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The Giant Awakens

This is indeed India!

The land of dreams and romance, of fabulous wealth and fabulous poverty, of splendour and rags, of palaces and hovels, of famine and pestilence, of genii and giants and Aladdin lamps, of tigers and elephants, the cobra and the jungle, the country of a hundred nations and a hundred tongues, of a thousand religions and two million gods, cradle of the human race, birthplace of human speech, mother of history, grandmother of legend, great-grandmother of tradition, whose yesterdays bear date with the mouldering antiquities of the rest of the nations – the one sole country under the sun that is endowed with an imperishable interest for alien persons, for lettered and ignorant, wise and fool, rich and poor, bond and free, the one land that all men desire to see, and having seen once, by even a glimpse, would not give that glimpse for all the shows of all the rest of the globe combined. Even now, after a lapse of a year, the delirium of those days in Bombay has not left me and I hope it never will.

Mark Twain, American author, 1897

For a literary giant so expert at distilling complex ideas into words, it’s revealing how awestruck Twain felt when he visited India. The colour and contrast of his language tell you all you need to know about this most mystical and beguiling of countries.

From Goa to the Ganges and from Kashmir to Kerala, the vivid intensity of India’s colours, smells, tastes and sounds all conspire to create a sensory overload. The rich choreography of Indian life makes you feel like you’ve lived your entire life in black and white, to be suddenly dazzled with Technicolor.

One in every six people on Earth is Indian.

With a long and rich history, India’s roots stretch out through the ages. Pre-Hindu Vedic scriptures, among the oldest religious texts still in use, date back to the 12th century BC and four of the world’s 12 classical major religions – Hinduism, Buddhism, Sikhism and Jainism – all originated in India. What’s more, the Indus Valley was one of humanity’s first urban civilisations – arising 3,000 years before Christ.

Given India’s sheer vastness it has often been likened to a continent, and it’s easy to see why. Home to 29 states and seven union territories covering 3.3 million km2, it is 13 times the size of the UK.


VIDEO   1:17

India: The time is now

One in every six people on Earth is Indian. And with over 1.3 billion people, its population will soon overtake China. Once a hindrance to growth, India’s mass of people will be its greatest asset in the future.

The reason lies in demographics. Indians are young with over 65% of the population under 35. The majority are highly educated and fluent in English. India’s workforce will be the world’s largest within the next 15 years. Over 70% of the population live in rural areas with massive potential for urbanisation. Indians are diligent savers and generally eschew debt. The potential demand for a variety of goods and services from a large and expanding middle class is huge.

India’s massive pool of human capital bodes well for future growth. The US government forecasts that India will be the third largest economy by 2030, behind the US and China but ahead of Japan.

However, as high-speed India powers ahead, there is a danger that some passengers are left behind. Unresolved issues may come back to bite a future, prosperous India. Growth without redistribution will leave millions in poverty and only widen income inequality. Greater employment opportunities without enlightened attitudes to gender equality will curtail female advancement where it is most needed. Economic advancement without equality of opportunity will only aggravate contemptuous attitudes to the lower castes and raise the fundamental question of what defines ‘development’.

As India marches forward, it needs to heed the lessons of the past and make growth inclusive for all.

Chapter 1

Full circle –
a history lesson

Many of the advances in the sciences that we consider today to have been made in Europe were in fact made in India centuries ago.

James Grant Duff, British Historian, 1826

India’s rise may seem unprecedented but it’s actually reclaiming a position it held for centuries. Throughout much of the last 2,000 years, India has been either the largest, or the second largest economy in the world.

Coming back to the fore

*India’s lowest share of global GDP in the last 2,000 years
**Figures based on purchasing power parity (PPP) (USD billion)

Source: Maddison, 2010 and International Monetary Fund World Economic Outlook, 2015

The Mughal period (1526-1858 AD), in particular, was one of great prosperity for India. An estimate of the annual revenue of Emperor Akbar's treasury in 1600 is £17.5 million. This exceeds Great Britain’s treasury two hundred years later in 1800, which totalled £16 million. From 1500 to 1700, India’s share of global gross domestic product (GDP) remained relatively constant at slightly under a quarter. Under British colonial rule, India’s prominence declined with its share of world income falling continuously until the late 1970s.

Shortly after independence in 1947, the government adopted a series of Soviet-style five-year plans to modernise its largely agrarian economy into an industrial one. Among the developments was the formation of the Planning Commission – a key agency for economic planning for successive governments through until 2014.

But in the following decades, India’s economy expanded at glacial pace, what was disparagingly termed the “Hindu rate of growth”. By the 1980s, investment in infrastructure, industry and scientific and technological research had started to manifest itself in improved growth. But this was not enough for India to avert a series of severe balance of payments crises, which culminated in near-default. The socialist and protectionist model of development had failed.

India’s inflection point came in 1991 when the government embraced widescale economic liberalisation, beginning the transformation of the economy into a market-oriented system. Embodied in this was a conscious shift away from the Licence Raj – the post-war era of corporate bureaucratisation and red tape that had stifled entrepreneurship and growth for decades.

The Indian government deregulated its financial sector, encouraged private and foreign investment and devalued the rupee to boost exports.

Economic liberalisation has been widely credited as the driver behind India’s rapid progress ever since. And rightly so. The economy grew seven-fold in the twenty years following 1992, and current far-from-Hindu annual growth rates of 6-8% speak volumes of the success of reforms. Today, India has a strong, diversified economy and is a world leader in various industries, notably information technology.

Yet, many obstacles remain, as those familiar with the ramshackle nature of the country’s infrastructure will be aware. In the past, the political establishment overlooked, consciously sidestepped or, due to the fragmented nature of Indian politics, were simply unable to address such complex and thorny issues.

Now India's bold and ambitious leader, Narendra Modi has torn up the rulebook and started afresh.

Chapter 2

Modi's moment

Earlier, it was believed that force indicates power. Now, power must come through the strength of ideas and effective dialogue.

PM Narendra Modi, 2015

Swept in by an overwhelming majority, Narendra Modi was elected as India’s 15th Prime Minister in May 2014. Much like Barack Obama in the US in 2008, expectations were sky-high that Modi could set his country on the path to economic success and improve its global standing. Shortly after his election, Modi announced a raft of reforms, from ‘Make in India’ to improving sanitation services to much fanfare and celebration.

VIDEO   3:02

Modi’s moment: Reform is happening

Satisfying or even exceeding the hopes and expectations of well over a billion people was always going to be an uphill battle. But Modi has done admirably well thus far.

A common perception in India is that the reform process is stalling and Modi’s popularity is under pressure. This is frequently aired in the general media but it mischaracterises the reality.

Our trip to India reinforced our view that the seeds of significant structural changes have been sown.

While considerable challenges remain, policy makers remain committed to addressing them. Importantly, where the government cannot find a way through a problem, it is seeking to find ways around it instead.

So what are we to make of the man bearing such high hopes and expectations?

Central to Modi’s success will be his continued focus on competitive federalism

Modi began his political career as a student activist campaigning against the ruling Congress party, before joining the opposition Bharatiya Janata Party (BJP) in 1985. He swiftly moved up the ranks, his strategy being credited as instrumental to the BJP’s success at the 1998 national elections. As chief minister of Gujarat, he led a reinvention of his native state as an attractive corruption-free investment destination. He was rewarded with four re-elections as Governor before his spectacular victory in the national elections.

Modi’s anti-establishment background and maverick persona is central to his popularity. He is perceived as an outsider, providing a welcome departure from the stale Congress party politics of the Nehru-Gandhi dynasty that ruled India after independence.

On a personal level, he is regarded as empathetic and in tune with the needs of the nation. He is recognised as a doer who has already formulated and implemented a range of new reforms. This is no mean feat in such a massive and diverse country with numerous vested interests.

India’s Parliament consists of the Lower House (House of the People) and the Upper House (Council of States). Modi’s BJP controls the Lower House but lacks a majority in the Upper House, which has veto powers.

To stand a chance at gaining control of the Upper House, the BJP must do well at the key state elections through to 2018. This has proved difficult – the party was hit for six when it lost consecutive elections in Delhi and Bihar last year as voters started to question Modi’s grand vision. Strong results in the forthcoming state elections will boost the BJP’s clout in the Upper House allowing it to push through nationwide reforms with less challenge.

Central to Modi’s success will be his continued focus on competitive federalism – the principle that Indians are best served by allowing state governments to compete with each other. He has wisely adopted a pragmatic approach and encouraged states to be reform-minded, rather than fixated on political persuasion. As Arun Jaitley, Finance Minister has said, “A ‘one size fits all’ approach to economic planning is obsolete. It cannot make India competitive in today’s global economy.”

Indicative of his unconventional approach, Modi disbanded the old top-down Planning Commission and replaced it with NITI Aayog – a government think-tank focussed on bottom-up economic policymaking at the state level. In the 2015 budget, Modi oversaw the largest ever devolution of central resources to the states, increasing their share of central tax revenue from 32% to 42%.

He has navigated a way around the impasse on land acquisition reform by encouraging legislation to be passed at the state level – something that is happening at pace.

Several factors illustrate Modi’s positive influence on the economy. India has now experienced two back-to-back deficient monsoons (defined as less than 90% of long-term average rainfall) for the first time since the mid-1980s and only the fourth time in over a century. Despite this, food inflation has remained relatively stable. In part, this has been helped by government measures to deter hoarding, ensure timely distribution of rice and wheat, moderate minimum support price increases and deter exports (or encourage imports) of key food products like onions.

Government efficiency is improving considerably and the number of stalled projects is declining.

Environmental clearances for projects have also been fast-tracked.

The low oil price has undoubtedly aided Modi in his reform agenda. As a major net oil importer, cheaper oil has improved India’s terms of trade with the current account deficit falling to 1.3% of GDP from 4.8% two years ago. It has also boosted corporate and consumer confidence and demand at an important time as India embarks on a series of game-changing reforms.

Modi’s popularity remains high. Research by the PEW Centre supports this, based on a survey of almost 2,500 people in 15 out of the 17 most populous states over April and May 2015. A massive 87% of Indians have a favourable opinion of Modi, up from 78% in 2013 prior to the election. Even among rival Congress party supporters, 74% hold a favourable opinion.

Chapter 3

Make in India

I will make such a wonderful India that all Americans will stand in line to get a visa for India.

PM Narendra Modi, 2015

We recently visited both Mumbai and Delhi. Arriving at the airports in these cities is now a very civilised affair. The new airport buildings are immaculate, tastefully designed and air-conditioned – a pleasant surprise for those accustomed to arriving in the India of old. The impact of investment is clear to see – both airports were developed under transformational public private partnership (PPP) models.

The $90 billion Delhi-Mumbai Industrial Corridor – one of the world’s largest infrastructure projects – will connect eight Smart Cities in a high-tech industrial zone spanning 1,500 km.

A short drive out of Mumbai airport and we were met by the noise, unusual smells and brutal traffic that all give the city its unique character. We frequently came across slum areas. The government has struggled to relocate slum dwellers, a reminder that India is a democracy where everyone has civil rights. That said, the government’s aim of achieving a ‘Slum-free Maharashtra by 2022’ will be a formidable challenge.

Even more difficult to get accustomed to, particularly as a father, is the sight of young children roaming the streets, knocking on car windows for a few rupees. The contrast between the haves and have-nots is made starker by the numerous impressive buildings popping up around the city, including Trump Tower near to some of the slums.

Adding to the frenetic atmosphere, our journey finished with our driver taking a so-called ‘shortcut’ down a road with fast oncoming traffic.

The whole experience highlighted that while some investment has taken place and more is to come, infrastructure is still poor. It’s therefore no surprise that Prime Minister Modi has announced the ‘Make in India’ campaign, which aims to boost India’s historically low infrastructure and manufacturing base, and create jobs and boost skills across 25 sectors of the economy.

One of the key proposals is 'Smart Cities' – a flagship program that aims to create 100 world-class cities over the next five years. The programme has backing from various governments, including the UK, China and Israel. The $90 billion 'Delhi-Mumbai Industrial Corridor' – one of the world’s largest infrastructure projects – will connect eight 'Smart Cities' in a high-tech industrial zone spanning 1,500 km.

Roads, power and transportation are all key target areas of ‘Make in India’. Between July 2014 and June 2015 over 1,400 new investment projects were proposed, with a total value of around 7.8 trillion Indian rupees (INR), or $120 billion.

The creation of brand new roads connecting India and the emergence of a burgeoning middle class will incentivise Indians to buy cars. There is incredible opportunity for growth – India has around 18 cars per 1,000 people, compared to China’s 130 and Brazil’s 250.

Cars per 1,000 people

Source: International Road Federation, 2015

In the railway sector, deals that were stalled for 10 years are being fast tracked. General Electric (GE) and Alstom are leading bids for setting up railway manufacturing units in Bihar. GE will be focussing on a diesel locomotive manufacturing plant while Alstom will build a manufacturing plant for electric locomotives. These are the first projects that include large foreign companies undertaking foreign direct investment (FDI) in the railway sector. The bidding process has been seen as clean and transparent.

"Tell him to get on a plane and go see the world’s best logistics park and then come back and build them in India"

In defence, Samsung-Techwin was selected to provide 100 howitzers in an order worth $800 million, with half of the parts due to be built in India. India spends about $15-18 billion on defence each year and an increasing amount is being spent domestically.

Foxconn, the Taiwanese electronics firm plans to spend $5 billion building 10-12 facilities in Maharashtra, potentially employing up to 50,000 people.

One of the main opportunities will be in the logistics sector, particularly warehousing, which will benefit greatly from eventual implementation of the uniform goods and services tax, growth of e-commerce and manufacturing through the ‘Digital India’ and ‘Make in India’ initiatives.

On our visit to Container Corporation of India, a logistics solutions company, we were told that Modi had personally taken a keen interest in the logistics sector. Modi had passed on a message to the chairman: “Tell him to get on a plane and go see the world’s best logistics parks and then come back and build them in India”.

Among the key drivers of the transformations taking place has been an opening up of the Indian economy to greater FDI. Notably, the Modi government has raised the limit on FDI in the defence sector from 26% to 49% and allowed over 50% FDI in the nation’s railway sector for the first time. The construction, agriculture and banking sectors are also set to benefit from greater FDI flows.

The policies thus far are achieving their aims. In the first half of 2015, India attracted more FDI into new projects than both the US and China

In aggregate, FDI flows have rose by around 24% year-on-year to $42.2 billion in 2015, and by 50% compared to 2013. This now more than covers the current account deficit, which was $15 billion over the first three quarters of 2015, and we expect to be approximately $19 billion, or about 1% of GDP for the full year. This is coming at a time when global FDI flows have been under pressure and is significant for India given it will provide a buffer in the event of portfolio capital outflows.

Given government policies to open up key sectors like insurance and defence, there is scope for a sustained improvement in FDI flows.

Chapter 4

‘Working’ the land

Every great and deep difficulty bears in itself its own solution. It forces us to change our thinking in order to find it.

Niels Bohr, Danish physicist and Nobel Prize Winner, 1944

The true success of ‘Make in India’ may depend on a related reform – the Land Acquisition Bill. This aims to streamline the complex process of acquiring land from rural farmers and tribes for building much-needed infrastructure.

Progress can now be made on a state-by-state basis without the need to wait for central government to pass legislation

Modi’s government was looking to refurbish the old bill to do away with a mandatory social impact assessment and consent clause from landholders, thus making it easier to utilise the land for infrastructure development.

The bill was always going to be a struggle to be passed at the centre given the BJP’s lack of control of the Upper House. Amid opposition from Congress in the Upper House, the government has been forced to water down the bill.

Now that the government has wisely passed the issue to the states, progress can be made on a state-by-state basis without the need to wait for central government to pass legislation – a prime example of Modi’s competitive federalism in action.

As the map below shows, although no state has reached the government’s desired score of 75%, many are making good reform progress. The hope is that states collaborate and learn from each other as they develop.

Reform progress across states

Source: World Bank & Indian Department of Industrial Policy and Promotion, 2015.

Evidence suggests there is sufficient land available in land banks (government-owned serviced land that is available to investors).

To cite examples, land banks in Andhra Pradesh grew by about three times in the last year to 764,000 acres. Punjab has created banks of valuable pre-cleared land complete with power supply to encourage development. The Chief Minister of West Bengal has assuaged concerns that her government would forcibly acquire land for industry, confirming there was enough land in land banks and industrial parks in the state for setting up industries.

While many states have already established land banks, there is a need to make information on this publicly available via an online portal, detailing what is available in each state and what the land can be used for.

Further work is also needed with respect to development of land banks. This is detailed in the 'Assessment of State Implementation of Business Reforms' (Ease of Doing Business) report, prepared by the World Bank and Indian Department of Industrial Policy and Promotion (DIPP).

Modi’s approach is likely to further foster competitive federalism. A healthy level of competition between states for land, funds, talent and other resources is good for the country.

Those states that are more proactive will likely see greater investment, foreign and domestic, faster growth and therefore wealth creation. It is therefore in each state’s incentive to reform, rather than waiting for a push from central government.

Chapter 5

The IT crowd

The transformation to a digital economy… has given the average Indian stature, ownership and identity. It has transformed the marketplace.

Ratan Tata, Chairman of Tata Sons, 2016

Perhaps the most radical of Modi’s reforms is ‘Digital India’, the government’s aim to transform the country into a digitally empowered knowledge economy and to boost standards of governance of citizens through better engagement with the government.

The programme seeks to bring India into the 21st century with IT at the heart of many industries including education, finance and health. It will also potentially create hundreds of thousands of jobs in IT, electronics and associated industries.

VIDEO   2:04

The IT generation: Digital India

One of the aims of the initiative is to allow citizens to access government services electronically and to receive information online, thus eliminating the use of paper documents and allowing sharing of documents across government departments.

Citizens will benefit from fast and efficient access to online government services and important documents like passports and degree certificates. And governments will be able to monitor projects more easily and identify problematic areas that require further attention.

Other key aspects involve broadening access to the internet. The infrastructure required is vast – numerous broadband networks will be required to fulfil the government’s promise of broadband in 250,000 villages and public Wi-Fi hotspots for citizens by 2019. Universal phone connectivity is also promised.

Indeed, states are increasingly using the internet to communicate with the public, central government and each other. Some states, for example, are starting to put information on land banks online.

Internet connectivity and e-commerce retail sales have grown rapidly in recent years, and the trend is set to continue, as the infographics below show.

No. internet users (millions)

Source: Statista, 2015

Retail e-commerce sales (USD billions)

Source: Statista, 2015

‘Digital India’, like ‘Make in India’, has been successful in attracting significant FDI flows. One of the analysts we met estimated that about 30% of FDI flows are tied to the rapidly expanding e-commerce sector.

Goldman Sachs has noted that the largest employers in India’s premium college campuses are now start-ups, many of them technology-focussed. Among the larger deals is Chinese e-commerce company, Alibaba Group’s investment of $680m in Paytm, an Indian payments start-up.

‘Digital India’ is one of many reforms that is helping make doing business easier in India.

Companies like JustDial, a search services company, and Flipkart, an Indian ‘Amazon’, have grown rapidly thanks to FDI and have strong revenue flows. JustDial links vendors to customers, providing a variety of goods and services via an app or web portal. The website shows consumers the cheapest place to buy a variety of products and they can be delivered within hours – a standard of service you wouldn’t expect in most developed countries.

For JustDial to operate requires thousands of people providing delivery services so it has created many related jobs. Technology is thus not just providing new business and employment opportunities but improving productivity and government services. Along with social media, this is aiding transparency and accountability.

‘Digital India’ is one of many reforms that is helping make doing business easier in India. It is long overdue – conducting transactions in India is painfully slow and bureaucratic. Widescale government and corporate corruption has been for too long a blight on the efficient and equitable use of funds.

Modi is tackling these problems head on.

Chapter 6

Simplifying tax:
it’s complicated

Great works are performed not by strength but by perseverance.

Samuel Johnson, English writer, 1759

Among Modi’s more contentious reforms is an overhaul of India’s tax system. In the words of Finance Minister, Arun Jaitley, implementation of tax reforms will “… put to rest various disputes and issues and make sure that the scope of discretions is eliminated and there is a greater degree of stability and predictability…”

GST will provide a boost to growth but the extent of that depends on the quality of bill passed.

A key element of the reforms is the replacement of numerous complicated inter-state taxes with a single uniform goods and sales tax (GST). A simplified tax regime is expected to improve compliance and revenue collections, as well as allowing the free flow of goods and services between states.

The GST bill needs a two-thirds majority of both Houses of Parliament and consensus and ratification by more than half of the states. Almost every economist and political analyst we’ve spoken to expect the GST bill to be passed by late 2016 at the earliest, with ratification by the states and subsequent enactment by the central government to follow.

GST will provide a boost to growth but the extent of that depends on the quality of bill passed. A poor quality bill with many exemptions could result in only a minor boost to GDP of 0.5% or less (alcohol is currently exempted). A good quality bill, however, could boost growth by more than 1.5%.

The rate has not been finalised yet but here again there is disagreement between the government, opposition parties and some states regarding what rate GST should be fixed at and whether net producing states should receive an additional levy or not. Clearly, further work needs to be done.

However, it is important to remember that the GST debate is not just a Congress/BJP issue. States that stand to lose have been among the fiercest opponents, including the PM’s home state of Gujarat. The objections of Gujarat and other net producing states are that under a destination-based consumption tax model, they will suffer loss of revenue. The government argues that such states will benefit from additional service taxes but a lack of clarity on the figures is providing some uncertainty.

The pertinent question is whether it is better to be patient and negotiate a high-quality bill, or to try to fast track a watered-down bill

If the government succeeds in strengthening its position in the Upper House, negotiating difficult reform measures like GST will be easier.

Chapter 7

Fixing corporate India

It is difficult, but not impossible, to conduct strictly honest business.

Mahatma Gandhi

Doing business in India is harder than it should be. According to the World Bank, it takes 28 days to start a business in India. This compares with 19 days in Pakistan, 11 in Japan, four in Korea and just three in Australia.

The government has reacted by waging war on red tape. It has introduced a new company registration form, effective since May 2015 and available online, that combines seven separate forms into one. In theory, this should bring the time needed to register a company down to just 48 hours in 70% of instances.

One scheme in Delhi, soon to be adopted in other parts of the country, has cut the time required to incorporate a company to just one day – something that is unheard of in the emerging markets.

"We’re in it for the long run. We’re playing a test match, not Twenty20"

The government’s ‘Start-Up India, Stand-Up India’ campaign is the first of its kind, bridging the gap between new start-ups and venture capital and angel investors. It promises to mobilise India’s talented youth to set up new and innovative businesses.

The plan offers tax exemptions to start-ups for three years and tax exemptions for investors on capital gains. Start-ups will also be able to be wound up more easily in case of bankruptcy. The initiative bodes well for the next generation of Indian companies. Alluding to Indians’ passion for cricket, one executive told us: “We’re in it for the long run. We’re playing a test match, not Twenty20”.

Between measures such as these, the government has already passed 50 or so other bills. Several of the reforms are being undertaken by the states and momentum remains strong.

Companies are starting to report that high-level corruption has virtually disappeared – a huge development

Multinational companies, in particular, see this as a massive game changer. Who you know in Delhi is becoming irrelevant; everyone competes on equal terms, putting them on a level playing field with domestic companies. If corruption at more local levels were drastically reduced – a key focus of Modi’s government – productivity and foreign investor demand could be boosted further.

A notable achievement that Modi has fulfilled his promise on is bankruptcy law. This can rarely be considered exciting but the Insolvency and Bankruptcy Code 2016 represents a watershed moment. The new code promises to streamline and accelerate the process through which creditors can recover their money when a company goes out of business.

The new code will help clear up bank balance sheets to allow lending for more productive purposes. This will, in turn, help support economic growth within a more stable financial system.

Yet the significance may run deeper. This legislation was approved by the upper house of parliament, a body packed with Modi’s political opponents, which has routinely blocked other reform efforts to undermine the government.

It was a refreshing change to see opposition politicians set aside party politics to work with the ruling Bharatiya Janata Party (BJP). This period of cooperation may not last, but it will serve as a powerful example of what can be achieved when other items on the reform agenda are revisited later.

Chapter 8

Broke banks

Banks are there to support businesses that have justifiable needs.

Vijay Mallya, Indian businessman and politician, 2015

If corporate India is to thrive, it needs a healthy, functioning banking system. Socially useful projects and initiatives require capital and banks should be able to allocate this capital efficiently. While progress is being made, India’s banks still remain a weak point in the system.

The divergent fortunes of India’s banks became clear to us on our latest visit

The origins of India’s current banking problems lie in the corporate investment binge of 2003-2008, which resulted in overcapacity and overextended balance sheets. State banks, in particular, were instrumental, lending excessively to infrastructure and steel companies for unprofitable road projects, power stations and factories.

These companies have now been left with high levels of bad and doubtful loans. Across the board, private investment is weak and companies are reluctant to spend, in some cases due to high levels of leverage.

Banks, in turn, have been left with a high proportion of non-performing loans (NPLs) – those on which the borrower is not making interest payments or repaying any principal. They are not lending enough as a result.

Appreciating the negative impact this could have on investment and future growth, the Reserve Bank of India (RBI) – India’s central bank – has now urged lenders to clean up all bad loans by March 2017

However, there is significant differentiation across the banks, with state-owned banks suffering from NPLs of 10% or more, while private banks and finance companies like HDFC (Housing Development Finance Corporation) have fared better with NPLs of only 1%.

The divergent fortunes of India’s banks became clear to us on our latest visit. On entering one public bank building, we waited in a sweltering, dilapidated room before meeting executives who, unlike the room, were quite cold. At HDFC on the other hand, we were guided promptly to a pleasant, air-conditioned room, complete with tasty refreshments and introduced to friendly staff who were excited to tell us about their business.

Encouragingly, things have improved somewhat in recent months. A collapse in input prices with minor changes in output prices has resulted in improved margins. There are initial signs that capital investment is starting to pick up, notably capital goods production and commercial vehicles sales. Nevertheless, in aggregate the sector remains subdued.

State Bank of India (SBI), India’s largest lender by assets, indicated to us that its lending rates had fallen prior to the end of September 2015. It is also seeing a rise in soft corporate and small and medium enterprise (SME) lending of around 10% with expectations that this could rise to around 12%. This is an improvement from the 6.6% pace seen last year, but still off its 15% target.

Retail lending has also been more resilient and could hit the 18% target for the year. SBI noted that it has the capacity to lend, with its statutory liquidity reserve (SLR) – the amount banks are required to hold in gold and government securities – at 27.5% versus the 21.5% required, indicating weak or unattractive lending demand.

Rather than focusing on generating new business, SBI is trying to improve its existing business and turn around underperforming accounts. In the mid-corporate sector, excess capacity in industries such as cement and steel has been – and still is – a problem.

Nevertheless, SBI believes that growth momentum is improving and characterise it by saying that under the old GDP growth series, GDP growth has likely gone from 5.5% to 6%. It also noted that administrative changes are starting to be felt, with the quality of personnel expected to improve and the government delegating more authority to senior management.

With the private sector unwilling or unable to participate in the current round of investment, pressure is on the government to bear the burden. All this is happening, with planned government expenditure having risen significantly this fiscal year.

This will in part be helped by lower government spending on oil subsidies, which fell by 63% over the same period year-on-year. There is also scope for savings of around INR150 billion from the INR300 billion the government budgeted for oil subsidies if oil prices stay relatively stable.

HDFC noted that the problem with a lot of lending is that the projects they are tied to have simply become unviable. In its opinion, while recapitalisation of the banks is needed, the state-owned enterprise (SOEs) could do a lot of it themselves by, among other things, selling off some of the huge amounts of real estate that they own.

The recent passing of the Insolvency and Bankruptcy Code will be critical to revitalising the banks. The new Bankruptcy Law will provide lenders with even greater security and speed up the process for dealing with bad debt. If these loans were addressed, the banks would be able to provide stronger support to the economy.

That said we won’t be seeing the impact from the Insolvency and Bankruptcy Code anytime soon. There are some 70,000 bankruptcy cases that will take years to clear and new institutions need to be set up, while a new class of insolvency professional will need to manage the resolution process and debtors’ assets.

Chapter 9

Rajan to the rescue

My name is Raghuram Rajan and I do what I do.

Raghuram Rajan, Reserve Bank of India Governor, 2015

A pro-growth environment, stable inflation and affordable credit are all crucial for Modi’s policies to succeed. This is where Raghuram Rajan and the RBI come in.

We had the pleasure of meeting Rajan on our latest trip. As we expected, Rajan spoke eloquently on a wide range of economic issues. But we were surprised to learn that he had a crucial Central Bank meeting following our meeting. The fact he had taken time out to meet us spoke volumes about his character.

Modi, who is apparently not taken to praising people, has publicly referred to Rajan as his guru. Modi certainly has much to thank him for.

The former International Monetary Fund (IMF) Chief Economist, turned economics professor, turned central banker has been instrumental in creating the economic conditions for ‘Modenomics’ to be realised.

One way to think about India today is to compare the country with the US in 1980. The similarities are uncanny. In 1979, Jimmy Carter appointed Paul Volcker to run the Federal Reserve and to fight inflation. The following year, Carter lost the election to Ronald Reagan, who led a series of sweeping reforms. Volcker and Reagan set the stage for a blossoming of America.

The Rajan/Modi double act will do for India what Volcker/Reagan did for the US in the 1980s.

In 2013, Manmohan Singh, India's then PM, appointed Rajan to run the RBI and fight inflation. The following year, Singh lost the election to Modi, who is pursuing India's most aggressive reform agenda in decades. The Rajan/Modi double act will do for India what Volcker/Reagan did for the US in the 1980s.

Historically, the RBI has been perceived as a "pro-growth" central bank, but under Rajan it has become an "inflation-fighting" one. Rajan is the first Governor of the RBI to introduce an explicit inflation target. Furthermore, he has switched focus from targeting wholesale prices to consumer prices (CPI), the latter being the most hawkish possible measure of inflation. This target aligns perfectly with Modi's desire to help raise the real incomes of poor people.

Typically, inflation in India has been in the high single digits when times are good, jumping to the teens whenever the monsoon rains fail and food prices go up. In a country where 99% of the population are desperately poor and pay no income tax, this matters because inflation is a pernicious tax – it hits poor people hardest.

Rajan successfully curbed inflation from 9.8% in September 2013 to a low of 3.8% in July 2015 based on the CPI measure, according to Trading Economics. The fall in inflation and slowdown in China and other emerging markets gave Rajan freedom to cut base rates by 0.5% in September to boost growth.

India has historically been vulnerable to swings in food prices, a major component of CPI. Despite this, food inflation was kept under control during two consecutive poor monsoons. Modi’s government succeeded in distributing grain supplies to areas in need and managed to deter hoarding.

Since last summer, however, inflation has risen consistently driven by high food price inflation –11.6% in December 2015 alone. This has resulted in a 5.6% year-on-year increase in CPI in December 2015 – near the top end of the RBI’s 4% +/-2% range.

Weather-related droughts have limited food supply and constraints relating to agricultural productivity and food distribution have compounded the problem.

Rajan has since announced that he will step down as RBI Governor in September this year. He has achieved a great deal over the last three years, establishing an inflation-targeting monetary framework and pushing hard for the establishment of a monetary policy committee (MPC), expected to be in place by the third quarter of this year.

The new MPC will be tasked with achieving inflation targets, and be required to explain and take remedial action if targets are not met. This will likely lead to greater transparency around the interest rate setting decision-making process.

Furthermore, Rajan has reinforced the critical need for banking sector reform. As these reforms have been established in law (the RBI Act and Bankruptcy Code) and essentially institutionalised, they can and likely will survive his departure, primarily because Modi more than anyone else understands their importance.

The government must now appoint a successor to Rajan but we see no reason to fear that the RBI cannot remain a credible institution. As Rajan himself recently stated, “…what is important is to not personalise this office. It will survive any Governor; it is bigger than any Governor”.

Whether now or in two years’ time, India ultimately would have had to continue on its reform path without Rajan. It continues to be in a strong position to do that.

Chapter 10

Looking outwards

Globalism began as a vision of a world with free trade, shared prosperity, and open borders. These are good, even noble things to aim for.

Deepak Chopra, Indian American author, 2012

India has generally underachieved in negotiating trade agreements and has shown excessive reluctance to open its economy to global competition. Disagreements with the US were partly to blame for a breakdown in the Doha Development Round. India must make more progress on trade agreements to reap the enormous benefits that international trade can bring.

India must make more progress on trade agreements to reap the enormous benefits that international trade can bring.

India’s engagement with other countries has improved under the new government. This will be important given news on the recent signing of the 'Trans-Pacific Partnership' (TPP) – a trade agreement between 12 Pacific Rim countries, but with the notable exclusion of India and China.

India is not a participant in the TPP and because it is not a member of the 'Asia-Pacific Economic Council' (APEC) it would also not automatically be involved in the potential 'Free Trade Area of the Asia-Pacific' (FTAAP), however some discussions with respect to both agreements are happening on the sidelines. It is questionable whether China would view India as a competitive threat and therefore look to veto any attempt to join APEC.

If India is unable to join the TPP and if the FTAAP is signed – or worse still, China joins the TPP and India doesn’t – it stands to lose out significantly, as other countries benefit from expanded multilateral free trade areas.

Given India’s record in the Doha round, it is questionable whether it would adhere to the more stringent requirements under the TPP. India participates in the 'Regional Comprehensive Economic Partnership' (RCEP), which doesn’t offer the depth of liberalisation of the TPP or, therefore, the same economic benefits. Furthermore, the reduction in tariffs it negotiated with some of its partners was much less than originally planned.

Chapter 11

Goading the elephant

If I were asked under what sky the human mind has most fully developed some of its choicest gifts, has most deeply pondered on the greatest problems of life, and has found solutions, I should point to India.

Max Müller, German scholar, 1883

India may be a land of over 100 problems, but it is also a place for a billion solutions.

Kailash Satyarthi, Indian activist and Nobel peace prizewinner, 2014

India has come a long way in the last 25 years. In 1991, India undertook reforms out of necessity – the country was on the brink of default and international ignominy. This time round, India is in far better shape and reforms have been implemented out of design, rather than need.

In less than two years, Modi’s government has transformed India’s political and economic landscape. Almost every week, we see seemingly intractable problems overcome by ever more innovative solutions. In particular, the shifting of power to the states has proven to be the most politically expedient way to resolve the longstanding issue of land reform.

Through the government’s initiatives, vital infrastructure is being built, business is becoming easier to do and corruption and bureaucracy are in decline. Indian companies will soon be able to access the global market for goods and services. India’s many young entrepreneurs will have the opportunity and incentives to realise their aspirations.

Contrary to some reports, Modi remains popular and reforms have not run out of steam. If one looks closely, changes are taking place everywhere. Indeed, reforms were always intended to be long-term in nature, rather than big bang.

India is a huge country, where traditions and ways of doing things are strongly rooted in the past. Goading a huge elephant in the right direction is hard work and takes time.

Transformations have been taking place amid a marked decline in the oil price. For a large net importer, this has been a boon for the Indian government, although exports to hard hit oil-exporting countries have fallen. The government needs to capitalise on its improved fiscal standing to boost much-needed investment.

Untapped rural regions are where growth will make the most difference. Currently, rural consumption is weak, hit by back-to-back deficient monsoons and with minimum support prices for agricultural commodities having fallen. But in the longer-term, rising incomes and the potential for urbanisation signal massive growth potential. All Indians can expect a brighter future replete with opportunity.

India’s report card is not perfect, however. There is significant room for improvement on efforts to boost international trade. As India grows, it will have to adopt a more outward-looking mindset as trade makes up a larger proportion of its economy. ‘Make in India’ and ‘Digital India’ will only underline the importance of trade to future development.

At a more fundamental level, India needs to do more to help its poor gain adequate access to healthcare and education. Efforts to champion a free and fair society, which does away with the social hierarchies and prejudices of the past, need to maintain momentum. Such outdated modes of thinking are not only cruel but also a barrier to progress. Including this massive pool of talent and labour in the development process will improve overall prosperity immeasurably.

But as we’ve seen so often, India has found solutions to the challenges it has faced and emerged better for it. Indians are, if nothing else, creative and persistent.

These attributes will be needed now more than ever. For a country that was one of the world’s pre-eminent superpowers, the Hindu tradition of viewing history as a series of repeating cycles is rather apt.

All eyes will be on India as the giant awakens.

Risk warning
The value of investments, and the income from them, can go down as well as up and you may get back less the amount invested.

Data sources used
Census of India
Reserve Bank of India
State Bank of India
Housing Development Finance Corporation
International Monetary Fund
World Bank
PEW Centre
Goldman Sachs
International Road Federation
Financial Times
The Times of India
The Economic Times and The Hindu

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