By Shanmuganathan “Shan” Nagasundaram
Over the 2000-2010 decade, the world's marginal growth was driven primarily by China, and to a lesser extent India. While the developed economies see-sawed between recessions and slow growth years, China and India managed an impressive 10 percent and 7.5 percent CAGR (compounded annual growth rate), respectively, of their GDP over this period. Other indicators, such as consumption of commodities, energy utilisation patterns, trade surpluses, etc., also exhibit a similar trend.
Today, the developed economies of the US, eurozone, UK and Japan continue to slip in and out of recession. And a slowdown in China is a distinct possibility. The question front and centre for investors is whether India can manage to grow in the current decade similar to what China managed in the previous decade.
To attempt a macroeconomic forecast, as we're about to do, is every analyst's minefield – fraught with risks and variables that lie in wait just below the surface. For starters, the global macroeconomic factors have been anything but stable over the last few years and volatility is expected to intensify. Perhaps more important are the changes in domestic economic policies – either in the direction of free markets (leading to prosperity) or in the direction of welfare and greater regulations (resulting in lower growth rates).
Against that backdrop, let's look at the assumptions that the forecasts are based on:
Assumptions on the external variables for the current decade
Higher energy prices: Energy prices, especially that of crude oil and coal, can easily double (in 2011 dollars) from their current levels.
Higher food prices: Similar to energy prices, we see the prices of agricultural commodities doubling or even tripling this decade.
Stagflation in developed economies: The US economy is likely to enter an inflationary depression in the years ahead. The other developed economies mentioned above are also likely to have an extended period of high inflation and low growth.
Bursting of the bond bubble and the decline of the US dollar Index: Despite the unprecedented US fiscal deficits and the monetisation by the US Fed, interest rates in the US have remained low and the Dollar Index relatively stable, ranging between 70 and 80. However, this is an unsustainable scenario, abetted largely by the central banks. Over the course of this decade we can easily foresee double-digit interest rates (especially at the long end) in the US and the Dollar index touching 40.
Assumptions on the Indian Economic Policies for the current decade
Continuing fiscal deficits: Despite having a roadmap to contain fiscal deficits at 3 percent of GDP (the earlier target of achieving this by 2006 has now been indefinitely postponed), the likely increase in the subsidy bills of food and energy are going to ensure that the combined deficits of the state and central governments will average 10 percent plus for the current decade. Besides, Indian policy makers have responded to the global turmoil since 2008 with one stimulus scheme after another (which is, incidentally, the exactly wrong thing to do). Considering we are still in the early stages of what is going to be an eventful decade, it is safe to assume that we haven’t seen the end of the stimulus era.
Higher interest rates: The high and chronic levels of fiscal deficit are going to send consumer prices as well as interest rates higher. Today's roughly 8 percent yield on 10-year government bonds is likely to shoot up by 3-5 percent over the next few years.
Policy of incremental reforms: The range of debate in policy-making circles on economic reforms has been between “very high government involvement” and “high government involvement.” For example, the big question regarding the food security bill, where the plan is for the government to deliver foodgrains to households at ultra-subsidised prices, is whether 64 percent or 80 percent of the population should be covered. There is no single voice espousing the merits of capitalism either within the government or amongst the industry chieftains. Hence, any positive change, if it happens, will be from "terrible" to "less terrible" policies. We don't expect "reforms" like this to have a major impact on the country's structural fiscal predicaments.
India’s GDP has three major components – services (56 percent), manufacturing (26 percent) and agriculture (18 percent) – and the CAGR for each over the last decade was 11 percent, 7 percent, and 3.5 percent, respectively.
Services have been the engine driving much of India's high growth over the last decade. It grew from about 43 percent of GDP in 1990 to 51 percent in 2000, and today captures about 56 percent. The trend of services gaining GDP share started as early as 1950, but really began to accelerate with the onset of liberalisation during the 1990’s. One factor that is likely to have a negative impact on this sector is a Greece-style downturn in the US economy (and it’s a question of “when” and not “if”). Such a slowdown would affect the information technology and IT-enabled services (IT/ITES) industry; harden the interest rate environment and impinge on the financial services sector; and, higher energy prices would lead to a downturn in tourism, transportation and related industries. Given these threats, services can be expected to grow about 6 percent to 6.5 percent in the current decade.
The manufacturing sector, expectedly, is highly sensitive to interest rates and energy prices. After recording a CAGR of nearly 10 percent in the first half of last decade, the subsequent economic volatility has taken its toll on Indian manufacturing. With rising energy costs (and lower availability, eg, mandatory power holidays for industries in many states) and higher commodity prices and interest rates, manufacturing has pretty much come to a standstill over the last few quarters. The only segment within manufacturing with any tailwind – like mining and oil exploration – has been slapped with higher “windfall” taxes, and costly and crippling environmental and other regulations over the last few years.
With the tailwind expected to shift to a headwind in the years ahead, we can expect manufacturing to achieve no more than 3 percent to 4 percent growth during the current decade.
The potential for achieving high growth rates in agriculture is embarrassingly obvious. Obvious to those outside the government, that is. Starting from abysmal productivity levels - ranging between 5 percent to 30 percent of global averages, depending on the crop – enabling private investments in the sector would easily lock in much higher growth rates. But the increasingly huge public investments, like the 20 percent boost planned for 2012, invariably ensures that the limited factors of production (land and machinery) end up in the wrong hands. And the continued absurdity of massive regulations (the sugar sector, import/export licences under the guise of inflation control, policy flip-flops that translate to uncertainty) guarantee that the historical 3 percent will continue to be the limits to growth.
Net-Net, India should be lucky to average more than a 5 percent CAGR for the current decade. For readers who think that the assumptions are too pessimistic, I would counter that if anything, they might err on the side of optimism. The assumed crude oil average price of $200 a barrel is more likely to average $300 rather than $100, and the dollar index going to 20 is more likely than a final destination of 60. In episodes of acute stress, there tends to be overshoot in the trend.
So is a return to the “Hindu growth rates” cast in stone? Pretty much. For India to achieve nirvana-like higher growth rates, the economic team has to put its faith in capitalism (free markets, limited government and deregulation) rather than the interventionist/government-knows-best approach they have adopted.
It’s actually a sad commentary on the understanding of economics (in India as well as most world governments) that I have to use the phrase “faith in capitalism.” After all, capitalism (Austrian economics) is the only economic school of thought that is not based on faith (defined as belief in something for which there is no evidence) and has stood up to intellectual and empirical scrutiny. In the 1990’s, when India was faced with a severe balance of payments crisis, we took the first baby steps in the direction of free markets, deregulation and private property.
Do we necessarily need another crisis before we can abandon the much improved, albeit far from ideal, economic system we have created today? It increasingly appears to be the case.
Shanmuganathan “Shan” Nagasundaram is founding director of Benchmark Advisory Services – an economic consulting firm. He is also the India Economist for the recently launched World Money Analyst, a monthly publication of International Man. He can be contacted at shanmuganathan.sundaram@gmail.
This article has been reprinted from World Money Analyst, an investment letter that lets readers profit from a team of successful investors and analysts as they uncover the best opportunities around the globe (www.worldmoneyanalyst.com)