Getting India Back to the Turnpike: What will it Take?

Getting India Back to the Turnpike: What will it Take? Rakesh Mohan Senior Fellow Jackson Institute for Global Affairs Yale University And Distinguished Fellow Brookings India George Washington University Washington DC October 5, 2016 October 5, 2016 1

Getting India Back to the Turnpike: Introduction What will it Take? The Indian Economy: A Story of Consistent Growth Getting Back to the Turnpike: A Simulation for 2017-32 Policy Imperatives for Getting Back to the Turnpike Conclusions October 5, 2016 2

Introduction (1) India s Recent Growth Trajectory The Golden Era 2003-08 Growth Pause 2008-09 Continued Growth 2009-12 The Great Slowdown 2013-14 Can India Get Back to Sustained High Growth? October 5, 2016 3

Introduction (2) The Global Economic Environment Global slowdown caused by North Atlantic Financial Crisis European Sovereign Debt and Banking Crisis, 2010 Protracted Recession in Advanced Economies, particularly Europe Global Trade Slowdown Possibility of Secular Stagnation Can India Get Back to Sustained High Growth? October 5, 2016 4

The Indian Economy: A Story of Consistent Growth A Story of Sustained Growth Consistent Acceleration Since Independence Interregnum 1965-81 Mostly Financed by Rising Domestic Savings High Industrial Growth 6-7 per cent Except 1965-81 Variable Agriculture Growth Consistent Acceleration in Services Not just Recent October 5, 2016 6

Indian Growth Record (1) Consistent Acceleration and Domestically Financed Percent 10 8 6 4 2 0-2 -4-6 GDP Growth 1950-51 1954-55 1958-59 1962-63 1966-67 1970-71 1974-75 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03 2006-07 2010-11 GDP Growth (Factor Cost) 5 per. Mov. Avg. (GDP Growth (Factor Cost)) Percent to GDP 40 35 30 25 20 15 10 5 0 Savings and Investment 1950-51 1953-54 1956-57 1959-60 1962-63 1965-66 1968-69 1971-72 1974-75 1977-78 1980-81 1983-84 1986-87 1989-90 1992-93 1995-96 1998-99 2001-02 2004-05 2007-08 2010-11 Savings Rate Investment Rate October 5, 2016 7

Indian Growth Record (2) 12 10 8.8 9.8 8.9 Percent 8 6 4 6.6 4.9 2.9 4.1 4.2 6.9 6.4 3.5 5.9 6.1 4.0 6.9 6.4 3.7 7.9 4.3 4.9 3.6 7.3 3.1 6.2 2 2.1 1.0 0.4 0 1950-65 1965-81 1981-90 1990-91 1991-97 1997-2003 2003-08 2008-12 2012-14 Agriculture Industry Services GDP (factor cost) October 5, 2016 8

Investment Both Public and Private Sectors are Drivers 40 35 30 Percent to GDP 25 20 15 10 5 0 1950-51 1952-53 1954-55 1956-57 1958-59 1960-61 1962-63 1964-65 1966-67 1968-69 1970-71 1972-73 1974-75 1976-77 1978-79 1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 2010-11 2012-13 Household Sector Private Corporate Sector Deterioration in public savings between late 1990s and early 2000s also a period of slow growth. Improvement between 2003 and 2008, associated with growth acceleration. October 5, 2016 9

The Golden Era of Growth (1) Prudent Fiscal Policy Combined Fiscal Deficit Halved Improvement in Tax GDP Ratio Subsidies Controlled Increased Public Investment Growth in Public Sector Savings October 5, 2016 10

The Golden Era of Growth (2) Complex Monetary and Financial Management Low Inflation Low interest rates High and Volatile Capital Flows Managed Floating but Managed Exchange Rate Banking Regulation and Supervision Tightened High Credit Growth High Banking Quality October 5, 2016 11

The Golden Era of Growth (3) Corporate Sector Sustained Growth in Profitability Availability of Own Savings No Crowding Out Step Up in Corporate Investment Households Continued Growth in Financial Savings Robust Consumption Demand Housing Investment October 5, 2016 12

The Great Slowdown 2012-14 (1) Excess Fiscal and Monetary Stimulus 2008-09 Some Revival of Growth 2009-12 Poor Quality Fiscal Stimulus Tax Cuts Increase in Subsidies Reduced Public Investment Hesitant withdrawal of Fiscal, Monetary Stimulus Revival of Capital Flows, not Managed October 5, 2016 13

The Great Slowdown 2012-14 (2) Consequences High Food Inflation/Overall Inflation: Corrected Crowding Out of Private Corporate Sector: Corrected Real Exchange Rate Appreciation: Continues Increase in Current Account Deficit: Corrected Fall in Savings Rate: Continues Fall in Corporate Investment: Continues Fall in Export Growth: Continues Collapse of Manufacturing Growth:? October 5, 2016 14

Real Deposit Rates: Negative 10 Nominal 10 Nominal 8 8 Percent 6 4 2 0-2 -4-6 -8-10 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Real Interest Rate Note: Real interest rate is nominal deposit rate less y-o-y CPI (Industrial Workers) inflation. Percent 6 4 2 0-2 -4-6 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Real Interest Rate Note: Real_One_Year_Ahead is nominal deposit rate less "one year ahead" inflation expectations of households as per RBI's survey. Dec-13 Jun-14 October 5, 2016 15

A Macro Economic Approach RMSM-X model Model projects investments possible in economy over next 20 years Reflects change between past trends and future estimates based on key economic assumptions Highlights financing gap for the economy Infrastructure investments and gaps can be derived Ensures consistency between projections of balance of payments and national accounts Bottom-up sector-specific financing needs may be much higher than what is feasible for the economy based on macroeconomic scenario Model estimates to be interpreted as broad ranges Objective is to present a broad idea of magnitudes implied by a relatively optimistic growth scenario October 5, 2016 17

Economic growth ICOR Key Assumptions Agriculture 4% p.a. [share in GDP declining] Manufacturing 8-10% p.a. [share in GDP: slight increase] Services ~ 9% p.a. Incremental Capital Output Ratio ~ 4 External sector Exports (goods) grow around 12% Imports (goods) grow around 10-11% Infrastructure investment Infrastructure includes railway, other transport, road and bridges electricity, water and gas supply, and communication Infrastructure investment : from 5.4 % of GDP (2011-12) to around 8% (2017-32) Shares in GDP based on national accounts October 5, 2016 18

GDP Trajectory 8 7 6 6.9 8.0 8.5 9.0 7.1 10 9 8 7 US $ trillion 5 4 3 2 1.9 2.1 3.1 4.6 6 5 4 3 2 Percent 1 1 0 2012-13 2013-18 2018-23 2023-28 2028-33 0 GDP (US$ trillion) (2012-13 prices) GDP Growth (Percent) (right scale) October 5, 2016 19

GDP: Sectoral Trends Manufacturing Growth Needs to Rise to 10% 100 90 Percent 80 70 60 50 40 30 20 10 0 56.3 Services 57.7 59.7 61.0 62.1 Industry 26.2 26.3 Agriculture 26.9 28.0 29.1 17.5 16.0 13.4 11.0 8.8 2012-13 2013-18 2018-23 2023-28 2028-33 October 5, 2016 20

Savings and Investment Requirements Savings 45 40 Investment 50 45 Percent to GDP 35 30 25 20 15 10 9.4 10.8 7.1 14.8 8.5 13.1 9.1 14.0 9.6 14.9 Percent to GDP 40 35 30 25 20 15 29.2 26.7 28.9 31.1 33.3 5 0 11.6 7.1 2007-08 2012-13 2017-18 to 2021-22 Household - Financial 11.4 12.3 13.0 2022-23 to 2026-27 Household - Physical 2027-28 to 2031-32 10 5 0 8.9 8.1 2007-08 2012-13 2017-18 to 2021-22 10.0 10.0 10.0 2022-23 to 2026-27 2027-28 to 2031-32 Private Corporate Sector Public Sector Public Sector Private Sector October 5, 2016 21

Investment Trend 9 8 7 34.7 36.8 38.9 41.1 7.1 43.3 45 40 35 6 30 US$ trillion 5 4 3 2 1 1.9 2.1 0.6 0.8 3.1 1.2 4.6 1.9 3.1 25 20 15 10 5 Percent 0 2012-13 2013-18 2018-23 2023-28 2028-33 GDP (US $ trillion) Total Investment (US $ trillion) Investment Rate (percent of GDP) (right scale) 0 October 5, 2016 Rakesh Mohan / Yale 22

Infrastructure Investment 4.0 3.5 3.0 7.0 8.1 8.1 8.1 3.1 9 8 7 2.5 5.7 6 US$ trillion 2.0 1.5 1.2 1.9 5 4 3 Percent 1.0 0.5 0.0 0.8 0.6 0.6 0.4 0.3 0.1 0.1 2012-13 2013-18 2018-23 2023-28 2028-33 Infrastructure investment Total investment Infrastructure investment (Percent to GDP) (right scale) 2 1 0 October 5, 2016 23

Transport Investment 0.8 0.7 3.3 3.7 3.7 3.7 4.0 3.5 0.6 2.6 0.6 3.0 US$ trillion 0.5 0.4 0.3 0.3 0.4 0.3 2.5 2.0 1.5 Percent 0.2 0.1 0.0 0.1 0.1 0.1 0.1 0.2 1.0 0.5 0.0 2012-13 2013-18 2018-23 2023-28 2028-33 Transport infrastructure investment Total infrastructure investment Transport infrastructure investment (Percent to GDP) (right scale) 0.0 October 5, 2016 24

Railways Investment 350 1.2 1.2 1.3 300 1.1 262 1.1 250 0.8 0.9 US$ billion 200 150 0.5 115 171 0.7 0.5 Percent 100 50 0 85 70 49 56 34 9 17 2012-13 2013-18 2018-23 2023-28 2028-33 0.3 0.1-0.1 Transport infrastructure investment Railways investment Railways investment (Percent to GDP) (right scale) October 5, 2016 25

Policy Imperatives for Higher Growth (1) Public Savings and Fiscal Policy Fiscal Consolidation: A Necessary Condition Restrain Subsidies to around 1 per cent of GDP Deregulate diesel prices Progressively deregulate kerosene/lpg prices Necessary for fuel efficiency Increase Tax GDP Ratio to around 18 per cent Implement GST Reduce Tax Expenditure Enforce Income Tax Compliance 65,000 Black Money Declarers; Average Rs 10 million Increase Public Investment in Infrastructure October 5, 2016 27

General Government Revenues: All countries Cross-Country Perspective Countries with revenue/gdp ratio above 60 percent dropped 2013 2013 120 60 General government revenue (% of GDP) 100 80 60 40 20 General government revenue (% of GDP) 50 40 30 20 10 0 5 6 7 8 9 10 11 12 0 5 6 7 8 9 10 11 12 Per capita GDP, log (US dollars) Per capita GDP, log (US dollars) October 5, 2016 28

Central Government Revenues 13 12 Gross taxes 11 Percent to GDP 10 9 8 7 6 1970-71 1972-73 1974-75 1976-77 1978-79 1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 2010-11 2012-13 2014-15 Revenue receipts, net October 5, 2016 29

Policy Imperatives for Higher Growth (2) Household Savings Monetary Policy for Maintaining Low Inflation Hence positive real deposit interest rates Contain food inflation: Food Supply Chain Strengthen Contractual Saving Pension Schemes Mix of defined benefit and contribution Provident Fund Life Insurance October 5, 2016 30

Policy Imperatives for Higher Growth (3) Private Corporate Sector Reduce Crowding out Manage Competitive Real Exchange Rate for Manufacturing Focus on Manufacturing Make in India: But Urban Land and Labor Reforms SEZs for Labor Intensive Manufacturing October 5, 2016 31

Policy Imperatives for Higher Growth (4) Foreign Savings and Capital Account Management Maintain judicious Current Account Deficit 2.5 per cent Continue Active Capital Account Management Calibrate External Debt Flows Carefully External Commercial Borrowing Limited Opening of Domestic Debt Market o But Opening of Domestic Bond Market Banking subject to Macroprudential Regulations Encourage FDI Continue Foreign Equity Portfolio Investments Accumulate foreign exchange reserves @ 6 months imports ~ 2 per cent of GDP Need Net Capital Flows ~ 4.5 per cent of GDP October 5, 2016 32

Policy Imperatives for Higher Growth (5) Structural Reforms: Acceleration in Manufacturing Growth Promote Labor Using Manufacturing Labor Legislation Reform Urban Land reform Environmental and Other Approval Process Special SEZ for Labor Using Manufacturing Active sourcing of Chinese manufacturing October 5, 2016 33

Indian Manufacturing: Continues to Underperform 15 13 11 Manufacturing Growth 18 17 16 Share of Manufacturing in GDP 9 15 Percent 7 5 3 Percent 14 13 1 12-1 -3 1950-51 1954-55 1958-59 1962-63 1966-67 1970-71 1974-75 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03 2006-07 2010-11 11 10 Manufacturing Growth 5 per. Mov. Avg. (Manufacturing Growth) 1950-51 1954-55 1958-59 1962-63 1966-67 1970-71 1974-75 1978-79 1982-83 1986-87 1990-91 1994-95 1998-99 2002-03 2006-07 2010-11 October 5, 2016 34

Manufacturing: India and Asia Economy Share in Output Share in Employment Year of highest Value of highest Year of highest Value of highest Data since share share Data since share share Azerbaijan 1990 1992 23.9 1983 1983 18.3 Bangladesh 1980 2011 18.2 1984 1989 13.9 Cambodia 1993 2004 19.9 1993 2006 10.8 China 1965 1978 40.5 1978 1988 15.9a Hong Kong 1970 1970 29.6 1974 1976 45.3 India 1960 1979 17.3 1960 2002 12.9 Indonesia 1960 2001 29.1 1971 1994 14.7 Korea, Rep. of 1965 1988 30.7 1963 1989 28.7 Kyrgyz Rep. 1990 1992 33.7 1986 1990 17.0 Malaysia 1960 1999 30.9 1975 1997 27.6 Pakistan 1970 2008 19.7 1973 1982 14.5 Philippines 1960 1973 26.6 1971 1971 11.5 Singapore 1975 2004 27.5 1970 1981 30.4 Sri Lanka 1960 1977 23.1 1990 2006 19.2 Taipei,China 1960 1986 39.2 1963 1987 35.2 Thailand 1960 2007 35.6 1960 2007 16.4 Memo: Average 27.8 20.8 OECD 25.9 25.7 a This refers to both urban and rural manufacturing employment. Available data for employment is only up to 2002. The share of urban manufacturing in total manufacturing employment is about 28% (for 2000 2010). OECD output and employment averages refer to 23 countries. Source: Key Indicators for Asia and the Pacific 2013. October 5, 2016 35

Policy Imperatives for Getting Back to the Turnpike (6) Transport Infrastructure Office of Transport Strategy Central Government State Governments Railways Organizational Reform Corporatization Accelerate Dedicated Freight Corridors Focus on Energy Commodities Transportation Modernization of Rolling Stock Need for at least 2 Mega Ports Coordination of Road and Rail Investment Arrangements for Multimodal Transport Logistics Parks October 5, 2016 36

Conclusions Return to Growth Turnpike Feasible Fiscal Consolidation Low Inflation Revival of Manufacturing Competitive Real Exchange Rate Step Up in Investment in Energy and Transport October 5, 2016 38

THANKS October 5, 2016 39