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• India has come a long way from its inward-looking economic strategy of over 50
years ago. Economic liberalisation and the gradual opening up to the world have
boosted growth and lifted millions of people out of poverty. This paper argues that
the continuation of the reform process will allow India to stay on a high growth
path of roughly 6% per year on average over the next 10 to 15 years. If reforms
were pursued more aggressively, real GDP growth could reach 7%-8% per year.
• India will thus become the fastest growing economy out of 34 developed and
emerging markets during that period and the world’s third largest economy by
2020. Moreover, its GDP per capita will double, from roughly USD 2,500 today (at
purchasing power parity) to almost USD 5,000 in 2020. Favourable demograph-
Editor ics, increasing investment in education and infrastructure and further integration
Maria L. Lanzeni with the world economy are the factors behind our projections.
+49 69 910-31723
maria-laura.lanzeni@db.com
• The implications of the projected growth trajectory are manifold. First, a larger,
richer consumer market will emerge. Second, consumption patterns will change,
Technical Assistant
with expenditure on healthcare and transport and communications growing sub-
Bettina Giesel
+49 69 910-31745 stantially. Third, household savings will increase, given the large amount of peo-
bettina.giesel@db.com ple entering the working years phase. Fourth, there will be rising demand for di-
versified financial instruments to invest those savings.
Deutsche Bank Research
Frankfurt am Main • IT-related services, textiles, the auto-ancillary industry and pharmaceuticals are
Germany expected to gain dynamism given India’s comparative advantages and current
Internet: www.dbresearch.com
sectoral trends. The banking sector has an enormous catch-up potential which is
E-mail: marketing.dbr@db.com
Fax: +49 69 910-31877 likely to be unleashed by the new domestic investment landscape, gradual priva-
tisation and opening up to foreign banks.
Managing Director
Norbert Walter Author: Jennifer Asuncion-Mund, +49 69 910-31714 (jennifer.mund@db.com)
India Special May 19, 2005
Dear readers,
This study is the first in our new India Special series, which highlights the significance of
India as a mega topic at Deutsche Bank Research. The series will depict India’s rising eco-
nomic and political position and its implications for Asia and the world.
This overview assesses India's potential to become the fastest growing economy over the
next 10-15 years, based on its favourable demographics and the growth-enhancing reforms
in which the country has embarked. The study also identifies the sectors and industries that
are likely to benefit most from India's ascent.
Subsequent issues for the India series will cover the following topics:
We hope that the analysis provided by this new series finds your interest and helps you in
your work. Any feedback from our readers is highly appreciated.
2 Economics
May 19, 2005 India Special
“No power on earth can stop an idea whose time has come.”
Quoted from Victor Hugo by PM Manmohan Singh on his appointment as premier,
May 2004
1
The World Bank (2003).
2
Bergheim et al (2005).
Economics 3
India Special May 19, 2005
15 or older than 64 years) will decline steadily in the coming years (see
Favourable demographics
chart).
1.6 44
Between 2003 and 2020, we estimate that India will be adding about 1.4
bn %
42
250 m workers to the labour pool. This means roughly 15 m on average 1.2 40
per year. To put this into perspective, in two years, India would be add- 1.0
ing all of Germany’s labour force! 38
0.8
36
0.6
B. Human capital: pockets of excellence but low average level 0.4 34
1990
1995
2000
2005
2010
2015
2020
India Vision 2020, Planning Commission, Government of India
However, economic growth does not depend on population growth Population (left)
alone. The quality of labour input plays a critical role in unleashing the Dependency ratio (right)
productive capacities and technical progress that ultimately lead to Source: UN, DBR
higher growth. In this light, India still has a long way to go, not least if
compared with its regional peers, as the table below shows.
Net primary
Govt spending
Gross enrolment ratio enrolment
on education (%
ratio
of budget)
Primary* Secondary Tertiary
India 12.7 99 48 11 83
China n.r. 114 68 13 93
Indonesia 9.6 111 58 15 92
Malaysia 25.2 95 70 26 95
Philippines n.r. 112 82 30 93
Thailand 28.3 98 83 37 86
*) Gross enrolment ratio is the ratio of total enrolment, regardless of age, to the population of the age group that
officially corresponds to the level of education shown. This is why the ratio can be higher than 100.
3
International Institute for Population Sciences (1995).
4
Census India (2001).
4 Economics
May 19, 2005 India Special
C. Rising integration into global trade and investment Source: IMD Yearbook, 2004
While India has made significant inroads in opening its economy since
it joined the World Trade Organisation (WTO) in 1995, there are still A still closed economy
remnants of its inward-looking development strategy. India’s trade vol- 200
ume as a share of GDP pales in contrast with other major Asian coun- Merchandise
tries, and its import tariffs remain comparably high (see charts). trade, % of GDP
150
But the prospects for greater world integration are promising, since a
political consensus is being reached on the need to further liberalise
trade and capital account restrictions. Recent discussions on expanding 100
trade agreements, e.g., with China, Singapore, Thailand and other
ASEAN members, attest to India’s resolve to gain further access to 50
world trade. The recent lowering of duties for non-agriculture products
to 15% from 20%, albeit small, is a step towards opening the country
0
further.
1990 2000 2003
Capital account restrictions, in particular those applying to foreign direct India China Malaysia Thailand
investment (FDI), are still numerous, although recent policy directives Source: DBR
are laying the ground for greater FDI. (For a complete list of current
guidelines on FDI please see the Appendix on page 14.)
The potential for FDI flows to India seems considerable, not least due Tariffs remain high
60
to the fact that flows are currently very small. The comparison with %
China is particularly striking: Annual FDI flows into India amounted to 50
just 0.5% of GDP (USD 3 bn) in recent years on average, compared to Average of
ASEAN-5* 40
about 4% of GDP for China (roughly USD 45 bn) (see chart on p. 6).
But this may start to change if market deregulation and liberalisation India 30
make further progress. Interest from foreign investors is already signifi-
cant. For example, leading executives of multinational corporations 20
rd
ranked India 3 in AT Kearney’s 2004 FDI Confidence Index (see chart 10
on p. 6).
0
D. Investment trends: huge potential in infrastructure 1990 2001
As a consequence of persistent shortfalls in public revenues, public *) Indonesia, Malaysia, Philippines, Singapore and Thailand
investment has fallen continuously over the years, leading to severe Source: World Development Indicators, 2004
infrastructure bottlenecks. The quality of India’s ports, airports and rail-
ways leaves much to be desired. Moreover, India has one of the lowest
electricity consumption levels in the world, at just 365 units per capita in
2001, attributed primarily to an unreliable supply and inadequate distri-
5
India Department of Industrial Policy and Promotion (2004).
Economics 5
India Special May 19, 2005
bution networks. This compares unfavourably with 893 units per capita
6
in China or 1,729 in Brazil in the same period. FDI: Room to catch-up
Similarly, despite having one of the most extensive transport systems in 60
the world, the sector continues to suffer from acute capacity and quality USD bn
constraints. India’s total road network (in km) is twice the length of 50
7
China’s. Its poor quality, however, inhibits greater efficiency in the de- 40
livery of goods, with the consequence that the volume of goods hauled
lags considerably that in China. 30
6
World Development Indicators (2004).
7
World Development Indicators (2004).
6 Economics
May 19, 2005 India Special
to be its Achilles’ heel. Public deficits since then have been very high at Governance indicators*
around 10% of GDP. Control of
India’s poor public finances have placed significant constraints on Corruption
growth. The so-called “development expenditure”, i.e., capital expendi-
ture on areas such as infrastructure that generates high social returns, Rule of Law
has fallen constantly as a percentage of GDP since the early 1990s. At
the same time, non-development expenditure, particularly interest on Regulatory
government debt, has risen continuously (see chart on p. 6). Effectiveness
The government has taken some initial steps toward fiscal consolida- Government
tion. The Fiscal Responsibility and Budget Management Act, passed in Effectiveness
2002, binds fiscal managers to specific deficit targets each year, with a Political
8
goal to bring down total deficit and revenue deficit to 3% and 0% of Stability
GDP, respectively, by 2008/2009. The introduction of the VAT system in
April 2005 is another critical measure expected to contribute to fiscal Voice and
Accountability
consolidation. Finally, a moderate resumption of the privatisation drive
will also provide relief to public finances. 0 2 4 6
Singapore China India
Institutional and regulatory environment: established, but still
inefficient *) The six governance indicators are measured in units
ranging from about -2.5 to 2.5, with higher values
India is a large country, not only with regard to its size but also in terms corresponding to better governance outcomes. Data have
of culture, languages, religions and contrasting convictions. Notwith- been rescaled to 0-5.
standing the country’s heterogeneous society, there is an established Source: World Bank Governance Index 2002
and binding institutional framework, which includes a legal system,
capital market regulators and banking supervisors.
"Obstacles in doing business"
However, the efficiency and efficacy of these institutions leaves much to indicators
be desired. World Bank indicators on governance and on obstacles in
doing business show significant room for improvement in India not only Employment
compared with advanced Asian economies like Singapore, but also in law index*
relation to China (see charts).
For example, India’s rigid labour laws are often criticised as unwieldy. Procedures
Singapore
to enforce a
Firms with more than 100 employees can not easily retrench workers. China
contract
Larger firms and foreign companies resort to elaborate measures to India
circumvent the country’s cumbersome labour laws. Reform proposals Days to
have been long debated but a concrete directive toward a more flexible start a
labour system remains elusive. However, it is likely that, as economic business
liberalisation progresses further, the opportunity (and the pressure) for Number of
change in the institutional framework will arise as well. start up
procedures
II. India’s unique economic development: by-passing
the industrialisation phase? 0
*) High score = very rigid labour laws
50 100
Economic development often follows a sequence whereby the share of Source: World Development Indicators, 2004
Economics 7
India Special May 19, 2005
and the inflexible labour laws. The agricultural sector’s share of GDP,
meanwhile, declined to roughly 23% in FY 2003/2004 from just below A services-led economy
60% in 1951.
1983
What makes India’s development even more unusual is the relatively Services
constant share of employment in each sector. The agricultural sector
still employs the majority of the workforce, comprising 60% of the total.
The services sector, on the other hand, employs just 25% of the total
labour supply (see charts). This phenomenon also partly explains why Industry % of labour force
urbanisation has been slow to develop. % of GDP
The IMF points to the critical role which economic liberalisation and a
growing demand for services exports in the 1990s played in increasing
10 Agriculture
the services sector’s dominance in GDP.
Surprisingly, IT represents a small fraction (less than 5%) of the ser-
vices sector. The most prominent sub-sectors which have grown rapidly 0 20 40 60 80
as a result of economic liberalisation, are business services (which
includes IT but as a minor percentage), communications and banking.
2000
However, given India’s availability of a high-skilled workforce in IT- Services
related areas, it is likely that this sub-sector will grow substantially as a
share of total services.
% of labour force
The question arises whether India can do without a sizeable manufac- % of GDP
Industry
turing sector. We think not. Manufacturing would provide India with a
needed source of sustainable growth, and would contribute to further
reducing poverty. A key pre-requisite for the future expansion of manu-
facturing activities in India is the improvement of the skills of the rural Agriculture
population. Combined with further liberalisation in agriculture, a more
educated rural population will find it easy to move from farming to more
productive areas. At the same time, this process should help to boost 0 20 40 60 80
rural incomes, thus generating demand for the manufacturing sector. Source: Reserve Bank of India, Ministry of Finance
By developing its industry, India would become more like its Asian
counterparts, whose economic growth over the past two decades has
evolved hand-in-hand with increased industrialisation (see chart). The Industrialisation has room to
transition from agricultural to industrial employment would also be in- catch-up
strumental in the path toward greater urbanisation, which the govern-
ment projects will increase to 40% from the current level of 28%. China
fell following the reforms in the 1990s, the number of reserved items at roughly over
400 is still significant.
10
Rodrik and Subramanian (2004).
11
This section was contributed by Stefan Bergheim.
8 Economics
May 13, 2005 India Special
GDP and the four fundamental drivers of growth, taking account of the Growth scenarios for India
information in the time series. 6
The model’s forecasts for the four growth drivers stem from a three- GDP per capita
USD, '000 (PPP) "Indian tiger"
stage approach. Extrapolation of their trajectories of the past 20 years is 5
the starting point. The exception is population growth, where we use the
UN’s forecasts. The second stage takes information from levels and
changes in other countries into account to dampen excessive move- "Measured pace of
4
reforms"
ments in the trajectories generated in the first stage. The third and most
important stage captures structural breaks through a broad-based
country-specific assessment of six clusters of trends in politics, society, 3
business and technology – based on the country expert’s assess- "Reform holdup"
12
ment. For example, DBR expects India to increasingly seize the op- 2
portunities offered by globalisation, and this is reflected in the trend
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
called “Global networking in business in economics”.
DBR’s model yields an annual per capita GDP growth of 3.9% and total
GDP growth of 5.5% on average in 2006-20 in the baseline outlook. Changes in income
Since the model is not equipped to take into account factors such as distribution: Urban
the high social return from expected investment in infrastructure, we 70
believe that growth is likely to be higher than the baseline, i.e., in the 60 % population
vicinity of 6%. 1992-93
50
1998-99
IV. Alternative scenarios 40
30
The growth path depicted above is our most likely scenario (with a
probability of about 60%), based on the expected trajectory for the 20
growth drivers and the course of policies. We call this scenario “meas- 10
ured pace of reforms”. Of course, it is conceivable that the pace of pol- 0
icy reform will be different – either faster or slower – than we currently <=35 36-70 71-105 106-140 >140
expect. Therefore, we have devised two alternative scenarios. (L) (LM) (M) (UM) (H)
Annual income (INR, '000)
Upside scenario: “Indian Tiger” (p = 30%)
Under this scenario, the government’s approach to liberalising the Rural
70
economy is much more aggressive than at present, and implementation
60 1992-93
of reforms is deeper and more rapid in spite of occasional opposition
50 1998-99
from other political parties. In particular, privatisation resumes at a simi-
lar pace as in FY 2003/2004. Privatisation revenues support the gov- 40
ernment’s drive to narrow its revenue deficit. Liberalisation in sectors of 30
the economy which had remained closed so far attracts larger inflows of 20
foreign direct investment. The government invests strongly in the agri- 10
% population
cultural sector in order to reduce the country’s dependence on the va- 0
garies of the monsoon. Social tensions arising from the widening in- <=35 36-70 71-105 106-140 >140
come disparities between rich and poor are kept in check by the gov- (L) (LM) (M) (UM) (H)
ernment within the parameters of the “Common Minimum Pro- Annual income (INR, '000)
13
gramme” , without affecting the investment climate or jeopardising the
fiscal consolidation process. All-India
70
Under this scenario, the economy grows at an average rate of 7.5% 60
% population
over the next 10-15 years. This growth rate is close to – albeit still be-
50 1992-93
low – the government’s own long-term target of 8.5% to 9%, as denoted
14 40 1998-99
in its document “India Vision 2020”.
30
Downside scenario: “Reform holdup” (p = 10%) 20
10
Under this scenario, economic liberalisation policies are held back by
0
frequent and protracted resistance to economic reforms. The fiscal
<=35 36-70 71-105 106-140 >140
(L) (LM) (M) (UM) (H)
Annual income (INR, '000)
12
“The trends that will shape future growth” on DBR’s website provides a map of these
trends. L=Low; LM=Lower middle; M=middle;
13
The Common Minimum Programme (CMP) is a blueprint of the government’s UM=Upper middle; H=High
economic and social goals that emphasises empowering the poor and rural areas. Source: National Council of Applied Economic Research
14
India Planning Commision (2000).
Economics 9
India Special May 19, 2005
10 Economics
May 19, 2005 India Special
Textiles
DB Research expects India to emerge as one of the winners of the
17
textile trade quota expiry in December 2004. In the years prior, the
Agreement on Textiles and Clothing (ATC), along with the preferential
treatment agreements, restricted the exports of many Asian clothing
15
Modigliani & Brumberg (1954).
16
For a similar projection see Sanyal (2004).
17
Heymann (2005).
Economics 11
India Special May 19, 2005
manufacturers to the US and EU. India had by far the highest export tax
equivalent for its trade with the US and EU (see chart). The removal of Export tax equivalents of quotas
the quota system will likely unleash significant potential for India to in- in clothing trading
crease its exports to the major developed markets.
IN
India’s strengths include a rich availability of inputs such as a large
CN
labour force, low-cost production and manufacturing of raw materials
(e.g. cotton and yarn). However, the surge of the industry is likely to be TH
gradual, particularly compared with China, which will emerge as the HK
main beneficiary of the end to textile quotas. This is explained by LK
China’s better infrastructure, which allows higher production and oper- BD
USA
ating efficiency, and more open export policies. Notwithstanding, as EU-15
ID
manufacturers will seek to diversify their import sources, India will cer-
tainly benefit. With expectations of further economic liberalisation, India PH
is expected to emerge as a highly competitive supplier of textiles and VN
clothing in the near future. HU
PL
Auto-ancillary industry
TR %
India’s auto-ancillary sector is becoming rapidly integrated into the
global industry. Outsourcing of production by large auto-component 0 10 20 30 40
manufacturers to India is expected to increase further as they seek to Source: WTO (model calculation using 1997 as base year)
cut costs. India’s advantages also include high engineering skill levels
and established production plants.
A recent report showed that this sector could grow to between USD 33
bn and USD 40 bn by 2015, from USD 6.7 bn in 2003, while exports
have the potential to soar from USD 1 bn in 2003 to between USD 20
18
bn and USD 25 bn by 2015. While these may still be relatively small
amounts considering a global industry size worth USD 700 bn, they
nonetheless reveal that India is capable of capturing broader pieces of
the pie over time. The key challenges ahead include quality upgrading
and dismantling of unfavourable government policies. Increasing joint
ventures between Indian companies and international players should
contribute to improving their efficiency, operation and technology.
Pharmaceuticals
The Indian pharmaceutical sector may be entering a paradigm shift as it
has just started implementing a new product patent regime. The new
patent law effectively puts an end to Indian pharmaceutical companies’
practice of reverse-engineering the production of patented drugs. This
is expected to significantly increase multinational drug companies’ pro-
duction in India.
At the same time, despite the implementation of the patent regime, Credit to GDP: Financial
India is expected to maintain its place among the top global producers deepening beckons
of generic drugs, due to the country’s cost advantages and its availabil- 160
ity of high-skilled scientists. With an estimated USD 55 to 65 bn worth 2003, %
140
19
of drugs expected to go off-patent within the next 2 to 3 years , India
120
could potentially capture a good size of this.
100
Financial industry 80
The financial sector, in particular banks, plays an essential role in eco- 60
nomic development since it facilitates the intermediation between sav- 40
ings and investment, thus fostering economic growth. As discussed in 20
the previous section, Indian banks have been the main recipient of 0
household savings. However, they have not performed well in mobilis-
India Korea Thailand Malaysia
ing these funds into loans, as evidenced by a very low ratio of credit to
Source: World Development Indicators, 2005
GDP (see chart). Instead, a big portion of banks’ assets (25%) is in-
18
McKinsey & Co. (2004).
19
Ernst & Young (2004).
12 Economics
May 19, 2005 India Special
Conclusion
India’s growth potential over the next 10-15 years sets the country at
the forefront of the developed and developing world. We expect that,
building on the country’s favourable demographics and sizeable talent
pool, the continuation of the reforms initiated over one decade ago will
unleash that potential and bring India to a more advanced stage of
development. There will certainly be obstacles along the way, but we
believe that the integration of India into the global economy and the
ensuing transformation of the country are here to stay. The pace of this
transformation will ultimately depend on the will of the Indian population
and the vision of its leadership.
Author: Jennifer Asuncion-Mund, +49 69 910-31714
(jennifer.mund@db.com)
20
The Prudent Man Rule states that “a fiduciary shall exercise the judgment and care,
under the circumstances then prevailing, which men of prudence, character and intel-
ligence exercise in the management of their own affairs, not in regard to speculation
but in regard to the permanent disposition of their funds, considering the probable in-
come as well as the probable safety of their capital.” [Association of Investment Man-
agement and Research, 1999.]
21
Asian Development Bank (2004).
Economics 13
India Special May 19, 2005
14 Economics
May 19, 2005 India Special
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Economics 15
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