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Economy: What's driving India?

Nov 28, 2006

India has been on the global radar ever since the much famous BRICS report by Goldman Sachs projected India to be one of the fastest growing economies in the world along with its peers China, Russia and Brazil. The fact that India's GDP has been growing in higher single digits (around 8%) and is expected to sustain the same in the Tenth Five Year Plan (2002-03 to 2006-07), has given the government and investors (both in India and abroad) much to cheer about. Here, let us understand what has been driving the optimism in India's growth story and the challenges going forward.'Feel good' factors...

Strong GDP growth: In FY06, the GDP growth rate stood at 8.1% against 7.5% in the previous year. This was led by strong performances from the manufacturing and services sectors. As per the Economic Survey 2005-06, growth of GDP in excess of 8% has been achieved by the economy in only five years of recorded history and two out of these five are in the last three years. This highlights the underlying strength of the economy in recent times. While there have been hiccups such as erratic rainfall and poor agricultural production, the GDP growth trend nevertheless seems to be on the right track.

'Outsourcing' story gaining momentum: The offshore 'outsourcing' story has been gaining traction and has been led by the software, pharma and the auto ancillary sectors. In the software sector, greater acceptance of the global delivery model, strong client additions and large order wins have led to the increase in business volumes. Similarly in the pharma sector, the ballooning R&D costs of global pharma companies juxtaposed against governments' efforts to reduce healthcare costs, has strengthened the case for outsourcing manufacturing and research activities to low cost destinations such as India. This outsourcing trend is expected to sustain in the coming few years.

'Consumption' effect: Growth in GDP and rise in the disposable income levels has paved the way for the consumption story in the country. Retailing companies are aiming to capitalise on the rising incomes and lifestyle focus of consumers to drive performance, as can be evinced from the mushrooming of malls across the country. Similarly, FMCG companies are aiming to target the rural areas to capture market share, increase penetration and consequently drive demand and growth of their products.

Younger demographic profile: While India is slated to become the largest populous country in the world tipping China, what is important to note is that the population of India will be younger. In India, while 50% of the population is below 25 years, around 65% are below 35 years of age. This implies that in the long-term, a big portion of the population will be within the working-age group, which will contribute to the economic growth and act as a source of the extra needed global workforce. That said, the quality of manpower would be critical in improving productivity, which will result in higher growth.

However, challenges abound...
Infrastructure - A serious bottleneck: Infrastructure continues to remain a spoke in the wheel of India's growth story. These roadblocks in infrastructure are in the form of power shortages, inadequate road, port and airport development. World-class infrastructure is pivotal in achieving sustained growth in any economy. However, due to poor infrastructure, the Indian economy continues to be a laggard when compared to its developing peers. To put things in perspective, in India, the power generated should usually be 1.5 times to GDP growth i.e., to achieve economic growth of 8%, power generation should grow at 12% per annum. However, this not being the case, India has had to succumb to growing energy shortages. Similarly, poor quality of roads not only in the rural areas but also in the more 'affluent' metros, have proven to be major bottlenecks. While the Indian government has laid a stronger emphasis on infrastructure development in the Union Budget 2006-07, execution will be the key going forward.

At the mercy of the 'rain gods': Despite the services and manufacturing sectors growing at healthy rates, India continues to remain a largely agrarian economy, subjecting it to the vagaries of the monsoons. The productivity of the agricultural sector also remains low, which is highlighted by the fact that while it employs around two thirds of the total population, it contributes just a quarter to the total GDP. Thus, the focus has to be on reducing the dependence on monsoons through development of irrigation facilities and better quality farm inputs.

People problem: Availability of quality manpower continues to be a cause of concern for many of the Indian companies and is critical in specialised sectors such as software and pharma (the former being people-intensive and the latter due to the heightened focus on R&D). Higher attrition levels across industries and companies could prove to be a dampener to the growth story going forward.

To conclude...
Strong trends in the economy have led to the upbeat mood of both domestic and foreign investors alike. Besides this, India has made significant strides in integrating with the global economy, which is likely to sustain going forward. Having said that, there are quite a few hurdles that the government needs to acknowledge and overcome if the current strong growth rates need to be maintained in the long-term.

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