• The London Financial

The next decade to come — Will India be the new China?

Updated: Sep 6, 2020

For years now, there has been a debate whether India will be the next China. While there are very few similarities between the two countries’ governance and political systems, monetary policy practices, cultures, and even societal functions, there is some merit in the argument. The countries share a long history of economic and religious ties, and are neighbours serving the world’s largest populations; while the developed world’s growth continues to slow and expenses rise, it was logical to assume the cheap labour markets of China and India will provide the necessary goods to the world and be the next economies to achieve >10% growth. Yet, while China has catapulted to become the world’s second-largest economy, stealing the spot from Japan in 2010, India has lagged to rise up the spot in both socio-economic indicators and geopolitical impact. However, the coming decade has the potential to provide India with the opportunities to fulfil its growth potential. I will dive into the reasons why India has a ripe environment to achieve the title of the world’s next ‘growth engine’, but I’d like to clarify the title of this article beforehand.

No, India will not be the next China. It cannot be measured and understood on the same terms as China, even though it has the prospective ecosystem to match China. The United States has been the world’s largest economy since the 1920s, and China will still take decades to match and overtake the US’ spot. Similarly, India’s economy will continue to grow in the years ahead, but it will take a long time for it to match China’s size today and then decades after that to overtake China. For perspective, China is currently five times bigger than India on a GDP basis. For India to even come close to China’s size, the country will have to grow at double digits for years while China suffers an economic crash. On another note, China’s rise was primarily founded on an economic model which cannot be replicated by India. Not just China’s, but India cannot mirror any model used by South East Asia. Economically, India suffered relatively less in the financial crisis and the Covid-19 pandemic primarily because its GDP is driven by consumption and services, not exports and a strongly linked global supply chain. As e-commerce and services continue to boom, there is significant room for productivity improvement which will drive India’s growth in the coming decade. India’s growth path ahead will be distinctly different from China’s, as it presents itself with a vast array of budding opportunities.

One of my favourite investors, Howard Marks, described a number of “salutary secular trends” and “long term economic trends” in his book Mastering the Market Cycle. These include the macro environment, corporate growth, popularization of investing amongst others. Demographic movements, technology, aspirations, investments and total factor productivity (TFP) fundamentally change the long-term rate at which an economy can grow. Expectations for growth in India have always been high but always failed to materialize. While gauging at the unmet potential through these trends highlighted by Marks, we get a picture. As we cannot change history, I think it will be more exciting to talk about how these trends can shape the future of India’s economic growth.

India is the only rival China has in terms of the abundance of labour. As the country is set to overtake China as the most populous nation by 2028, it has a stark advantage, as, by that time, it is predicted that 20% of the world’s working population will be India. The median working age in China is 38 while it is a mere 28 in India with an average of 10 million people expected to join the workforce every year. China’s working population peaked in 2015 and is on a steady decline. Marks highlights such long-term trends to be a key factor in the growth of an economy. But alongside a labour supply, he also talks about demographic movements. The migration of millions of Chinese from farms to cities is an example of how China fueled its rise as a low-cost global manufacturing hub. Similar trends took place in the US with the help of Latin American workers. As Gandhi said, “India is not Calcutta and Bombay; India lives in her seven hundred thousand villages”, it’s the migration from the villages and the young population of India that will drive this strong growth in the coming decade as technology and education quality improves. The aspiration and desire of the youth to profit and live better lives are among the tempting forces to work harder and produce more. At first glance, these motives might seem obvious, but they aren’t. The profit motive was not a part of the economic system under the Soviets, while the willingness to work more is constrained in other economies. India is far known for its legacy to put in the extra and long hours of work. To say if it’s respectable or unscrupulous is not the point. The necessity to point out this trend to increase overall output is.

As the Covid pandemic highlights key structural issues in global business chains, foreign firms are considering their options beyond China. The tensions arising due to the US-China trade agreement only exacerbates the problems. It is noticeable, as any increase in tensions between the world’s two largest economies sends volatility in the stock market spiking. A recently conducted UBS survey shows that many CFOs view India as a preferred alternative destination. India has drastically improved on the ‘ease of doing business index’ and foreign direct investment has significantly increased in the past years. According to the government of India, FDI in 2020 is expected to reach $161B, almost twice the size of 2019. The trend will continue to improve as policymakers focus on a “China-plus-one” strategy, which is to diversify supply chains rather than directly competing with China. As mentioned above, what sets India apart is the increasing base of demand from the domestic market which absorbs a large share of the country’s output. Brooking’s Institute research found that India’s middle class is on its way to become the second largest in the world by 2030 and will account for 17% of the global middle class in a decade. As manufacturing increases, the overall output will too. Developing a strong manufacturing set up is essential; although services account for 56% of the GDP, it does not contribute to the multiplier effect as robustly as manufacturing does. Capital investment, expenditures and employment rise at a faster rate with an investment in manufacturing than in the services sector. High government expenditure on infrastructure for this exact effect has been a key message to the government by Raghuram Rajan, the former Governor of the RBI.

Marks, in his book Mastering the Market Cycle, talks extensively about Total Factor Productivity. To achieve GDP growth rates higher than 8%, a TFP growth of 3% is required (as seen in several economies who experienced such a change). India’s TFP is well below this threshold. Fortunately, the country’s growth drivers are majorly internal and, therefore, can be structurally altered relatively easily. Urbanization, formalising of the economy, upskilling the labour force — all help to increase the TFP of a country. Of course, it is easier said than done. Fundamentally changing the workforce takes time and effort. India’s labour reforms are still very strict, providing less leeway for companies to increase productivity. For instance, if a company wants to cut back on over 100 workers, it needs to gain approval from the state government. Such an issue is a particularly sensitive one but ultimately hinders a firm to reach its full potential.

Delhi now needs to kickstart a virtuous cycle of infrastructure spending – power, transport, logistics sectors – all helping to attain higher employment generation and investments. The problem faced by the government in such a situation to boost investment is the high costs of financing these big projects. The 10-year government bond yields 6.23% while the policy rate is at 4%. These high costs of financing can be mitigated by long-term inflation targeting. On the positive side, corporate taxes have been reduced and are now on par with China. For the more newly opened manufacturing facilities and under economic schemes, the tax rates can be as low as Singapore’s. Companies like Samsung have their second largest mobile producing facility in India and Apple plans to shift almost 20% of its China capacity to India.

India has the demographics, a long entrepreneurial tradition, an expanding middle class, and headroom for an increase in TFP on its side. With fundamental changes to the economic structure in the world, the conditions look ripe for India to leap forward. The pandemic, with all its downsides, has also provided an opportunity for India’s economy to become globally competitive in manufacturing. Global supply chains, especially with those who have a link to China, are stressed and are eyeing an alternative. India can offer not just those alternative links, but also human capital advantages. The government aspires to reach a $5T economy, a 66% rise from the current $3T GDP number.

By Alpit Kale — Former Senior VP at King's Global Markets

This article was first published on LinkedIn.

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