Identifying the growth hotspots in India

A new McKinsey Institute report identifies growth hotspots (or investable pockets of growth) in India for the next decade. It takes into account two main factors: urbanization rate (shows how fast the economy is growing) and the shape of income pyramid (shows how fast consumer class households are added). India has 29 states and 7 union territories – all different in terms of economic drivers and income level.

Goa, Chandigarh, Delhi and Pondicherry are classified as very high performing states and union territories. The per capita GDP of these states was twice the national average in 2012. 

Gujarat, Haryana, Himachal Pradesh, Kerala, Maharashtra, Punjab, Tamil Nadu and Uttarakhand have per captia GDP between 1.2 and 2 times the national average and are called high performing states. These represent large, prosperous, and fast growing states of India— in other words, India’s economic powerhouses.  The main attributable factors for this are the investment in human and physical capital, higher urbanization, relatively superior land use, and structural advantages (for instance, coastlines). All have good fiscal position and host high-skill industries like automobiles, petrochemicals, financial services, etc. Gujarat’s growth is led mostly by manufacturing sector. Tamil Nadu’s growth is driven by services sector and knowledge-intensive industries.

Very high performing and high performing states accounted for:

• 45% of India’s GDP in 2012
• 58% of India’s consuming class households (4 million in very high performing states and 14 million in high performing states). Consuming class households are those with household disposable income (at 2012 prices) ranging from INR 0.485 million and INR 1.7 million or/and above INR 1.7 million.
• Except for Kerala and Punjab, these states benefited from higher productivity of non-agricultural workforce (and hence higher consuming class). Kerala benefited from larger share of remittance inflows, and Punjab benefitted from strong agricultural production (India’s wheat basket)
• Households demand more consumer durables and automobiles, and also spend significantly higher share of income on transportation and recreation.

Although Bihar and Madhya Pradesh are low performing states, they will make good progress with the ongoing investment climate reforms, including developing industries and better performing legislatures. However, Bihar, Uttar Pradesh and Jharkhand will likely remain low performing states in 2025 due to high population growth rate.

Over 2012-2025, the high performing states are likely to account for:

• 52% of India’s incremental GDP growth
• Tamil Nadu, Gujarat, Kerala and Maharashtra are likely to be more than 50% urbanized by 2025 (against 38% average for whole of India). The rapid urbanization and the associated income growth will likely increase these states’ income to that enjoyed by global middle income countries in 2012.
  
• 57% of India’s consuming class (or 51 million) will be concentrated in these states. Consumer expenditure on non-food items will increase faster than the national average (education, health care, automobiles, personal products and recreation)

Finally, below is the map of potential growth hotspot cities in India.

Need for higher public capital spending to close infrastructure deficit in Nepal

Capital spending has been persistently weak, with both planned and actual spending languishing far below what is required to close the infrastructure deficit, which has been estimated to require capital spending equal to between 8.2% and 11.8% of GDP per year until 2020. Raising the amount and quality of capital expenditure is one of the country’s most pressing challenges. Accelerated capital spending is needed to scale up infrastructure investments and thereby attract the private investment needed for Nepal to attain higher economic growth that is both sustainable and inclusive.

Source: L. Andres, D. Biller, and M. Herrera Dappe. 2013. Reducing Poverty by Closing South Asia’s Infrastructure Gap. Washington, DC: World Bank.

In its provision and quality of infrastructure, Nepal is rated one of the least competitive countries in the world, ranked 132 of 147. Disaggregating aspects of infrastructure, Nepal’s ranking on the quality of electricity supply is 136, on air transport infrastructure 129, and on roads 115. These dismal figures indicate that Nepal needs more and better investment to foster innovation, make the economy competitive, and enhance the efficiency of markets for goods, labor, and finance. Gross fixed capital investment has to be raised to at least 30% of GDP from the current 22% to support higher economic growth. Higher public capital spending is crucial, as it is the catalyst for private capital investment.

Source: ADB/WB

Capital spending comprises government spending on, among other things, land, buildings, furniture and fittings, civil works, vehicles, and plant and machinery. The average planned capital expenditure in the past 4 years was 5.6% of GDP, but actual spending averaged just 3.3%. Given Nepal’s huge infrastructure financing needs, budgeted capital spending is insufficient in itself to bridge the infrastructure deficit in such critical sectors as energy, transport, water supply and sanitation, irrigation, and telecommunications. The government’s recent commitment to meet certain infrastructure needs by developing public–private partnerships is an encouraging sign that the gap can be closed. A worrying observation, though, is that project spending has averaged only 71% of budgeted allocations in the past decade, indicating that the government is unable to fully disburse allocated funds on time.

Note: Changed report system to Government Finance Statistics (GFS) 2001 in FY2012.  In FY2011, actual reporting was done based on GFS 2001, but budget allocation was done based on earlier GFS. Source: MOF/ADB

Efficient budget execution has been hampered by bureaucratic hassles over project approval and by such structural issues as the limited capacity of line ministries to prepare a pipeline of projects ready to implement. That projects are included in the budget despite lack of readiness has left large sums of money unspent at the end of each fiscal year. A project will face many problems in execution if it is launched without detailed design, clarity about land acquisition, project offices properly established and staffed with the required personnel, and detailed procurement plans. Further, delays affecting government ministries’ project approval and budget release, and inherent weaknesses in procurement processes, and contractors’ capacity and construction management, have hobbled implementation. Finally, the desired acceleration of capital spending has been hampered by political interference and by frequent staff turnover that weaken project planning and implementation capacity.

Source: World Economic Forum. The Global Competitiveness Report  2014-2015.

The government recently reached a number of decisions to tackle these challenges. It resolved to abolish or shorten some of the processes required for project approval at the National Planning Commission, require the advance submission of procurement plans for projects seeking approval, and provide better mechanisms for planning and monitoring projects to troubleshoot in a more effective and timely way critical issues that slow project implementation. The government is amending the existing Public Procurement Act to remove legislative hurdles for accelerated project implementation. Essential to boosting the quality and quantity of capital spending are prudent public finance management, better interministerial coordination, the elimination of political interference, better qualified and lower turnover of staff for project offices, careful planning and preparation, sound construction management, and more diligent project monitoring.

(Adapted from Asian Development Outlook 2015, Nepal chapter. It is also cross posted in Asian Development Blog)

Are economies facing reduced level and growth rate of potential output?

The latest World Economic Outlook (April 2015) by the IMF focuses on potential output growth. It argues that the world economy is facing a slower ‘speed limit’ (potential output growth) due to the impact of aging, lower capital and productivity growth. Hence, unless there are appropriate policy responses to foster innovation, productive capital investment and effective responses to aging, the major economies will have to ride on lower speed limits.

Potential output is a measure of an economy’s productive capacity with stable inflation and is affected by the supply and productivity of labor and capital. The slower capital accumulation and labor growth (due to ageing) have led to lower potential growth in advanced economies. However, in emerging economies, this is caused by slower total factor productivity growth. After the global financial crisis, both the level and growth rate of potential output has reduced.

Even if capital investment increases as economic conditions improve, labor growth may not be as rosier as population age and workers retire. This is going to impact potential output growth as well in both advanced and emerging economies. Furthermore, the productivity growth may be weaker than before as the previous drivers (past technological improvements and enhanced educational attainment) don’t have similar strong impact as before because the catch-up gap with advanced economies is already narrow. Hence, potential output in advanced economies will remain below pre-crisis level (despite an improvement over 2008-2014). But, emerging economies will see lower potential output than before.

Now, to raise potential output growth, pro-active policy measures may help. Some of these as outlined in the report are as follows:

• Encourage innovation and enhance productivity by high R&D investment
  • Strengthening patent system, tax incentives, appropriate subsidies
• Improve labor productivity by improving education quality
  • Focus on secondary and higher education
• Higher infrastructure spending
• Improved business conditions and more efficient product market
• More female participation in the labor market
• Fiscal policy effective to boost investment and capital growth. Monetary policy may also support aggregate demand.

The reasons behind Indian (and South Asian) children being short

Here is an abstract from a paper by Jayachandran and Pande titled “Why Are Indian Children So Short?”:

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India's child stunting rate is among the highest in the world, exceeding that of many poorer African countries. In this paper, we analyze data for over 174,000 Indian and Sub-Saharan African children to show that Indian firstborns are taller than African firstborns; the Indian height disadvantage emerges with the second child and then increases with birth order. This pattern persists when we compare height between siblings, and also holds for health inputs such as vaccinations. Three patterns in the data indicate that India's culture of eldest son preference plays a key role in explaining the steeper birth order gradient among Indian children and, consequently, the overall height deficit. First, the Indian firstborn height advantage only exists for sons. Second, an Indian son with an older sibling is taller than his African counterpart if and only if he is the eldest son. Third, the India-Africa height deficit is largest for daughters with no older brothers, which reflects that fact that their families are those most likely to exceed their desired fertility in order to have a son.

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Bernanke, Summers and Krugman on secular stagnation (saving glut and liquidity trap)

Here is a summary of the interesting debate on secular stagnation started by Bernanke on his blog at Brookings.

Achieving full employment, low and stable inflation, and financial stability are the three core objectives of economic policy. Larry Summers argued that achieving these three objectives simultaneously is difficult because slowdown in population growth and the pace of technological advance result in lower capital investment by firms and subdued household consumption. It means difficulty in attaining full employment.

So, inadequate aggregate demand leads to low growth and less than full employment. Low aggregate demand will eventually lead to low aggregate supply as productive capacity of the economy is restrained. The solution is to jack up public infrastructure spending in case real interest rate cannot be lowered below a threshold (zero) to stimulate private investment. In the face of secular stagnation and relatively ineffective monetary policy, the US should turn to fiscal policy (productivity-enhancing public infrastructure spending).

Bernanke is skeptical that the US economy is facing secular stagnation. First, if real interest rate (nominal interest rate minus inflation) is negative, then any investment will appear profitable. Hence, prolonged subdued capital investment is not realistic right now. Second, the current slowdown may be caused by temporary headwinds that may be dissipating soon. Third, better investment opportunities abroad will mean that there are will be more outward FDI, which would weaken dollar and then boost US exports. This in turn will increase growth and employment. Returns to capital investment may not be low everywhere at the same time.

Summers responded that (i) saving and investment may not equate at full employment smoothly due to interest rate adjustment (secular stagnation is all about saving > investment); (ii) excess saving may flow abroad if returns to investment are attractive; (iii) at zero real interest rate, government debt service is very cheap and hence it can borrow without adding much debt overload to finance public infrastructure spending (Keynesian fiscal stimulus effect kicks in); (iv) savings-investment balance is for the global economy, so economies with excess savings may consider reducing their savings or increasing their investment (narrow the gap between desired savings and desired investment).

Bernanke responded again arguing that the secular stagnation hypothesis holds true if the whole world is suffering from such a phenomena. Else, such trends in the US would be negated by FDI and exports boost to other countries that have relatively better aggregate demand. Hence, another policy implication is that the US should work on lowering or elimination of FDI outflows and export barriers.

Paul Krugman added that Summers paid insufficient attention to international capital flows (which he agreed in response to Bernanke). But, this does not mean that even if they were accounted for the secular stagnation concerns are obviated. Secular stagnation occurs when “countries face very persistent, quasi-permanent liquidity traps”. Japan is an example. Japan faced really low nominal interest rate since 1990 and persistent deflation as well. Real interest rate was still positive and the other economies offered relatively better investment opportunities (the US and the EU saw such low rates only after 2008). But still Japan was stuck in low growth equilibrium for a long time. Policies to boost demand are the call of the hour right now.

[Presentation] Nepal’s economic outlook for FY2015 and FY2016

Here is the presentation made during the press conference on Asian Development Outlook 2015 in Kathmandu.

ADO 2015 Nepal

Nepal’s economic outlook for FY2015 and FY2016

The economic outlook is less favorable than in FY2014 (ends 15 July 2014)  because agricultural output is crimped by a weak monsoon and the political situation is fluid. The Constituent Assembly, the second of which was elected in November 2013, failed again to write a new constitution, this time by the 22 January 2015 deadline agreed by all political parties. There is yet no unanimity among the political parties on how to proceed. Many of the outstanding issues that the earlier Constituent Assembly failed to resolve remain contentious, leaving uncertainty over the future course of politics regarding such basic matters as the number, names, and functions of proposed federal states, as well as on the overall structure of governance.

The weak monsoon and such natural disasters as floods and landslides will affect the output of paddy, maize, and millet. Industry may see better conditions in the medium term following the government’s strong commitment under the FY2015 budget to ease business regulations by introducing updated policies and legislation, though a downside risk is that the unsettled political environment will derail legislative action. Nevertheless, news from the power sector bolstered business and investor confidence. The government concluded project development agreements in the first half of FY2015 for two 900-megawatt hydroelectricity projects promoted by Indian investors.

Considering the unfavorable monsoon and the lingering political uncertainty, GDP growth is projected to slow to 4.6% in FY2015, less than the government’s revised target of 5.0%. The Ministry of Agricultural Development projects paddy output to drop by 5.1%, and maize by 6.0%. Almost half of growth will come from services, particularly robust growth in wholesale and retail trade, tourism, and transport and communications. The reform-oriented budget calls for higher capital expenditure and for total planned spending to increase to 23.7% of GDP, up by 5 percentage points. This should help to underpin growth, especially in construction, even if capital spending falls modestly short. Assuming a stable political situation, a normal monsoon, a timely budget and its effective execution, and strong remittance inflows, GDP growth is expected to rebound to 5.1% in FY2016.

Despite the expected agricultural shortfall—and an increase in civil service salaries and allowances for a second consecutive year—average inflation is expected to continue to slow to 7.7%, lower than the target set by the central bank in its 2015 monetary policy, as neighboring India experiences markedly lower inflation and the drop in international oil prices passes through as lower administered fuel prices. Food inflation is expected to ease somewhat but will remain elevated owing to the smaller domestic harvest. Inflation is projected to edge lower in FY2016 to 7.3% on a better harvest, broadly stable oil and commodity prices, and central bank’s progress in efforts to rein in excess bank liquidity.

The external position is expected to weaken in FY2015 with lower surpluses in the current account and overall balance of payments. Though export growth is expected to stay at 5.0% and import growth to slow to 10.0% on lower prices for petroleum imports, the improvement in the trade deficit will likely be offset by some slowing in remittance inflows, narrowing the current account surplus to 2.7% of GDP. A pickup in export growth, strong remittance inflows and tourism receipts, and continued low global oil prices are expected to boost the current account surplus to 3.5% of GDP in FY2016.

Adapted from Asian Development Outlook 2015, Nepal chapter.