Securing India’s place in the global economy

Securing India’s place in the global economy

India is moving quickly to capture its place on the world stage. Just 16 years after embarking on the path of economic reform, the country has freed itself from the slow growth that plagued it during the decades after independence; in the past fiscal year, GDP (gross domestic product) growth reached a robust 9.4%. India’s best companies are targeting global markets, as Tata Steel’s $11 billion (Rs48,675 crore in January) takeover of its Anglo-Dutch rival Corus shows, and the Indian consumer is attracting worldwide attention. But to sustain these advances, the country cannot rest. Its leaders must focus on building infrastructure and developing a thriving labour market.

The economic reforms that began in 1991 marked a turning point in India’s economic history. Under the programme, the country successfully laid the foundation for robust economic growth by transforming itself from an agrarian, underdeveloped and closed economy into an open and progressive one that encourages more foreign investment, and draws more wealth from services and industry. Real GDP growth averaged 8.6% over the past four years, and the country’s economic planners expect it to grow by an average of 9% a year through 2012. India boasts companies with world-class capabilities in sectors such as automotive, information technology, manufacturing and pharmaceuticals. Net capital inflows topped $46 billion in fiscal 2006–07, compared with only some $24 billion a year earlier.

Most important, the benefits of reform have reached a broad constituency. Since 1985, India has lifted more than 100 million people out of desperate poverty in urban centres and the hinterland alike, according to research by the McKinsey Global Institute (MGI). India’s population grew by 352 million during this period, and 431 million fewer people live in desperate poverty today than would have if it had remained at the 1985 level. Looking forward, MGI estimates that if GDP grows by a modest 7.3% a year over the next two decades, the country’s poorest people will continue to gain ground, so that the deprived segment—those making less than Rs90,000 annually, about a dollar per person a day—will drop from 54% of the population in 2005 to 22% by 2025.

Yet India can’t afford to rest on its laurels. Sustaining inclusive economic growth will require the country to focus on improving its infrastructure, both hard and soft, and on creating a thriving labour market. To accomplish these goals, a series of economic and social reforms will be needed.

Infrastructure challenge

India’s need for a better infrastructure is evident. The inadequacy of the present hard infrastructure is manifested in the country’s poor and insufficient roads, its crippling electric-power deficit, the shortage of rail freight corridors, the poor ports, the bursting cities, and the overcrowded and stiflingly hot airports. As for the soft infrastructure, such as schools and hospitals, discouraging infant mortality rates and alarming levels of illiteracy are just two symptoms of its gross shortfalls. The hard and soft infrastructure alike must improve at an even faster pace than they are today.

Cement and steel

India’s hard infrastructure hasn’t kept pace with economic developments. From 1998 to 2005, annual investments in it averaged 4% of real GDP, compared with 8.2% in China, which invested early and heavily to build a world-class infrastructure that can attract foreign money and spur growth. In contrast, India’s infrastructure investments have taken off only recently, reaching about 4.7% of GDP, or $34 billion, in fiscal 2005–06. Current plans call for an additional $475 billion in infrastructure investments over the next five years, with a significant share privately funded.

The Indian government should be applauded for its greater pragmatism about public-private partnerships and its willingness to take on ambitious efforts, such as Bharat Nirman (a rural development programme) and the privatization of the Mumbai and New Delhi airports. Infrastructure deficits in urban areas, roads, ports, and power are being addressed as well. Yet these measures, taken as a whole, hardly suffice.

To improve the infrastructure significantly on a nationwide scale, the government will also have to undertake systemic reforms. Immediate action is needed in a number of areas: land market barriers (unclear land titles and insufficient databases, for instance); inadequate long-term financial instruments to meet the equity and debt needs of large infrastructure projects; weak policies and regulations, stemming from coalition politics, which are subject to frequent change; and unrelenting red tape at the lower levels of Central and state governments and other authorities.

Further, among other things, state governments must repeal the Urban Land Ceiling Act (which restricts the amount of land available for housing), resolve unclear land titles by creating fast-track courts, computerize land records, raise property taxes and change the tenancy laws. To improve India’s crippling electric power deficit and reverse its adverse impact on business, the government will have to secure payment guarantees for private power generators, establish a power exchange and push for the partial or complete privatization of power distribution.

Minds and bodies

India is expected to become the world’s most populous country by 2035. It’s already the youngest: one-fifth of the world’s population under 24 years of age lives here. While this kind of population growth represents a huge opportunity, it also highlights the need to invest substantially in human-resource development, particularly in education and health care, and to create adequate employment opportunities.

Building the institutional ability to ensure the timely and equitable delivery of such services will be vital for equitable growth. What’s more, the huge and pressing demand for soft infrastructure can’t be addressed by the government, private enterprise, or the community acting alone. Only when all parties work together can these needs be satisfied.


India has the world’s largest school-age population. If these children had access to quality education, they could drive the innovation, productivity, and development needed to ensure the nation’s continued growth. Unfortunately, however, India’s educational attainment remains poor compared with that of other nations, including China: only 60% of Indians are literate, compared with 90% of Chinese. Reforms designed to improve literacy rates must begin at the elementary school level. Experience around the world suggests that a good primary education in rural areas is critical. By and large, India’s state governments have failed to provide quality education to these students.

Another key issue plaguing India’s educational system is a dearth of qualified teachers, since research suggests that they are crucial for improving results. The average student-teacher ratio is estimated at 37, potentially in line with the World Bank’s recommended norms. But more than a third of the children attend schools with significantly worse ratios, and more than half of the school teachers haven’t completed secondary school.

In higher education, India must increase the number of openings substantially and improve the quality of instruction. To stimulate private sector investment in colleges and universities, the government might create pilot focused-education zones, where educational institutes could be set up with complete autonomy in admissions, fees, course offerings, faculty recruitment, and delivery and evaluation methodologies. The zones could be open to foreign universities and for-profit entities that would offer regular degree courses, with the entry and exit of players determined by market forces.

India must produce more graduates with the skills needed for employment in the global economy. Lifting literacy rates will be vital to shift a growing populace from agriculture to high-value economic activity not only in high-tech services, but also in manufacturing. Even in the former, where India is often thought to have abundant talent, our research suggests that there may be a shortfall of about 500,000 qualified candidates by 2010. Part of the solution for generating a greater volume of qualified job seekers must be public-private partnerships that strengthen industrial training institutes and more vocational programmes tailored to the needs of various industries.

Health care

Altogether, India produces roughly 400 public health professionals a year, about as many as a couple of public health schools in the US might. Yet, 2-3 million Indians are infected with HIV/AIDS—accounting for the world’s third largest infected population. The country’s infant mortality rate is more than twice that of China, which also boasts a substantially longer life expectancy. Clean water and sanitation remain out of reach for many people in India; the emergence of lifestyle diseases (such as obesity and diabetes) and the increased level of systemic health burdens are worrisome too. Yet, public spending on health care is less than 1% of GDP. This situation must change quickly, and the Central government plans to increase spending to 2-3% of GDP by 2012.

McKinsey research suggests that during the next 10 years, India will need more than 10,000 public health professionals to supply preventive health services. These experts will also be needed to train 500,000 volunteers, whom the government intends to place in villages throughout India as part of the National Rural Health Mission, and to shape the response to myriad public-health policy issues through meaningful research and advocacy.

What’s more, to have a strong and healthy workforce, India must act urgently to increase the number and reach of its effective public health services. The Public Health Foundation of India, a public-private partnership established to produce 10,000 qualified public health workers over the next few years, is one effort to bridge the gap between the need for and the supply of skilled service providers.

Labour market

India’s huge and growing population—of somewhat more than a billion—could be considered one of the country’s biggest assets, representing an almost limitless labour supply and consumer demand. Yet, this mass of people could become one of the greatest forces against reform if they can’t find jobs; in 2003, for instance, the labour force grew by 12 million, but employment in the organized private sector fell by 200,000. India absolutely must create a thriving labour market not only to shift workers from agriculture to higher value-added activities, but also to absorb a growing workforce and sustain social equilibrium.

A critical step would be the systematic deregulation of sectors such as retailing, defence, the news media and banking, which remain crippled by archaic policies. With deregulation and the opening of markets, vital foreign direct investments of capital and skills could flow more readily into India, making its industry more effective. Coupled with low interest rates, such an influx of foreign capital would help sustain the economy’s buoyancy.

In addition, reforms are needed in the coal, power and natural-resources industries to increase competitiveness, foster the creation of higher-value jobs and support economic growth. Continued privatization of state-owned enterprises must also remain a focus for the government.

Private sector non-agricultural employment has stagnated at below 9 million for the past 20 years, though the labour force now exceeds 400 million people.

Beyond general deregulation and liberalization, India must repeal its complex and rigid labour laws, which discourage the creation of jobs by offering excessively stringent protections for people who work in the organized part of the economy. According to the World Bank, India’s level of private sector non-agricultural employment has stagnated at below 9 million for the past 20 years, though the labour force expanded to more than 400 million people during that period. Removing the rigidities will allow India to harness the potential of its growing workforce. That is especially critical for the manufacturing sector and for creating opportunities in rural areas.

Manufacturing growth

India can no longer expect to outperform its competitors unless manufacturing grows substantially. Its high-tech industry has rightly won fame, and it can look forward to tens of thousands of new jobs emerging if, as expected, revenues from the business process outsourcing (BPO) and IT industries triple by 2010, to at least $60 billion. However, these sectors will never provide the number of jobs needed for all of the tens of millions of Indians seeking opportunities.

If India were to leverage its inherent strengths in skill-intensive manufacturing, exports could surge to about $300 billion, creating 25-30 million jobs by 2015. Emphasizing apparel, auto components, electrical and electronic products, and specialty chemicals could help “Made in India" to become the next big manufacturing exports story. But achieving this goal will require action on a number of fronts.

The first step will be to ignite domestic demand, which would help attract multinational manufacturers and provide the scale needed to be globally competitive. To this end, the government should move rapidly to create a uniform general sales tax across all products and states.

More important, the total taxes on manufactured goods should fall to 15% of retail prices (the current level in China) over the next three years. Our study of a variety of product categories in India and China shows that for every drop in prices of 25 percentage points, consumption increases threefold to fivefold.

Also, the government should reform indirect taxes, such as excise duties levied by individual states, and lower import duties to 10% to boost domestic demand and support manufacturing growth.

In addition, innovations such as special economic zones (SEZs) must remain under consideration, despite recent controversies about them. To accelerate manufacturing growth, these zones should have governance structures insulating them from political changes and pressures and offer simple administrative procedures, as well as a world-class infrastructure, physically attractive environments and anchor tenants that plan to reach significant operating scale through substantial capital investment. These manufacturers should also have access to domestic markets using a dual bookkeeping system similar to that in China, where products sold locally are subject to local taxes and duties on materials imported for their manufacture, while products exported are not.

Rural India

To ensure that India’s economic growth reaches the whole country, the government must supplement the Bharat Nirman programme with job creation plans in the farm and rural non-farm sectors. Such initiatives, focusing on skills and assets already in place, could create 30-40 million jobs in rural areas and increase rural incomes by 1% annually over the next five years.

For such plans to succeed, India must launch a second Green Revolution, reform the food industry and create a thriving service sector in rural areas.

A second Green Revolution should embrace three features. First, the country’s prime farmland should be expanded beyond the states of Haryana and Punjab, into Bihar, Madhya Pradesh and Uttar Pradesh. This prime area would focus on growing grains such as corn and barley.

Some farms should be encouraged to replace grains with fruits and vegetables, as well as livestock; historically, demand for these higher-value products increases as economies develop and incomes rise.

Finally, wastelands—vast tracts that have low water tables and infertile soil—should be cultivated with crops such as eucalyptus trees and jatropha, which have global markets and can be grown economically on relatively unproductive land.

Special tourism zones with tax benefits could generate as many as 25 million jobs over the next five years

Reforming the food industry is also important. Key measures include amending laws such as the Agriculture Produce Marketing Committee (APMC) Act (which restricts the retailers’ access to produce), creating a legal framework for contract farming and liberalizing the interstate movement of produce.

Over time, the government should shift its role from market participant to facilitator. The systematic development of the food processing industry is also necessary to make better use of the country’s resources, since supply chain problems prevent large quantities of produce from ever getting to the market.

Finally, creating a vibrant service economy in rural India by focusing on labour intensive sectors such as tourism could be enormously beneficial.

Special tourism zones with tax benefits—an arrangement similar to SEZs for manufacturing, but without any need for the large scale acquisition of land—could generate as many as 25 million jobs over the next five years. These zones could attract an additional 20 million foreign tourists annually, as well as 400 million domestic ones.

Retail banking, health care and education are other service sectors that could grow significantly in rural India as incomes and aspirations continue to rise.

India is on the verge of one of economic history’s great achievements, which could lift hundreds of millions more of its people out of desperate poverty and create a huge and thriving middle class.

But that won’t happen without a strong political commitment and concerted action from all stakeholders—the government, the private sector and society at large.

Adil Zainulbhai is managing director, India, McKinsey & Co.

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