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Economy: Key considerations

Apr 11, 2007

Reforms undertaken since 1991, demographic structure and strong economic growth has helped India register buoyant GDP growth over the last 3 years. However, the concerns of demand running ahead of supply, lack of physical infrastructure and weak government finances have been creating bottlenecks. In this article we look at the positive and the negative factors concerning the Indian economy.

Positive factors:

Demographics: India is and will remain for some time one of the youngest countries in the world. A third of India's population was below 15 years of age in 2000 and close to 20% were young people in the 15 to 24 age group. In 2020, the average Indian will be only 29 years old, compared to 37 in China and the US, 45 in West Europe and 48 in Japan. The population bulge entering the working age groups will result in acceleration in growth leading to a huge window of opportunity.

Rising income: Post liberalisation, the Indian economy has sustained the growth momentum resulting in the rise in income levels and created a large middle-class population base. There has been a healthy growth in the number of households in the middle-income and higher-income categories. The number of households in the lowest income bracket has witnessed a sharp fall - the number is estimated to have fallen by 13.5% between 2001 and 2006. Households with an annual income of over Rs 0.5 m have also almost doubled during the same period.

The expanding wallets of the middle-class households can be partly attributed to the growth of the services sector in the last few years, particularly information technology, IT-enabled services, retailing, insurance, and banking. A large number of young people are being employed by these sectors. We believe that the increase in the spending power of young workers, who have fewer dependents, will sustain the consumption pattern.

Credit growth: Rising income levels have also triggered a leverage-heavy consumption pattern. Borrowing constraints have been reduced with banks and consumer finance companies becoming aggressive lenders. Private sector and foreign banks have also widened their presence to cater to a larger population base. This enabled consumers to increase their current consumption by borrowing against their future income. The credit availability has made it possible to spend a higher percentage of the discretionary income.

Retail lending 2005 2006 % change
Housing loans 134,276 179,116 33.4%
Consumer durables 3,810 4,469 17.3%
Credit card receivables 8,405 12,434 47.9%
Auto loans 35,043 61,369 75.1%
Other personal loans 85,077 118,351 39.1%
Source RBI, CMIE

Negative factors

Inflation: After three years of near double-digit growth, the Indian economy is showing signs of facing an inflationary spiral. Food prices are climbing for just about everything from lentils to onions. Apartment rents and prices are rising steeply, especially in large cities. Annual inflation touched 6.5% for the week wending 10 March 2007, which was way above the upper limit of the inflation tolerance band (5.0% to 5.5%) projected by the Reserve Bank of India (RBI) for FY07. Demand for nearly everything from housing to food is outpacing supply because salaries are rising faster in India than anywhere else in Asia, climbing 13.7% on average over the past year. Though supply is coming up, it is slower than the pace at which demand is growing. RBI has taken stand to reduce inflation by reducing the liquidity in the system. It has raised the CRR and the repo rates. However, with demand still very high the situation is likely to remain sticky.

Infrastructure bottlenecks: Infrastructure is clearly holding back the economy from achieving higher growth. Low spending on infrastructure has been holding back India's average growth with the actual amount spent being miniscule compared to the requirement. The gap is evident in almost all areas of infrastructure, including roads, airports, seaports, railways, electricity and industrial clusters/estates. India needs to chalk out a national plan to increase infrastructure spending gradually to US$ 100 bn per annum, about 8% of GDP by 2010, from an estimated US$ 24 bn in 2004, to push the economy on to a sustained growth path of 8% per annum.

Qualified labour: According to UN estimates, the working-age population (15-64 years of age) in India will touch 762 m in 2010. India is set to be the largest contributor to the additional working-age population globally over the next five years, accounting for 23 % of the worldwide increase, according to UN estimates. Despite India's 1.1bn population, almost every industry is complaining of difficulty in finding qualified staff, higher attrition rates, and sharply rising wage levels. This is not only evident in the labor-intensive business and IT and BPO services sector in India, but is a widespread phenomenon now. With attrition rate of 15% to 20% and wage hikes of 14.5% in 2007 from 2006, will lead to India being less lucrative in terms of labour going forward.

Lack of political consensus: This continues to remain a very crucial factor in terms of economic growth. The ruling party is the deciding factor in terms of implementation of the economic policies. If regulations are made to suit their values and for their personal motives, economic growth will surely get hampered.

To conclude...

While higher inflation and infrastructure bottlenecks have certainly tempered our economic growth estimations for the near term, demographic support, rising income levels and a fairly broad-based demand across sectors continue to offer an upside to our estimations.

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