‘Growth acceleration better than expected’

‘Growth acceleration better than expected’

Montek Singh Ahluwalia has been deeply involved with India’s economic reforms since they were launched in 1991. In those days, as secretary of the Department of Economic Affairs, he worked with then finance minister Manmohan Singh to assemble a programme that would deliver the country from “Hindu rates of growth"—the scathing label given to India’s seeming inability to sustain growth rates of more than 3% after its independence in 1947.

Today, Singh is prime minister and Ahluwalia, as deputy chairman of India’s Planning Commission, is the country’s chief economic planner and a close adviser to the administration. (The Prime Minister is the commission’s chairman.) While the country is basking in the success of economic reform (GDP growth hit 9.4% for the fiscal year that ended in March), Ahluwalia is working to make sure India can sustain these growth rates.

The Planning Commission is targeting average annual growth of 9% in its 11th Five-Year Plan, which spans 2007 to 2012. The initial reforms, in the early 1990s, were “no-brainers", the Oxford-educated economist says. They focused on dismantling the “licence raj" (a tangle of regulations that gave bureaucrats too much control over too much of the economy and invited corruption) and on opening India’s tightly closed markets to imports and foreign investment. Strong growth followed. But Ahluwalia acknowledges that the next set of problems—infrastructure, education and health care, for example—will be far more complex, and the pace of change hasn’t been as fast as he’d like.

Over tea in his office in New Delhi, Ahluwalia recently talked with Adil Zainulbhai, a director at McKinsey’s Mumbai office, about the former’s confidence in the country’s continued growth and the challenges that lie ahead.

What was your reaction to India’s strong growth in 2006–07? Can it be sustained?

There is no doubt that we were very pleased, but I wouldn’t say we were entirely surprised. I’m not talking about the 9.4% growth in 2006–07, but about the fact that the economy has accelerated significantly in the past three years and looks set to continue robust growth in the current year.

Plan panel deputy chairman Montek Singh Ahluwalia

Our perception was that the benefits of economic reform in India were going to be substantial, but slow to surface simply because the reforms were introduced in a fairly gradual manner. We are now seeing the build-up of momentum with a tremendous surge of economic activity and investment in the private sector.

In the current fiscal year, 2007–08, the low estimate for growth is around 8.5%, and it could be closer to 9%. If you look at the four years from 2004 to 2007, you will see an average growth rate of 8.6% or so. I think that’s very good. I had expected an acceleration in growth, but I would say it’s better than I had expected.

We are currently projecting an average growth rate of 9% for the next five years. Many people think that’s a bit underambitious, given it was 9.4% last year. But I think an element of cyclical correction is going to take place.

What are the critical challenges India faces in sustaining this growth?

In the short run it’s infrastructure; a little bit longer term than that is education. We can’t do much about education in the short term, but we can do a lot over a five- to 10-year period.

Political sustainability is another dimension. In a democratic environment, people have to be able to see benefits reach them. From that perspective, a better story on agriculture is absolutely vital. Agricultural growth was 3.6% per year from 1980 to 1996, then slowed down to less than 2%. We want to bring it up to 4%. Faster agricultural growth will also stimulate the non-agricultural part of the rural economy, so it’s kind of a double-whammy effect.

Health is also a major priority. We need to address our high levels of infant mortality, maternal mortality and child malnutrition, as well as gender gaps in school. The good news is we don’t have to worry about industry: give them a competitive market, reasonable macroeconomics and deliver the infrastructure, and our entrepreneurs know what to do.

How are you addressing the infrastructure shortfall?

We have not invested as much in infrastructure as we should have in the past. When the economy was growing at 6 or 6.5%, this constraint was less evident. One of the major objectives of the 11th Five-Year Plan, which we’ve just begun, is to sharply increase investment in infrastructure as a percentage of GDP, from less than 5% in 2006–07 to about 9% by the end of the five-year period.

This expansion is not going to take place through the traditional public sector expansion route. The public sector cannot mobilize resources on this scale, especially if we have to invest massively in education and health.

We have, therefore, crafted a strategy for infrastructure development based on public-private partnership. That’s not an easy thing to achieve. We estimate that about three-quarters of the increase in infrastructure investment above the business-as-usual projections would have to be privately funded. The industrialized countries, historically, created their infrastructure through the public sector. China also built infrastructure through the public sector, funded by the public sector banks. We will also rely substantially on public sector investment in areas where private investment cannot be expected—for instance, rural infrastructure. However, we want to encourage infrastructure development, with private sector entrepreneurs taking some of the risk wherever possible.

The good news is that it is possible. Telecommunications is one area where infrastructure constraints have been visibly relaxed. A huge amount of money came in, and it’s been used very efficiently. We’re hoping to replicate that result in other areas, but of course conditions differ across sectors. In roads, for example, the revenue model cannot work based on tolls alone. Therefore, the policy provides for capital subsidies up to a stated level, based on competitive bidding for the lowest subsidy. However, even in roads, since the land is provided by the government, there have been cases where bidding has resulted in a negative subsidy.

Are you confident that current plans will fix India’s infrastructure?

I am optimistic, but it will take time for results to show, especially since rapid growth will strain existing capacities. Consider airports for a minute. We are engaged with the private sector in the major modernization of Mumbai international airport and Delhi international airport.

Two new private sector airports—one in Bangalore and one in Hyderabad—are nearing completion. By 2010, all four of these airports are going to be fully operational; 35 airports are being modernized through the public sector. You will see much better airport infrastructure by 2010.

Urban infrastructure is a very difficult problem and has to be tackled by state governments and municipalities. The Central government has introduced programmes designed to give states financial assistance linked to their efforts to undertake urban reform. Many of the states are responding. I expect that you will see very significant changes in this area over the next five to 10 years.

How are bottlenecks at the state level affecting growth?

There is a cascade effect of reforms starting in the Centre and then spreading to the states. However, there are important differences across the states. There are many examples of state governments recognizing that economic growth is going to result from attracting private investment and responding to this perception by trying to create an investor-friendly atmosphere.

Industry organizations routinely prepare rankings of states indicating the ones that are more investor friendly and those that are less so. Once politicians recognize that their performance is going to be judged by whether they’ve actually attracted investment and created organized sector jobs, the internal political motivation to get things moving will increase.

Has today’s prosperity reached all levels of Indian society?

I wish I could say, “Yes, definitely", but this is one area where there are many deficiencies, and democracy and a free media ensure that we can never forget them. Terrific growth is taking place in some places, but there are parts of the country that don’t seem to be seeing an acceleration. We definitely need to look at that. Agricultural growth was low for many years, but in the past three years, there has been an upturn. Is inequality widening? Marginally perhaps, as often happens in a growth acceleration, but much less than what has happened in China. However, the toleration of gaps is shrinking massively.

People no longer ask, “Have I got a school in my rural area?" They ask, “Is the quality of the school such that my child has a good chance of getting into a good educational institution?" This is a totally different question. People are now aware that many diseases can be treated by modern medicine, and they expect the public health system to deliver quality medicine. Increased expectations of what should be delivered have led to a greater intolerance to the existence of gaps. That puts pressure on the government to deliver faster, which is on the whole a good thing.

People today also want much greater assurance of upward social mobility. One of the most positive things about the IT revolution in this country is that virtually every single one of the icons of the IT world is a new entrepreneur.

That implicit social mobility resonates extremely well with the growing number of people who are getting access to education. These expectations are now spread over a much broader range of people: the growing Indian middle class. However, rising personal incomes don’t solve all problems.

Many people who are above the poverty line don’t have access to clean drinking water and good sanitation. In the absence of those two—even if your income takes you above the poverty line—your children are likely to suffer from diarrhoea and water-borne diseases, and that will lead to child malnourishment, which is a major problem in India.

Is enough being done to increase power capacity?

I have no doubt that our performance in power over the past several years is the weakest. This is a difficult area where most of the critical actions lie in the hands of state governments. The Central government has to put in place an appropriate legal and regulatory framework, and the good news is that this is now in place. Performance, however, is lagging behind.

In the 10th Plan, which ended a few months ago, we were supposed to add 40,000MW in power capacity, and actually added only 21,000. A lot of power plants that were in the works have slipped somewhat, and for the next two years we expect to see a very large increase in generation capacity as these come onstream. We haven’t actually set the target yet for the 11th Plan, but we are hoping to be able to add about 78,000MW of capacity over the next five years.

Adding generation capacity will not be a problem. The real weakness is in the distribution end. We are running a system which, at the moment, doesn’t collect revenues on something like 34% of power that’s pumped into it because of theft and transmission inefficiencies. Some of the revenues collected are at very low rates.

The result is a system that is not financially viable, making it difficult to attract private sector investment in generation, since the power companies are not sure they will be paid. We have to improve the efficiency of the distribution system, which includes investment in distribution, metering and management to control theft.

The second, very important reform in distribution is open access. The Electricity Act mandates that open access to the distribution grid will be allowed for power generators starting 1 January 2009.

Anybody investing in generation today knows that by the time their plant comes onstream, they can reach high-tension consumers, who have a connected usage above 1MW, using the existing distribution system to transmit the electricity.

Many people say that the system would be more efficient if distribution were privatized. Very recently, the state government in Delhi did privatize the distribution system. If it turns out that Delhi has been enormously successful with this experiment, then I think maybe other states might do the same. However, that’s a politically controversial issue and not something that the Central government decides.

(Reprinted with permission, ©2007/McKinsey & Co. The article was originally published in The McKinsey Quarterly and can be found on its website, www.mckinseyquarterly.com)

Coming in Monday’s Mint, Part II of the interview, including Ahluwalia on corruption and challenges in sustaining reforms.