The Hindu Business Line : Fuel the `inclusive' model of development

India has transitioned to a 7 per cent-plus growth, and one contributor is the emerging consumerism. But the imperative is an `inclusive' model of development with focus on the poor. The broadening and deepening of consumer support, consequent to inclusive policies, should shift the GDP dynamic and ensure robust growth, says ADITYA PURI.

The Hindu rate of growth has moved up to 7 per cent-plus. More important, the economy, with the internal consumption push, has evolved favourably for sustainable growth.

Private consumption accounts for 64 per cent of India's GDP compared to 42 per cent in China, 55 per cent in Japan, and 58 per cent in Europe.

The `inclusive' model of development is a political, social and economic imperative. The focus of the model is the poor and is, therefore, inherently biased to consumption-led growth.

Corporate India is strategically focussed on market expansion based on geography (rural) and lowering price.

Our problems — infrastructure, saving, FDI and vested politics — have reached the inflection point of crisis-induced decisions.

India has, through a combination of the above, transitioned to a 7 per cent-plus growth as a result of the emerging consumerism of one of the world's youngest populations. The broadening and deepening of consumer support, consequent to inclusive policies, should shift the GDP growth dynamic to the upper side of the 7-9 per cent range.

The increasingly powerful internal consumption dynamic should ensure robust growth. Superimpose the government-induced growth consequent to inclusive economics requiring rural development, job creation, infrastructure spending, coupled with private investment spending, and we have a tremendous `opportunity'.

It is imperative to ensure `objective'-based planning, monitoring and accountability; else we are likely to repeat the last 50 years of grand plans and dismal performances.

It would be worth discussing a few sub-plots of the future.

Funding

Seven-10 per cent growth in GDP would translate (depending on the multiplier used) into credit growth of 25-30 per cent. Funding this growth would require a greater monetisation of the economy. The stock of gold and jewellery in India, approximately $200 billion, is equivalent to half of bank deposits.

Deposits represent 60 per cent of GDP compared with 190 per cent in China and 142 per cent in Japan. Corporate banks make up 1 per cent of India's stock of financial assets compared to 10 per cent in Thailand, 20 per cent in Malaysia, and 30 per cent in South Korea, US and Europe.

We clearly need a vibrant debt market and this will require reform in pension and insurance, to create investors, coupled with the introduction of derivatives, to impart liquidity and price discovery. Credit derivatives disperse the risk of the banking system. Simultaneously, the securitisation market must be activated to allow banks to disperse the risk and create funding.

Spread of banking is a must. This will require active partnerships among banks, cooperative institutions, post-offices, micro-finance organisations, and so on. We also need to create sustainable livelihoods for the farmer to be able to service his loan and cover disaster risk through insurance.

Demographic dividend

We are all today enthused by the demographics of our population which will provide us a competitive advantage in the future. However, we need to understand that to reap this advantage, we must create 12-15 million jobs annually and an appropriate skill-set in the population to do the jobs that are created. Otherwise, this demographic dividend will turn into a nightmare. We need to focus on labour-intensive manufacturing and servicing, coupled with revamping of the food chain. Simultaneously, we need to revamp the education system, which continues to produce `Bhadralok' — graduates capable of doing clerical jobs whereas the job opportunities in the future will require specific skills.

Two Indias

It is obvious that we need to carry the under-privileged with us. The current system of broad-based subsidies has not helped. We need target/result-oriented subsidies. The success of micro-financing and self-help groups clearly shows what can be achieved with small amounts of money. The employment guarantee scheme should look at creating sustainable employment. Prof Lawrence Summers, while delivering the L. K. Jha Memorial Lecture, raised some important issues that need to be debated upon, followed by agreed-upon action.

First, the net flow of capital is substantially from developing countries towards the industrialised world, mainly the US. This trend, which has persisted for several years, is based on current projections and is expected to continue.

Second, the build-up in US net foreign debt is largely mirrored in reserve accumulation by emerging markets.

Third, global reserves of emerging markets are far in excess of any accepted criterion of reserve need for financial protection.

Fourth, expected real returns on these reserves are low. Since the reserves are largely invested in the dollar, a return of around 4 per cent would be normal. This presumes no exchange rate adjustment

The dollar will fall substantially — only the timing is uncertain. The reasons for the expected fall are:

First, 7 per cent and growing is an unusually large deficit (in the US).

Second, the current account deficit is financing consumption rather than investment as the US net national savings rate is now at a record low of under 2 per cent.

Third, investment is tilted towards real-estate and the non-traded goods sector rather than the traded goods sector and away from exportables.

Fourth, the net flow of direct investment is out of the US and the flow of incoming capital appears to be of shortening maturity and coming increasingly from official rather than private sources.

Developing countries are paying a high cost of holding reserves beyond what is necessary for financial stability. Excess reserves of various countries defined as reserves in excess of twice short-term debt are given in the Table. Suppose we presume that these reserves could earn between 7 per cent and 10 per cent depending on the countries risk appetite, India could earn (incrementally) annually $3-5 billion while, at the same time, reducing its risk in case of a dollar depreciation.

Prof Summers rightly asked at his lecture: "Spending of what amount of money by the government for uplifting the poor makes headlines or warrants a special mention in the Budget speech." Now, there is the possibility of generating $3-5 billion annually to meet key objectives.

Sustainable self-sufficiency

Let's accept it, we cannot have two Indias. The underprivileged have to be helped and quickly. This should create sustainable self-sufficiency. While it is agreed that everybody has to do something, the thought remains in the air because we plead lack of resources. Therefore, it is imperative to examine why this huge amount of revenue for spending cannot be generated. The key questions that need to be debated are:

Who will decide the country's risk appetite?

Parliament being the representative of the people is the appropriate body to take the decision. This will ensure that the debate brings a convergence between politics and rational economic decision.

Who will manage the excess reserves?

The management should be given, at best, to five fund managers. The mandate should clearly specify the risk appetite. We can start with a few low-risk investments; for example:

Buy on standing AAA Indian Paper which now yields 7-8 per cent with a residual maturity of around five years.

Fund infrastructure projects with a yield of 7-8 per cent.

Balance in a fully diversified equity fund.

Who will be responsible for any unforeseen setbacks?

The fund managers should have a quarterly/monthly review with the standing Committee on Finance, which should have experts from the public/private sector for the review.

Infrastructure

We must spend on infrastructure. This cannot wait for the restructuring of the economy. It is imperative to re-examine/support the Planning Commission Deputy Chairman, Mr Montek Singh Ahluwalia's proposal for using forex reserves for the development of infrastructure. We should also consider incremental deficit financing as long as it creates productive infrastructure.

The recent initiative in terms of right of information and objective-based expenditure evaluation are excellent tools to ensure greater effectiveness in public spending and accountability. This must be backed with appropriate monitoring.

India is changing. There is a "can-do attitude" and a confidence. We can match the best in the world. Let's all make sure we reach our rightful place in the world.

(The author is Managing Director, HDFC Bank.)