INDIA GROWTH STORY: India sits on human capital goldmine, says Parekh

Deepak Parekh, chairman of India's first housing finance company, HDFC, was the recipient of FinanceAsia's first Lifetime Achievement Award at our awards dinner on January 24. This is his keynote address.

Global markets have been fraught with uncertainty as the world ponders the fate of the US economy. A slowdown of the US economy was inevitable but the prolonged credit crunch, oil at over $100 per barrel and collapsing house prices have sent fresh fears as economists debate the dreaded “R-word” - will the US economy slip into a recession or manage to skid over?

Clearly, there are tough times ahead and amidst pandemonium in the global markets, India demonstrated resilience in its ability to meet new global challenges. To my mind, three key events of last week best demonstrate this:

- the overwhelming response to a mega IPO that re-affirmed investor confidence,

- India’s successful testimony of its manufacturing prowess as it unveiled the world’s cheapest car at $2,500 and

- the Indian prime minister’s visit to China, which re-emphasised to the world that the 21st century belongs to the two Asian giants as they seek greater economic co-operation.

But that was last week and this week came with a fresh set of shocks, collapses and rebounds. Markets are now so volatile that one has to learn to expect the unexpected. The Indian stock markets were no exception in the global meltdown earlier this week but like most markets, managed to clamour back up as sentiments improved following the Fed rate cut.

The Indian market had been enjoying a bull run over the last four years. An analyst aptly summarised the current market scenario and I quote, “India is now in a corrective phase in a bull market.”

Though market sentiment may keep shifting, it is important to note that in the Indian context, the real economy is driven by its own investment and domestic consumption and this continues to remain robust. The long-term fundamentals of the India story remain intact.

So setting aside the recent frenzy let me return to the core of the India story which dates back to over 60 years ago when, on the eve of India’s Independence, our first prime minister, Jawaharlal Nehru said: “India has made a tryst with destiny”.

It has really been over the past few years that India has begun to see that destiny come true.

From a country that was once considered a weak nation and had to convince investors of its growth prospects, India has now become a force to reckon with. Over the past four years, GDP growth has averaged 8.6% and over the last two years, growth rates have crossed the 9% mark.

Financial year 2007 was a remarkably good year with GDP clocking 9.4%. In line with expectations, the industry and services sector grew at 10.9% and 11% respectively, though agricultural growth continued to remain slack at 2.7%.

The oft-posed question for this trillion-dollar economy is whether the growth rate will slow down in line with global trends or whether India will be able to attain the much-targeted 10% growth rate?

Conservative estimates have trimmed India’s GDP forecast to 8.5%, citing the overall slowdown in global GDP growth. In the first half of the current financial year, India’s growth rate stood at 9.1%, giving little indication of an impending slowdown. The key issue is that the economy is on firm ground and the growth rate is sustainable and well-calibrated.

The breed of ‘India optimists’ continues to multiply. Today, there are over 1,250 foreign institutional investors with a cumulative investment of $67 billion. Contrary to some opinions, the restrictions on P-Notes by the regulator did not have a significant impact on FIIs investing in the Indian stock markets. Long term India players understand that it is the prerogative of a regulator to know the source and identity of money flowing into the country. The Indian stock markets have been greatly influenced by FIIs and the markets have benefited by their presence, especially in terms of improving governance standards, investor relations and valuation processes.

However, what is gratifying to note is that the Indian stock markets are no longer dominated by or heavily dependent on FIIs. Last year, FIIs pumped in an estimated $17 billion while domestic insurance companies, mutual funds and retail investors collectively invested close to $30 billion. Domestic money from insurance companies and pension funds is expected to pick up further.

Markets tend to work well when there is a diversified investor base and investors have different investment objectives and perspectives. With the mix of FIIs and domestic investors which is increasingly gaining ground, the investor base in India is becoming broadbased.

Admittedly, with the Sensex trading at a price to earnings ratio of around 20 times 2009 earnings, valuations of certain stocks may appear high, but this is a reflection of the strong growth potential. India Inc’s performance has been impressive. According to the RBI, corporate India continues to show an impressive performance with over 2,300 non-government, non-financial companies posting a growth in net profits of 34% in the first half of financial year 2008.

India has now become a magnet for foreign direct investment – a sea change from the time when FDI would only come in trickles. FDI flows have tripled from $6 billion in 2005 to $19 billion in 2007. The government has now confidently set a target of $25-$30 billion for next year. According to the World Investment Report of UNCTAD, India has emerged as the second most attractive location after China for FDI.

For India to remain a conducive FDI destination, the government will need to focus on reducing the number of sectors that require government approval, provide a level playing field in sectors with public sector dominance, open up more sectors for FDI and ensure long-term, consistent policies.

In terms of foreign investment flows, the year 2007 belonged to private equity as it emerged as the most preferred route for raising funds, with over $17 billion being invested in India Inc. These were mainly in sectors like real estate, infrastructure, financial services and information technology/IT enabled services.

With over 500 private equity firms investing or preparing to invest in India, there are concerns of overcrowding, but what this also means is that the funds will need to look at diverse sectors and new investment strategies.

While the India story is on a roll, it is imperative to prioritise certain issues that will help the country attain its growth potential.

Agricultural growth in India has been a laggard. An increase in agricultural growth will guarantee India a 10% GDP growth rate. The agricultural sector has been plagued with low investment, vagaries of weather, imbalance in fertilizer use and a distorted incentive system.

Lack of focus on the agriculture sector has serious implications – we cannot talk about inclusive growth when more than 50% of India still derives their livelihood from this sector. Further, poor and volatile performance of the agricultural sector has repercussions on the maintenance of price stability owing to supply side constraints of primary commodities. Clearly, the way forward is increased investments in food processing technologies and improving integration of the supply chain from the farm gate to the consumer’s plate.

Secondly, and an issue that is rather evident is the need to improve the country’s infrastructure. Many of you may have been witnesses to the inadequacies of infrastructure: cities bursting at their seams, power shortages, delayed flights and potholed roads/traffic jams.

The good news is that things are changing, the bad news is that it is probably not changing as fast as it should.

Over the next five years, the government has envisaged that investment in infrastructure needs to rise from 5% of GDP to at least 9%. This translates to an investment requirement of $492 billion. For instance, investment requirements in power is $161 billion, railways is $82 billion and national highways is $61 billion and telecom, state highways, rural roads require a combined amount of $150 billion.

These amounts appear intimidating owing to the sheer vastness, but to quote India’s finance minister, P. Chidambaram who said, “I can say with confidence that no country than India needs and no country than India can absorb so much funds for the infrastructure sector.”

It is ironic that a country that has a strong institutional infrastructure is grappling with physical infrastructure. The bulk of investment for infrastructure needs to be channeled into power, roads and urban infrastructure and the challenge in these sectors particularly, is that the levy and collection of adequate user charges has proved difficult. But given fiscal constraints, it is apparent that going forward, infrastructure will have to be increasingly financed through user charges and by the private sector.

The crucial issue is that the private sector will step in to fund infrastructure only if it is sufficiently incentivised. So how can this best be done? At a policy level, there needs to be an overhaul in the way some of these sectors are governed. Take the example of power – a sector that continues to be mired in regulatory turmoil. The country currently faces a 15% peak power deficit. There is a need for full-fledged reforms in distribution of power but realistically, before that happens, the state governments need to be more amenable to the privatisation process. With the government’s goal of providing “Power to All” by 2012 and with more IPOs lined up, the power sector is expected to receive large amounts of investments.

On the flip side, market-oriented reforms in the telecom sector have paid off with India now adding 7 -8 million mobile subscribers each month. Tariffs are also among the lowest in the world. Total telephone subscribers have reached over 250 million and most of this growth has happened over the last 2-3 years. Tele-density has risen from 3% in 2002 to 13% in 2006 and currently stands at 23%.

Private investments in national highways, ports, airports and railways have begun to flow, but this flow has to be a deluge, not a trickle.

But then there are the soft infrastructure issues that also pose a challenge –there is a need to increase investments in primary education and health care. Currently less than 3% of GDP is spent on education and 1% on health care. There are investment opportunities in these sectors as well but to improve soft infrastructure across the country, the government will need to undertake systemic reforms.

So far, the Indian economy has withstood the test of political coalitions, rising oil prices, spikes in inflation, appreciation in the currency and stock market corrections – still the economy has enough steam left to catapult it into the big league. This is ample testimony that India’s economic fundamentals are well entrenched.

Today, action has decisively shifted towards emerging markets with the BRIC economies alone accounting for over 10% of world GDP. For India, the change in the business environment is not entirely captured in macroeconomic numbers.

The mood of Indian business has been anything but sombre – it is almost defiant. The ambition and confidence of corporate India has grown dramatically. Indian M&A has been swelling, both inbound and outbound. Last year, M&A activity in India stood at over $50 billion with over 660 deals. Seven of these deals were over $1 billion in size.

This growth momentum is expected to continue in 2008. Besides wanting to be a part of the India story, the more pertinent question today is whether your business can afford not to be in India?

India is sitting on a human capital goldmine. It has one of the world’s youngest skilled work force. India generates over 11 million jobs annually, higher than any other emerging country. It is no wonder that India accounts for 65% of the global industry in offshore IT and 46% of the global BPO industry.

One of India’s greatest strengths is that it holds the dual advantage of a low cost, English speaking and highly skilled workforce. Every year, India produces around 2.5 million university graduates, including 400,000 engineers and 200,000 IT professionals.

Unfortunately, not all of them are directly employable. A recent study revealed that only 25% of engineering graduates and 10 to 15% of general college graduates are suitable for direct employment in the outsourcing industry. This means that the need for additional training is imperative. It is, however, ironic that in a country of over 1.1 billion people, we are increasingly struggling with skills shortage. The shortage of the talent pool gets further skewed when wage wars spiral just to attract or retain talent. So how India manages and effectively trains its human resources will determine its course of competitiveness in the global markets.

The opportunities in India are aplenty and the returns are there for all to see. Yes, investing in India requires patience and time. The reform process is irreversible, though the pace needs to increase. As the world’s largest and possibly noisiest and most opinionated democracy, consensus building is a must for change. This has its own trials and tribulations but it is a small price to pay for a free market. Nonetheless, with India’s need and capacity to absorb investments, newer opportunities will keep emerging and we are confident that global investors will continue to view India favourably in the years to come.