India's tiger economy stalks Beijing

India will soon register faster economic growth than China but its per capita income remains woefully low. The decision to amend foreign direct investment rules will help to turn this around, slowly.

Despite more than a decade of strong economic growth, India has been dogged by persistently high inflation and chronically inadequate infrastructure. In an effort to tackle these problems, prime minister Manmohan Singh has amended the foreign investment rules to allow foreign retailers and supermarkets to enter India.

This is an important element of the Singh government's reform agenda as it works to invigorate the economy in areas that can easily build competition and dampen inflation pressures over the long run. In coming years, Wal-Mart, Tesco and Carrefour are likely to establish retailing operations throughout India as a result of the law change.

For many in the industrialised world, allowing foreign direct investment in retailing would seem a tiny reform. For India, the approach has several aspects to it, not least having firms with huge economies of scale operating to supply food and other household goods more cheaply than at present. This will be critical in capping the prices for retail goods compared with the current structure of retailing which is characterised by many small, localised and inevitably inefficient operators.

The retail reform, like most significant structural changes, is expected to take many years to bring to fruition.

Another reason for the slowness in the implementation of these changes and something that is a massive constraint on the ability for the mega-retailers to set up and operate, is India’s woefully inadequate infrastructure. The business models of the big retailers centre on the efficient and speedy transportation of goods from producers and importers to their shops, warehousing is critical and an unbroken supply of electricity is vital for the storage of perishables. On transport and electricity generation, India is poorly serviced, a point that will make the retailing reforms slower to implement.

Mr Singh, like all Indian policy makers, is acutely aware of these infrastructure shortcomings and has committed his government to build such infrastructure, but the time lag can be long for such projects.

The plan to allow foreign retailers into India is not without controversy. Resistance has been most evident from those populist politicians in the conservative Bharatiya Janata Party seeking to protect the existing local retail outlets who are unlikely to survive when the foreign retailers establish their operations. There is also the nationalist notion that these foreign firms will by-pass local expertise and also direct profits out of India, the usual hallmarks from protectionists around the world.

Thankfully common sense is prevailing and India is set for a massive boost of foreign direct investment that will increase productivity and efficiency.

While India is the world’s third largest economy in terms of GDP, the per capita income levels are extremely poor, despite more than a decade of strong economic expansion.

According to the World Bank, in purchasing power parity terms, per capita GDP in India is just $US3,650 per annum, ranking it 125 in the world. In US dollar terms, India’s per capita GDP is $US1,514 per annum, ranking it 139 in the world. India’s per capita income is below Honduras, Iraq, Syria, Swaziland and the Philippines, highlighting the poor starting point for these reforms. But it also highlights the opportunities that the reforms are likely to deliver.

By way of contrast, China’s per capita GDP in purchasing power parity terms is more than 130 per cent higher than in India. It may take 20 years or so of sustained economic growth for India to catch up to even half the per capita income of China.

Reform of the retailing sector is only one aspect of the Singh government’s efforts to relax the foreign investment rules and bring much needed capital flows into India. He is looking to change the rules to allow for greater foreign direct investment and additional competition in banking, insurance and pensions.

The more that India embraces pro-market policies and structural reforms that boost productivity and economic growth with low inflation, the more sustainable the long-run expansion will be.

The recent OECD report on structural change in the global economy to 2050 highlighted its assessment that within a decade, India will be registering faster economic growth than China. While demographic factors play an important role in this turnaround, India playing catch up on infrastructure, competition policy and economic reform more generally will certainly help.

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