Monday, January 12, 2009

the boom from the bottom

Isolated from world trends, India's aspiring poor will help it grow through the credit storm.

Jason Overdorf
From the magazine issue dated Jan 19, 2009

Though it may not look it on the ground at times, India is one of the few bright spots in a global economy with decidedly dim prospects in 2009. It is forecast to grow at a robust 5 to 6 percent this year—which is faster than it averaged in the 1990s, and nearly double the rate of expansion over the country's first three decades of independence. Yes, its stock market has crashed, unemployment is spiking, swaths of the real-estate market have more than a passing resemblance to Miami Beach and it now turns out that Satyam Computer Services—one of the country's top five IT companies—has been cooking its books. But a one off incident of fraud in the flagship IT sector won't knock the country off the rails. India boasts an unlikely growth driver all its own: legions of poor whose incomes have risen just enough in recent years to create powerful demands for basic goods and services.

The rise of India's aspiring middle—a group that lives above the poverty line but hasn't yet attained true membership in modern consumer society—is hardly a new story. But what's surprising is the resilience of this cohort, and the extent to which it has counterbalanced the global credit crisis and the slump in the global export economy of which India is a key player. In part, this is a consequence of New Delhi's past failures; policymakers were never able to make India the export powerhouse that China has become over the past three decades, so now they don't rely nearly as heavily on growth driven by investment and demand from foreign markets.

Yet Indian planners deserve some credit, too, for avoiding a national addiction to cheap credit and creating "growth multipliers" like roads and telecom networks that now link the country's vast interior to modern cities. "The basic component of domestic demand [in India] is consumer demand, because people still have incomes to earn," says Saumitra Chaudhuri, chief economist at ICRA, an Indian credit-ratings agency affiliated with Moody's. "And those incomes are not substantially influenced by international developments."

The idea that Indian backwardness is a plus may sound absurd. But it is always easier to grow from a poor base, so the fact that India is not yet a major economy is an advantage in a downturn. A population so large that subsists at such a low economic base is a powerful economic driver if it can be mobilized. India's has been, and it is proving resilient to the prevailing headwinds in the global economy. "It's kind of a self-sustaining process," says Subir Gokarn, chief economist at Crisil, the Indian arm of Standard & Poor's. "There's a huge, huge underpenetration of most commodities and services, and you have enough people at the bottom experiencing enough of an increase in income to sustain growth."

So even as middle-class consumption wanes in India—signified by a sharp drop in auto sales, airline travel and fine restaurant dining since mid-2008—domestic demand remains strong thanks to aspiring consumers, many still tied to the farms, who spend their rupees on essentials like soap, medicine and the shoes and clothing that they wear to work. As Gokarn puts it: "If you go back to the economic textbooks, they will tell you that the poorer you are, the stronger your propensity to consume."

The contrast with China, Asia's other economic giant, is stark. Domestic demand makes up three quarters of the Indian economy, compared with less than half for China, which is "why, relative to East Asian economies, India is somewhat insulated from the global trade slowdown," says Shankar Acharya, a former chief economic adviser to the government. Another Indian mainstay—agricultural growth—should remain steady this year, and the services sector, which now accounts for about 55 percent of India's GDP, is expected to be "more resilient" than manufacturing, says Acharya.

Despite the financial crisis, the nation's IT sector managed to grow some 20 percent in 2008, according to India's National Association of Software and Services Companies, and IT companies have already extended 100,000 new job offers for 2009. "For whatever reason, China has been highly focused on the export market, while Indian business has been highly focused on the domestic market, and their exports have been incidental," says Chaudhuri. Which makes India, more than China, a master of its own destiny.

The conventional wisdom has always held that India failed to become an export-driven dynamo on the Chinese model because its democratic system couldn't deliver the hard infrastructure and soft labor laws needed to manufacture competitively. While there is some truth to that, what is often overlooked is how much India's current growth multipliers—all of them linked to infrastructure—resemble China's in the 1980s.

One example: India's ambitious program to expand the national highway system, launched in 2003, which is now adding about 100 kilometers of highway per day to the grid. Each new strip of pavement links additional villagers to urban markets, allowing them to fetch more for what they grow or make and to travel farther afield for wage-paying jobs. Capitalized at a whopping 5 percent of GDP in 2000, India's rural roads program will ultimately connect all Indian villages of more than 500 people to one another with all-weather roads. Fewer than half of these villages had roads of any sort when the project started. Similarly, in a six-phase national project, the National Highway Authority plans to add or upgrade nearly 30,000 kilometers of highway, which would expand the existing system by a third.

Telecommunications has made faster inroads. In 2008 the subscriber base for India's national telecom network topped 350 million people, and India's telecom market is now growing faster than even China's. Charges have dropped to less than 50 U.S. cents per call. That connectedness has a huge potential impact on incomes in a job market "extremely sensitive to how quickly one can get information," says Gokarn. There's also the IT sector itself to consider. It has created 1.8 million jobs directly over the past decade, and as many as 6.5 million more support jobs for drivers, security guards and gofers with primary or high school educations. That has put rupees into the hands of people "more likely to spend it rather than save it," says Gokarn, and though job creation will slow as the IT sector cools off, the huge workforce creates a good deal of momentum.

India's bottom-up boom can't drive the economy at full speed, to be sure. But it is largely immune to the downturn that's evident higher up the consumer chain. The stock bust hasn't affected the aspiring underclass because its members are not invested in the markets, and they're not to blame for the drop in auto sales because they're too poor to afford cars. Even the housing bust is far removed from them; despite the glut of top-end condos in places like Mumbai and New Delhi, India as a whole is suffering an acute housing shortage. The problem: construction companies all aimed for the top of the market, leaving the lower tiers underserved. According to the National Planning Commission, urban India needs an additional 24.7 million ordinary homes to satisfy current demand. As evidence of this unquenchable thirst, when the Delhi Development Authority held a lottery last year to find buyers for 5,000 affordable flats it built in the city, some 500,000 applications flooded in.

The mismatch illuminates India's way forward. Like many other governments, New Delhi recently announced a major new spending package aimed at bolstering growth. And it, too, seeks to spur domestic demand. Yet the main target isn't the urban middle, as in China or the United States, but the poor. In October, Parliament approved additional spending of about $50 billion (or 4.5 percent of GDP) to boost salaries of government workers, waive farm loans, further fund the rural-employment-guarantee program and finance petroleum bonds so that oil and fertilizer companies can keep prices low. "While there are legitimate concerns about the long-term impact of some of these measures," says Gokarn, "they will undoubtedly help boost consumption spending, particularly by lower income households, which in turn will help shore up growth in the immediate future."

India avoided a U.S.-style housing bust and is better positioned to pump money into the cash-starved financial system today because its much-maligned central bank was never wooed by the allure of easy money—no matter how loudly industry clamored for faster growth. When the central banks of other countries were essentially offering free money, India's realized that, as a democracy of mostly poor voters, it couldn't afford to grow at 10 percent a year if that meant skyrocketing prices for essential commodities like rice and flour. For that reason, the central bank constricted the money inflating the real-estate bubble (and prices for everything else) by raising interest rates to a peak of 12.5 percent last summer, which earned it criticism for being out of step with more aggressively growth-oriented central banks. Because of this, India has ample ground clearance to lower rates and reduce reserve requirements for banks to spur growth and avert deflation.

The private sector is in pretty solid financial shape, too. The central bank kept a close eye on both state-owned and private banks, preventing them from leveraging to perilous heights by keeping the cash reserve ratio high, limiting the use of securitizations and derivatives and essentially barring the off-balance sheet vehicles that U.S. banks used, disastrously, to hide their debt. As a result, India's banks aren't sitting on a mountain of bad loans, which makes them freer to lend to companies in need. Indian companies, cognizant of the cash crunch that burned them in the late 1990s, didn't overextend this time, either. "[One] great source of strength is India's corporate sector, who have much stronger balance sheets [than in the past]," says Chaudhuri.

One sign of that is companies that are putting their wealth to work. In December, India's Wipro Technologies purchased Citigroup's captive IT services firm Citi Technology Services for $127 million in cash, and in October, Tata Consultancy Services was able to buy Citi's business process outsourcing business, Citigroup Global Services, paying $505 million. Both moves suggest that reports of the IT sector's demise in India are greatly exaggerated.

The biggest risk to India in 2009 at this point may not be the global economy but domestic politics. Prime Minister Manmohan Singh's United Progressive Alliance will see its term expire in May, and India's election rules mean that he can no longer enact any significant policies—a measure adopted to prevent incumbents from stacking the deck with populist sops. That means as much as five months of paralysis, precisely when speedy, creative action is the order of the day. Moreover, though the nemesis of Singh's Congress party—the Bharatiya Janata Party—mostly favors similar policies, a change in government would likely result in some further slowing of infrastructure projects that are already running behind schedule. And elections in India can be tricky. In the last one, the BJP-led National Democratic Alliance lost despite racing economic growth, because poor voters rejected the BJP's campaign claims of an "India Shining."

With the light bulb flickering, Singh's Congress may face an even bigger challenge winning them over. The poor don't care how much faster than other nations India is growing, only whether their lives are better than they were five years ago.