PROSPECTS FOR INDIA'S DEVELOPMENT
24 April 2000
Business 487
Professor Marvin Zonis
Leonardo Cherman
Meredith Persily
Debra Strober
Tomoko Tanaka
Gary Wong
ACKNOWLEDGEMENTS
The India group would like to thank CNA Financial, Deutsche Bank, Diamond Technology Partners, and Pfizer for making our trips possible. Through their support, we were able to perform primary research in New Delhi, Bangalore, Goa, Jaipur, and Bombay. The additional regional perspective provided tremendous value to us when developing our hypothesis about the Indian market.
In addition, we would like to thank the many interview contacts who welcomed us to their country and candidly provided information and perspective to us.
Table of Contents
ACKNOWLEDGEMENTS
Table of Contents
I. The Bottom Line
II. Model and Variables
In order to develop a model for India we analyzed the following variables:
III. Data and Analyses
A. The Political Environment
Current Status
Barriers to Progress
B. Labor Policy
Snapshot
Status and Barriers
C. Privatization and Liberalization of Key Industries
Snapshot
Initiatives
Barriers
D. Financial Reforms and Foreign Direct Investments (FDI)
Snapshot
Status
Initiatives and Barriers
E. Information Technology Sector
Snapshot
Status
Impact on Investment Potential
Barriers
IV. Variable Mix
V. Conclusion
VI. Appendix I: Exhibits
Exhibit III.A.1: The Lok Sabha Elections -- General Summary 1952-1998
Exhibit III.A.2: National Voter Turnout in Federal Elections: 1960-1996
Exhibit III.A.3......
Exhibit III.B.1: Purchase Power Parity
Exhibit III.C.1: India Telecoms Regulatory Structure
Exhibit III.C.2: Infrastructure and Other Investments, as% of GDP (Private Sector Investment)
Infrastructure
Other
Exhibit III.D.1
Exhibit III.D.2
Exhibit III.E.1 IT Sector Revenues for 1994-1999 (source: NASSCOM)
Exhibit IV.1: Variable Interactions
Exhibit V Alternative Scenarios...... 27
End Notes
I. The Bottom Line
On the surface, India presents itself as a tremendous growth opportunity given its enormous population, well-established democratic institutions, notable successes in the software industry, and its recent introduction of competition in certain key industries. At the same time, the government's failure to implement necessary privatizations, reduce subsidies substantially, streamline its government agencies, and meet the educational needs of its population put into question the government's commitment to wide-scale reform. The government's need to attain consensus has presented a significant barrier to rapid reform. Meanwhile, the federal government has put much of the decision-making power into the hands of the state governments, and, certain southern states have pioneered privatizations in energy and telecom and have also excelled in private industry. As a result, we see tremendous growth potential in these states.
India still maintains some of the legacy of the Soviet Union that failed to push the country towards market reform. China's recent development has made the country begin to question its development path. Southern states, that are more industrially aligned with the West, have begun to see the fruits of private industry and will continue to develop and present excellent investment opportunities. The lagging states in the north will only develop once they begin comparing themselves to the south and recognize that they are missing out on much of what reform has to offer.
II. Model and Variables
In order to develop a model for India we analyzed the following variables:
1) Politics: Stability, the Party System, Coalitions and Consensus
2) Labor Policy and Education
3) Privatization and Liberalization of Key Industries
4) Financial sector reforms and impact on Foreign Direct Investment
5) The Software Industry and the Role of Overseas Indians
Indeed, an infinite number of variables are relevant to the India model. However, we sought a mixture of macro and micro variable in order to grasp the challenges at the local and national levels. Indeed, this approach was appropriate given that the country offers some micro opportunities, both in terms of geography and selected industries. Where the country falls short, however, is in the ability to enact necessary structural changes in the society.
III. Data and Analyses
A. The Political Environment
Current Status
At the most basic of levels, India’s overriding political environment can be broken into two realms: international and domestic. India’s foreign policy consists of a necessary preoccupation with Pakistan (with whom it seems to skirmish every Spring), with China (it’s largest threatening neighbor) and those general issues involved with building and maintaining a nuclear arsenal. While its relationships with regional neighbors are tenuous at best, all factors indicate that India’s standing in the international community is such that beyond diverting precious funds and attention away from domestic issues, India’s international realm should pose no major hurdles for the near future. On the other hand, the domestic realm very strongly characterizes the near-term future of foreign investment in India. The nature of coalition politics and the problems it causes for consensus-building is hindering the necessary political and economic reforms that will allow India to effectively create and implement domestic policies. A strong government that can lead India through initially painful economic reforms is necessary if India is to emerge as a new Asian tiger. Only a strong leadership will allow India to surmount the major hurdle that is Nehru’s 45-year legacy of protectionist economic ideology and the remnants of its Cold War era alignment with the Soviet Union in order to create the necessary conditions to entice foreign investment.
Barriers to Progress
International Climate
Pakistan
Though the Indian self-perception as a major international power makes China its primary regional threat (and primary nuclear threat), for the foreseeable future Pakistan is India’s main source of instability. As evidenced by the recent 28% increase in the defense budget, large amounts of funding are diverted to the military for fighting skirmishes over the Line of Control (LOC) in Jammu and Kashmir. The October 21, 1999 military coup in Pakistan has further destabilized the region while the hijacking of an Indian Airlines plane in December of 1999 remains a source of embarrassment for India. Peace between the two countries is not yet on the horizon. Pakistan cannot initiate peace because its new military regime requires the immediate Indian threat to legitimate its existence. Nor can India broker peace because its historic policy of non-compromise on the “internal” issue of Kashmir dictates that a compromise on the question would seal the doom of the new coalition (see following section on domestic politics for more information). Yet full-scale war between the two countries also remains unlikely. Pakistani General Pervez Musharraf cannot initiate an official war with India because his economy relies too heavily on the generosity of the international community (namely the US and the IMF) to risk their dismay. Meanwhile, India must maintain its historical position of taking the moral high ground where Pakistan is concerned in order to maintain its international standing. So, for the near future, with both countries devoid of stable leadership, capital and time-intensive skirmishing will continue to be a drain on resources, but should not prove fatal.
The Nuclear Issue
In terms of nuclear weapons, as long as China maintains its nuclear arsenal, and as long as the non-proliferation regime supported by the West remains incapable of extending the security of a nuclear umbrella to non-nuclear states, India will retain its nuclear arsenal and refuse to sign the Non-Proliferation Treaty (NPT).[i] Though historically this has been a point of contention in particular with the United States, it looks like the NPT will become less of a sticking point for Indo-US relations in the future. For example, in October 1999 the US ratified the Glenn Amendment (to the Arms Export Control Act) which allows the President to waive certain types of sanctions imposed on India in the aftermath of its controversial May 1998 nuclear test. In addition, the US Congress, having failed itself to ratify the CTBT, has severely hampered US ability to leverage Indian non-compliance with the NPT. Both of these events suggest a slackening of tension over non-proliferation issues, hence, the lowering of a barrier to foreign investment in India.
Domestic Climate
The Coalition Government and Rapid Turnover
India’s domestic political system has lacked stable leadership for close to six years – in just one year alone, three different governments controlled the country. There have been three elections since 1996, the most recent of which took place in October of 1999 and brought yet another monstrous coalition government to power – an increase in the number of parties from 18 to 24. (The problem is getting progressively worse as the 1997 coalition government that was ousted had only 13 parties.) The regularity of turnover is extremely disruptive for policy-making – when the last parliament was dissolved in 1999, 106 bills pending in the lower house (Lok Sabha) were discarded.[ii]
The Coalition Government and Consensus-Building
The problem with such a fractious coalition government is not the failure of the Democracy. The fact that the government has been overturned 3 times since 1996 through peaceful, legal and legitimate elections, initiated by a government of popular consent, suggests that the parliamentary democracy and all of its requisite checks and balances are fully institutionalized. India truly is the world’s largest democracy. Regarding the “quality” of India’s democracy, the 1998 Indian elections lured 61.97% of the voting population to the poles, while the United States, arguably the world’s most successful democracy, coaxed only 49.08% of its voters to the poles during the 1996 presidential election. And the trend in India has been increasing over time. [Exhibits III.A.1 and 2]. The problem is that a coalition government’s existence is at the mercy of small political parties’ very specific interests. For instance, the ¾ of Indian society that is agrarian will continue to use their political will to ensure that high government agricultural subsidies continue for their products, their electricity supplies, and their tax breaks. They have the power to request a vote of no confidence and catalyze a new round of elections should the present government attempt to cut those subsidies. And due to the fractious nature of the coalition, many different interest groups maintain the power to do the same. [Exhibit III.A.3.]
This lack of consolidated leadership slows progress to a crawl. (The first and last major economic reforms came between 1991 and 1993 – over 6 years ago). This first round of reforms marked a real departure -- an opening of the Indian economy to the world. The current coalition leader is still the Bharatiya Janata Party (BJP) as it remains the largest party in the coalition.[iii] Although the new government has acted in favor of reform in its early days in office (by opening the insurance sector, liberalizing the FX management regime and allowing the trade of derivatives on stock exchanges), regardless of its beliefs, it will still be held prisoner by the nature of coalition politics.
B. Labor Policy
Snapshot
From the labor market perspective India faces very good growth prospects mainly due to its current low levels of salaries and capital stock. Cheap labor is abundant and markets are poorly served which can represent a significant opportunity for investment. Nevertheless, sustainability is an issue for public policy is not being conducted as to achieve productivity growth. Note that productivity has a broad definition encompassing all factors that make the combination of labor and capital more efficient: infrastructure, processes, human capital/education, technology, regulatory environment. India clearly falls behind in the overall productivity level with an inadequate and overloading labor regulation for the potential employer.
Status and Barriers
Labor and wages
One noted exception to the very good data collection system in India is the absent set of reliable data on employment and unemployment. According to a compilation of official data provided by ISI Emerging Markets Data, unemployment rate as a percentage of total labor force is 1.89%, an extremely low figure for international standards not endorsed by industry specialist, labor experts and local managers[iv]. It is important to understand, however, the definition of an unemployed person so that we can conclude that such figure is heavily underestimated. As per India's criteria, unemployment rate is based on "usual status" defined as a person not working, and either seeking work or available for work in the major part of a reference year. The usual status is considered the chronic open unemployment. Most important however is to understand that only 8% of the total labor force are employed in the so-called organized sector and thus counted in the statistics. The remaining 92% are a part of a massive contingent of workers that make a living either through part-time occupations, seasonal jobs (agricultural, e.g.) or underemployment (approximately 6%), not to mention illegal occupations.
Pattern of population growth: One other important point, not completely captured by official statistics is the growth of the unemployment rate resulting from the increase of the adult population (2.5% per year according to official figures) not met by the current rate of job creation (2.3%). While this gap seems small, there is a significant reason for concern for only now the labor market will feel the consequences of the population boom of the 60's and 70's (despite population growth of 1.9% on average between 94 and 98, labor force will grow by more than 60 basis points). To India, this gap represents an increasing challenge because six million jobs[v] will have to be created every year for the next two to five years in addition to the number of jobs that have already been created in past years. This challenge is even larger for six particular states according to estimates of the Planning Commission[vi]. While workers in Kerala, Punjab and Tamil Nadu face few opportunities because employers prefer to settle on States with lower costs (these States have the highest level of minimum wage in the country), those in Uttar Pradesh, Rajasthan and Bihar seem to lack proper skills and training. Contrary to the former, the latter cannot rely on relocation as a means to escape from unemployment and will probably have to depend upon government initiative (through education and training) to enter the labor force.
As a result of a controlled foreign exchange policy, there is a significant gap between the Rupee exchange rate and the purchase power parity in terms of dollars. According to estimates from The Economist Intelligence Unit[vii], a dollar can purchase RS 43 in currency but only RS 10.71 in goods. This imbalance accentuates the low cost of labor for potential foreign investors but, on the other hand, hurts the revenue line with the reduction of purchase power. According to a study by C.K. Prahalad and K. Lieberthal from the University of Michigan[viii], the income distribution in India results in approximately 80% of the population being "economically unattractive" (Exhibit III.B.1)
Regulatory Environment and Social Security
As already mentioned above, the regulatory environment can be very harmful for the achievement of full employment. The establishment an inflated minimum wage is not the only piece of regulation to blame. The Industrial Dispute Act of 1948, for example, states that all employee lay-offs within firms that have more than 100 employees have to receive permission from the government even for the closing of a business unit. When the government intervenes in the lay-off, companies find loopholes in the law (for shutting down a factory, for instance, employers would stop to pay electricity bills).
As of today, more than 125 different pieces of legislation coexist in India, most of them completely outdated and some pieces from the last century that originally were meant to be temporary but became definitive.
Government is failing to protect workers not only through the lack of a unified and modern labor law code but also through an inefficient and poorly run Social Security system -one that only increases the costs of doing business in India and does not provide any benefit for the 92% of workers that are not part of the organized labor force. The red-tape is so rampant that foreign companies find joint ventures with local groups a safer and easier way to learn the "India way of doing business", which can vary on intensity from the use of influence in dealing with government officials to the payment of bribes.
Another important point is the decreasing but still significant power of unions. Since 1991, unions have been realizing that meddling in the labor markets was a necessity. The alternative for a more liberal approach would be the repetition of the phenomenon observed in Calcutta, where unions are to be partially blamed for the migration of whole industries to other states, only now the country as a whole will be at risk.