst over the fate of U.S. production workers, whose numbers peaked in 1979, is not unlike the epitaph for farm workers in the early 20th century, says Steve Wieting, senior economist at Citigroup Inc. "Real manufacturing output has risen 77 percent even though the number of manufacturing workers has fallen 22 percent since the 1979 peak," Wieting says. Similarly, real farm output rose 96 percent since 1979 with 31 percent fewer agricultural workers. Because output equals income, "something was earned with the gains in manufacturing and farm output during the last 25 years of falling employment in these industries,'' Wieting says. A rising supply of food and consumer goods caused prices to rise more slowly than per-capita income, giving consumers more income to spend on other things -- on services that didn't previously exist. "While manufacturing and farm employment has fallen by 22 percent and 33 percent, respectively, since 1979, total U.S. employment still managed to grow 41 percent,'' Wieting says.

Perhaps one day human beings will be redundant in manufacturing production. (Hey, that will free up more of them to man customer and technical support hotlines!) Hard as expendability is on workers themselves, increased productivity is the way progress is made. "Our studies suggest that hunter-gatherer societies offer full employment for all, simply providing the basic necessities of food and shelter,'' Wieting say. Of course, with all of their resources devoted to providing food and shelter, they have little ``income'' left to consume anything else -- made in China or otherwise.
Source: Caroline Baum, Bloomberg

China Envy at Fever Pitch?

Some plusses and some minuses in this article by William Pessek in Bloomberg. India never was a 'basket case' for anyone with eyes. India's 'moment of opportunity' is not just a moment either. But at the same time we may not be all the way in yet. Growth in the IT sector is spectacular, but India is enorous and poor. 700 million people live in the villages of rural India, and, although the birthrate is coming down fast, population momentum means that the numbers will keep going up for some time to come. How to cushion this rise, this is India's big problem, and it seems to be all to do with the balance between the rural and the urban. And remember, even if GDP is rising fast, it could be some time yet before per capita incomes really start to rise. ( Thanks to Rueben at the zoo station for the link).

China-envy is reaching a fever pitch as nations struggle to compete with the world's most dynamic economy. The China-all-the-time mindset is making it difficult forothers in Asia to get attention. Nowhere is that truer than India. Even though Asia's third biggest economy may grow more than 7 percent this fiscal year, India is struggling to get onto more executives and investors radar screens. Those who ignore India may regret it. "The India story is a good story and it's likely to get even better", says Rajeev Malik, an economist at J.P. Morgan Chase &Co. Granted, India is getting more headlines as stocks rise, bond yields grind lower and the currency, the rupee, appreciates. Its benchmark stock index is up 49 percent this year in U.S. dollar terms, shining a brightening spotlight on one of the world's fastest-growing economies.

Yet many of India's attributes are being taken for granted, especially among corporate executives. Asking about different economies in Asia, you often get similar answers. China's economy? "Oh yes, we're excited about it", investors say. Japan? "Looking better." Thailand and Indonesia? "Sure, we're paying attention." And India?"Hmmm, well we've got big concerns about the place."

China bulls aren't necessarily wrong. The most populous nation has remarkable potential and its meteoric rise spotlights India's economic backwardness. Twenty years ago, India and China were close competitors, both struggling to pull their mushrooming populations out of poverty. Now India is being left behind. Ignoring India's long-run potential, however, could be one of the biggest mistakes executives and institutional investors make in the next decade. India has myriad problems. Even if the country grows the 7.1 percent groups like the National Council for Applied Economic Research expect, it may not be fast enough to raise 400 million of its 1 billion people out of poverty. New Delhi says it needs 8 percent growth over the next decade to do that. Dodgy infrastructure and notorious bureaucracy continue to steer away the kind of long-term investment China gets loads of.

Yet India is no longer a basket case, and it's likely to be one of the great investment surprise stories of the next decade. There's a reason Boeing Co., Motorola, Australian phone company Telstra Corp. and Accenture Ltd., which manages services and computers for clients including AT&T Corp., have all announced investments in India in the last 12 months. Its appeal lies as much in its pool of software engineers and English-speaking graduates as its billion-person market.

Southeast Asia also is eying India's promise. Last year, India got its first invite to the annual summit of Association of Southeast Asian Nations (ASEAN), yet Prime Minister Atal Bihari Vajpayee played second fiddle to Chinese officials. At last week's summit, Vajpayee was signing trade agreements with ASEAN. Where India has an advantage over China is the nature of its economy. China's is a political one and its success comes from a top-down approach to things. India, for all its problems, is a bottom-up economy in which entrepreneurs are pushing the government to reform and streamline. That tension could give India an edge in the long run. China's boom isn't hollow, per se, but it's heavily dependent on foreign direct investment (FDI); the economy mostly serves the demands and needs of foreign-owned firms in foreign markets. It explains the dearth of internationally known Chinese companies that operate on a global scale and market their products abroad. You would be hard pressed to find a global investor who hasn't heard of Indian software firms like Infosys Technologies Ltd. or Wipro Ltd. Ditto for drugmakers like Ranbaxy Laboratories Ltd. and Dr. Reddy's Laboratories Ltd. The presence of such names explains why India is attracting increased institutional investment, while China isn't.

The question is how much China's rise shakes India out of complacency and catalyzes officials to modernize the economy. Privatization Minister Arun Shourie, whose progress in selling state assets has impressed many investors, warns that China's economy could surpass India's by six times over the next 15 years if the current pace of reform continues. Shourie argues that India's improving growth environment offers a "moment of opportunity" but "only a moment." It's an important point. New Delhi's bureaucracy gets in the way of that opportunity. Entrenched bureaucrats resist change because of political differences, not sound economics. While that's true anywhere, not every nation is dealing with such crushing poverty. Once India begins attracting more foreign direct investment, its comparative advantages over China "like entrepreneurial and management skills" might be reinforced and boost Indian growth. "Countries in Asia seem to be fighting for a shrinking FDI pool," says Gene Frieda, a strategist at the Royal Bank of Scotland. "That won't last forever, though." One sign of hope is the rupee's rise. It indicates a sense of economic maturity and confidence. It's attracting capital into Indian markets, boosting stocks, reducing interest rates and allowing the central bank to keep borrowing costs low. It also is prompting the government to step up plans to repay more high-cost overseas debt before it matures. China is going places, but so is India.
Source: William Pessek Jr, Bllomberg

Tuesday, October 14, 2003

Welcome To Vivek

India Economy Watch is a new project, and as such we hope it will be changing/evolving/improving quite a lot in the not to distant future. The most immediate change is that we'd like to welcome Vivek Oberoi to the team.

Our objective is India Economy Watch is to try with time to produce a non-sectarian forum where a wide variety of views associated with the hopes and difficulties for India's future can be debated. We also hope to bring you ongoing coverage of the most important developments in real-time: that is, as they happen.

IEW has no 'group line', but among the themes which interest us are: what kind of agriculture, the future of indian industry, structural and regulatory reform, trade and Cancun, IT business outsourcing, technology and simplicity, and, (of course) demography and economic growth, rural and urban India, is an alternative development path available to India etc etc.

We hope to have more news and more changes in the not too distant future, but meantime, and as a form of introduction, here's a piece Vivek wrote for Business Standard, back in the summer:

Have you seen Tea with Mussolini? It's quite a charming film - especially if you are the sort who loves art and Italy. The film is set in Italy at the time when the fascists were in power. At least one protagonist - an English lady - is happy with the turn of events.

She is happy that the trains run on time! Many Italians, of course, shared the same sentiment at the time. I have heard similar stories about the emergency in India. More than a few people have said that the emergency really wasn't so bad. The trains ran on time, everyone came to office at the right time and so on. The more things change, the more they remain the same! Meanwhile, this month The Atlantic Monthly carries an article in which "analysts at the RAND Corporation lay out 10 international security developments that aren't getting the attention they deserve".

One such international security development is the growing "Hindu-Muslim divide" in India. Rollie Lal, a political scientist at RAND writes, "A defining element of Indian politics since independence has been a commitment to secularism. That commitment is now at risk from an aggressive brand of Hindu nationalism that equates Indian national identity with Hindu religious identity." So what do the Italian fascists and the emergency in India have to do with each other? Well, both have their roots in stresses produced by rapid urbanisation and industrialisation.

Sunday, October 12, 2003

India and the Second Track

Another of Atanu Dey's ideas relates to the skewed development produced by a highly clustered export driven growth in the context of the enormous agricultural sector which caters for over 700 miliion of India's population. Clearly some strategy which takes this reality into account is essential.

Before the Information Age was the Industrial Age. Policy was then focused on ways to make the transition from an agricultural to an industrial economy. Among the various models (such as export-led growth, import-substitution industrialization, and others) there was one that was called 'agricultural demand led industrialization', or ADLI, which was pioneered by Irma Adelman. ADLI recognized that cost-reducing technological change increased agricultural productivity and thus increased rural incomes. Increased rural incomes provided a demand boost for manufactured goods both for consumption as well as for use in agricultural production. The increased demand for domestically manufactured goods raised wages which in turn were spent on the consumption of agricultural output.

On the labor side of the market, as agricultural productivity increased, labor shifted from the agricultural sector to the manufacturing sector. Thus the industrialization of the population was achieved at pace with the labor transition and was based on increased agricultural productivity attained through the use of appropriate technology. The lesson from the ADLI model is directly relevant to the question of ICT production and use in an LDC's economic growth strategy. The ICT sector is very small compared to the rest of the economy for any LDC. While IT exports will only lead to direct gains only for the IT sector, far more gains can be realized through the use of IT in the non-ICT sector and through the production of IT for domestic consumption. The use of IT in the non-IT sector will increase productivity leading to higher incomes and greater demand for consumption goods which will increase employment, and so on. We can call it the 'Growth from IT Adoption', or the GITA model. One institution that I have worked on which operationalizes the GITA model is 'Rural Infrastructure and Serices Commons' or RISC.

Now this argument is very interesting, and curiously enough it is very similar to one being used by Mogan Stanley's Daniel Lian, in connection in particular with the rural consumption dimension of what is increasingly being called Thailand's second track development strategy:

The development challenge for resource-rich Southeast Asia, given the rise of China and its growing dominance in mass manufacturing, is the implementation of a balanced development strategy that lessens its dependence on external demand and mass manufacturing driven by foreign direct investment (FDI) from multinational corporations (MNCs). The key to future economic success and survival for Southeast Asia is better leverage of domestic demand and resources to produce 'inner' economic strength, economic winners and pricing power through the growth of local enterprises that thrive on indigenous resources and skills, rather than positioning their economy as tax havens and cheap labor sites for MNCs. The winning Southeast Asian economies are likely to be niche and nimble, with large parts of its economy residing outside the domain of mass manufacturing, as China seems destined to become the global factory.

The second track of the dual-track strategy that we have consistently been advocating over the past three years has two dimensions (see Twin Dimensions of Mr. Thaksin's Dual Track Mode, May 7, 2003). The first dimension concerns policy initiatives aimed at producing a structural lift in domestic demand. This should alter the mix of external and domestic demand in terms of contribution to growth as well as overall output. The second dimension concerns the creation of a 'local enterprise element' consisting of local enterprise and product development alternatives to mass manufacturing for export.

Local enterprises should not only cater to local demand, but their indigenously created and developed products and services should also be used to open new export markets by leveraging the country's unique skills and resources. Unlike the defunct single development track through mass manufacturing, these local products and services would not conform to supply chains controlled by global industrial MNCs, or be tied to the excessively volatile global capex cycle; instead, sources of external demand for these local products and services would be the discerning tastes of global consumers.

The success of Prime Minister Thaksin Shinawatra's economic program vividly demonstrates the validity and merits of the second track principles............The Thai rural and SME sectors had been vastly underdeveloped. As at end-2000, about 40% of Thai households engaged in farming and other rural activities but contributed just 10% of GDP. In the past 30 years, there has been little government support for vigorous SME development. At the beginning of Mr. Thaksin's economic regime -- early 2001 -- the government administered a small dose of fiscal medicine, for example, the introduction of the village fund and numerous micro credit programs for SMEs. These were not only aimed at stimulating rural demand through private consumption, but chiefly encouraged the formation of rural businesses and the development of SMEs to structurally ignite the underleveraged rural economy and SME sector.
Source: Morgan Stanley Global Economic Forum

ICT and Indian Development

RISC group member Atanu Dey had an article on Rediff back in February. If most of you have already seen this, I apologise, but IEW did not exist back then, and the RISC ideas are sufficiently interesting that it may well be worthwhile drawing attention to them again. The essential idea is that the existence of ICT makes an alternative growth path available to India. Atanu is obviously right. IT exporting alone will not give India a sustained development path. But IT exports, and business process outsourcing offer a momentum to the Indian economy which, if creatively used, can facilitate a much more broadly based growth process. He is also right to stress that economic development is a non-linear process. It is not the 'eternal repetition of the same', there is constant novelty and leapfrogging. Coming later to the party need not always be a disadvantage. India has the tremendous opportunity of learning from the experience of the present OECD world - and in particular from its urban-rural configuration - in an effort to come up with a different, and perhaps superior, solution. Leveraging the benefits of ICT enabled activities across the rural landscape is one part of this. Producing IT hardware which will be both cost-effective and feasible in the Indian context (Rajesh's thin clients?) could well be another. (A more extensive (PDF) version of Atanu's ideas can he found here ).

ICT can spur growth, bridge digital divide

The role of information and communications technologies (ICT) is popularly held to be very critical to economic development. But there has to be greater domestic use of ICT as an engine of economic growth, in contrast to the production of products and services for export. The advanced industrialised countries were underdeveloped (by today's standards) once upon a time and their transition from subsistence to a modern exchange economy did not involve ICT.

In my view, the reason is that the already developed economies were sufficiently efficient that the introduction of ICT had only a marginal effect. The production of ICT products and services added to the gross domestic product, but did not have a significant multiplier effect. In contrast to the experience of the advanced industrialised countries, the developing countries find ICT available to them at a much earlier stage of their development. These economies are not very well optimized and the use of ICT has the potential to help them transit from subsistence to an exchange economy relatively rapidly. But for this to happen, ICT must be targeted for domestic use, and not just seen as an avenue for foreign exchange earnings.

ICT is arguably strategically important for economic growth of all less developed countries. However, government policies tend to emphasize the export-led growth potential. The successes of countries like India in the IT-exports sector is often used as an example to be emulated by countries similarly placed along the development spectrum. It is important to recognize that while IT exports-led growth is an attractive goal, it cannot deliver sustainable economic growth to any country.

Indeed, pursued in isolation and without a more broad-based IT-enabled growth strategy, it is unlikely that the goal of IT export led growth can be attained. Only a policy that stresses the use of ICT within the country will lead to the development of an IT industry that can serve as an engine of growth by its direct contribution to job creation and GDP growth. There are a number of reasons why IT exports-led growth can be considered less optimal than alternate strategies. The production of IT related products and services targeted for export markets is generally done in high-technology enclaves.

The benefits of the production and the use of IT is therefore limited to the small number of producers and users in the importing developed countries. The products address the needs of the importing countries and they gain significantly from the use of IT produced at low cost in the less developed countries. While the IT-exports sector may be earning foreign exchange through IT production, there is no benefit from the use of IT products and services to the country as a whole. The vast majority of the people is completely unaffected and does not obtain any gains from the use of IT; only the producers of the IT products increase their human capital. Consequently, the digital-divide within the country itself grows.

IT-exports led growth alone cannot result in broad-based growth because the knowledge-goods produced by the country are targeted not at a domestic market but at an export market. Clearly expanding the market for the IT products and services to include the domestic population will lead to a balanced IT-enabled economic growth that is broad-based. First, the use of IT in the domestic sphere will more efficiently increase human capital. Technology adoption growth models show that economic growth is a result of a rapid diffusion of IT. Second, there is the demand side effect. Domestic demand for IT products and services will spur the domestic production of IT and knowledge-goods. There are important forward and backward linkages in the domestic consumption of IT products and services that go beyond the benefits attained by IT exports alone.

For instance, the use of IT in the education and health sectors will provide a large user base that will not only have access to new technology but also participate in the information economy. The ICT sector is very small compared to the rest of the economy for any developing country. While IT exports will only lead to direct gains only for the IT sector, far more gains can be realised through the use of IT in the non-ICT sector and through the production of IT for domestic consumption.

The use of IT in the non-IT sector will increase productivity leading to higher incomes and greater demand for consumption goods which will increase employment, and so on. Is there any hard evidence that ICT has an effect on growth? Most of us believe that ICT does have a positive effect on growth. My prejudice regarding the question of ICT and economic growth of developing countries is that the use of ICT is critical and not the production of ICT.

I think the question whether ICT contributes to growth or not is akin to the question whether transportation contributes to growth. Both are instrumental and provided they are used appropriately, growth will be enhanced. The operative word is 'appropriately' and that is where the rub is. Investment in ICT for developing countries is not an option anymore than investing in a transportation network is. It is absolutely necessary, although it is far from sufficient to ensure growth.

The two most important functions for ICT are these: first, improving the functioning of markets, and second, is in the area of production and delivery of educational content. When the majority of the population is illiterate, the resources needed for educating them (and not just making them literate) would be formidable. ICT provides the only hope of leveraging limited resources to address this problem.

India has had a reasonable amount of success in the export of ICT products and services. In India the industry generated $5.7 billion in 1999, 15 times the level in 1990, and exports rose from $150 million in 1990 to nearly $4 billion in 1999. One study estimates that this could rise to $50 billion by 2008, leading IT to account for 30 per cent of India's exports and 7.5 per cent of its GDP. Employment in the software industry is projected to rise from 180,000 in 1998 to 2.2 million in 2008, to account for 8 per cent of India's formal employment.

ICT has created new outsourcing opportunities by enabling services to be provided in one country and delivered in another. Delivered by telecommunications data networks, the services include credit card administration, insurance claims, business payrolls and customer, financial and human resource management. The global outsourcing market is worth more than $100 billion, with 185 Fortune 500 companies outsourcing their software requirements in India alone. India now has 1,250 companies exporting software.

By providing education for IT -- India's English language technical colleges turn out more than 73,000 graduates a year -- and investing in infrastructure (especially high-speed links and international gateways with sufficient bandwidth), the government has ensured India's place in the new economy. These efforts will deliver long-term benefits for human development and equitable economic growth. It is important to note that only export-related IT activities show up above. I have yet to find figures about domestic IT use. Casual empiricism would indicate that very little IT is used within the country. Domestic ICT use must be given the attention it deserves because only through broad-based ICT use can the benefits of modern technology be made available to all and bridge the digital divide.

Domestic use will have important linkages to the supply of human capital required for the export of ICT products and services.For a large country such as India, domestic demand for ICT products and services can provide the necessary base for sustaining the industry and to shield it from external shocks. For a small country like Sri Lanka, domestic use of ICT is crucial for developing the human capital required for the export market. Therefore, governments of developing countries must create the institutions that encourage the use of ICT domestically.
Source: Rediff.Com