Can India Catch Up?FORTUNE.COM

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INDIA REPORT

Can India Catch Up?

FORTUNE

Monday, April 29, 2002

By Anthony Paul

 

To get an idea of where India has been, where it is, and where it

hopes to go, take a drive on the new six-lane section of the Grand

Trunk Road north of Delhi. The GTR, as Indians call it, stretches

some 1,800 miles across the subcontinent, from Calcutta to the

Khyber Pass. An artery as old as India itself, it was first paved by

the Mogul emperor Sher Shir 500 years ago. In the 19th century,

Rudyard Kipling, the bard of the British raj, called it "a river of

life"--a description just as fitting today. The GTR is the essence

of 21st-century India: simultaneously living in the age of the

wheel, the Industrial Revolution, and the information era. Lanes

separate bullock and camel carts from fast-moving cars and

semitrailers, and the traffic is monitored by Indian-designed,

Internet-linked management systems.

 

Such juxtapositions are hallmarks of modern India. In Karnataka, 20

miles from Bangalore, farmers using centuries-old tools to dig

potatoes from the ground check market prices on high-tech touch-

screen devices called Simputers. In Sirsa, northwest of Delhi, an

application to buy a buffalo can be downloaded at an Internet-linked

PC kiosk for 10 cents.

 

But even as India tries to catch up, it is falling further behind.

In most Asian countries, the number of young adults is declining. In

India the percentage of the population in the 15-to-24 age group is

rising 1.6% annually. That means the economy is headed for a

rendezvous with demographic destiny: To keep all those young people

employed, it will have to create no fewer than ten million jobs a

year between now and 2010. In order to do that, says a recent report

prepared for the government by the McKinsey Global Institute, the

Indian economy needs to grow 10% a year. The best the country has

managed since independence in 1947 is far short of that--7.8% in

1996 and 1997. The current level of growth, 5.4%, translates into

just four million new jobs a year.

 

In principle, McKinsey argues, India can do it--as China, Thailand,

and Malaysia have all proved. But reaching and sustaining 10% growth

will require an enormous effort, starting immediately. And while a

recent visit to the country turned up some reasons for optimism--an

$11 billion national highway improvement program, an extraordinary

display of information technology, a grassroots microeconomics

movement--it also provided plenty of evidence that India won't make

it.

 

India's modern economic history begins on British campuses in the

1930s. Academics who admired the Soviet Union's forced march to

industrialization were in vogue. One of the most prominent was

Harold Laski of the London School of Economics. Laski taught many of

the Indians who ran the country in the early years after

independence from Britain. His message: Profit is synonymous with

exploitation, markets should be ruthlessly curbed, and wealth

redistribution (rather than its creation) should be the government's

policy focus. To this day, the LSE's Website boasts that when newly

independent India's cabinet met, "there was a chair reserved for

Prof. Laski." But the school cannot brag about one of Laski's

legacies--decades of squandered economic opportunities.

 

In line with Laski's thinking, independent India replaced the

British raj with what came to be known as the "license raj."

Bureaucrats reduced contact with overseas markets and manipulated

the private sector with licenses, permits, taxes, fiats, and

tariffs. Untested by foreign competition, Indian goods failed to

develop export markets. The country's share of world trade fell from

2.4% in 1947 to 0.4% in 1990. (It is currently stagnant at 0.6%.)

The economy grew about 3% to 4% annually during those years.

 

In 1991, India hit something like bottom, and the central bank had

to fly part of its gold reserves to London as collateral for an

emergency IMF loan. Under pressure, the government, then controlled

by the Congress Party, abruptly shifted economic direction,

devaluing the rupee, lifting some price controls, embracing

privatization, and lowering taxes and tariffs. India avoided

default, and for a time the economy perked up. As the sense of

urgency faded, however, reform lost momentum.

 

It has to be galling that even though socialism on the subcontinent

never reached the extremes Mao imposed on China, India is faring

much more poorly than its neighbor to the north. A decade ago, India

and China had roughly the same GDP per capita. Now India's is about

$460 and China's $840. If India continues to grow at 5.4%--a rate it

has never been able to sustain over any length of time--it would

take 12 years for it to reach China's current income level and

decades more to reach that of Thailand or Korea.

 

Much of India's sluggishness is self-inflicted. Its 30% average

tariff on imported products is lower than what it was in 1991, but

it is still among the world's highest, and the 115% fee added to the

cost of California raisins, or the 706% added to the price of some

imported distilled spirits, is simply astronomical. Nontariff

barriers abound: As many as 100 clearances may be needed for

approval of a typical foreign investment. "There's a growing mood,"

the Business Standard, a Delhi financial daily wrote recently, "that

in spite of reforms there's simply no way of doing business here

without being trapped by the bureaucracy, for which Indians have

unique genius."

 

 

A greater role for India's private sector cannot come too soon, as a

visit to the grimy and chaotic Delhi domestic air terminal confirms.

The place would have shamed a Soviet coal town. But board a Jet

Airways flight to Mumbai, and the view is altogether different. The

closely held private airline, launched nine years ago, operates new

Boeing 737s, offers three meal choices, and has won 42% of the

domestic market. Profits aren't disclosed, but CEO Steve Forte says

the airline has been in the black from the start. In part that's

because Jet employs only 160 people per aircraft, compared with 500

for its main competitor, Indian Airlines, a state-owned money loser.

(Air India, the state's international airline, has more than 700

employees per aircraft.)

 

Although the Indian government pledged in 1991 to sell $11 billion

in shares of state-owned enterprises within a decade, it has so far

managed to sell off only a third of that amount. Resistance by

politicians who view privatization as a sellout of the nation's

patrimony is largely to blame. Hopes that the speed of privatization

would increase were raised in March when the government sold a 25%

stake of its overseas telephone monopoly to the Tata Group. But the

simultaneous sale of petroleum marketer IBP to another state-owned

company, Indian Oil Corp., dampened those prospects.

 

What happened in the auto industry when government controls were

relaxed in 1991 is an example of how private industry can prosper,

to the benefit of Indians, when the red tape is loosened a bit. The

government permitted more Indian firms to make cars and invited

foreign companies to enter the market. As a result, Ford, General

Motors, DaimlerChrysler, Toyota, Suzuki, BMW, Hyundai, and Fiat are

all successfully manufacturing here. Old, pre-reform auto plants,

such as those making the Ambassador, a comical throwback to the

1950s, have lost market share. At the same time, demand soared for

cheaper, better Indian-made cars. Auto industry employment rose by

11% from 1992 to 2000, despite a stunning 256% growth in

productivity. "If we can do it with autos," asks Shirish Sankhe,

project manager for the McKinsey study, "why can't we do it with

another ten sectors?"

 

In one sector in which the government never had a toehold--

information technology--India has shown extraordinary command,

supplying software to more than half of the FORTUNE 500 companies.

Two Bangalore software superstars, Infosys Technologies and Wipro,

have campuses whose architecture and manicured lawns resemble well-

endowed California universities. Despite a brutal worldwide slowdown

in demand, Infosys has kept its operating margins above 30% for the

past seven quarters. Wipro's revenues are up 27% from last year.

 

Both companies are focused on climbing the value chain as they

evolve from software developers to consultants for giants like GE,

Intel, and Sun Microsystems. "The big companies would give us

specifications, and we'd develop software for them," says Wipro vice

president Vijay K. Gupta. "We want to move to the position where we

say, 'This is what you need, and we can do it for you.' " One reason

for the companies' success is India's extraordinary pool of English-

speaking engineers, who typically make about 20% of U.S. salary

levels. Another: The software industry was so different the

government didn't know how to regulate it to death.

 

Mumbai, India's largest city, represents the population apocalypse

at its most imminent. Half of its 11 million residents live in some

of Asia's worst slums. Yet hundreds of new migrants stream in every

day, drawn by the aura of opportunity. If the city continues to grow

at its current rate, it could have a population of 27 million by

2015. Mumbai is not ready for them. "More than six million slum

dwellers have access to only 77,000 toilets," complains A.B.

Madhuskar, a retired city official.

 

Still, Mumbai retains enormous commercial vitality. It is home to

many of India's oldest and most prominent business families, as well

as to the 127-year-old Bombay Stock Exchange, which, along with the

newer National Stock Exchange, accounts for more than 90% of India's

stock trading. With income levels triple the national average and a

cosmopolitan population, the city is a magnet for foreign investors.

That includes, improbably, McDonald's. Cows are sacred to Hindus,

and pork is forbidden to Muslims, so Hardcastle Restaurants,

Mumbai's McDonald's franchise operator, has replaced beef and bacon

with items like the Chicken Maharajah and the Veg Surprise, an herb-

and-potato-filled bun. In five years Hardcastle managing director

Amit Jatiya has opened 34 McDonald's outlets in western India; he

figures India's potential McDonald's market at 50 million people.

 

One of Mumbai's most vigorous business activities is providing IT-

enabled services. GE Capital Services opened India's first

international call center in Delhi in 1993. Its 10,000 employees now

handle accounting, claims processing, and credit-evaluation services

for more than 80 General Electric branches. British Airways and

Lufthansa run frequent-flier programs out of India. Dell supports

its home and small-business customers from India. Banks using India-

based call centers include Citibank, Deutsche Bank, HSBC, and

Standard Chartered. Last year's revenues from all IT-enabled

services here totaled $480 million. By 2008, the industry boasts,

India will be "the world's back office"--a $16.2-billion-a-year

industry employing 1.1 million people.

 

One Mumbai IT services firm, First B@se, offers digital archiving

for accounting firms and hospitals. The company can hire qualified

accountants and doctors to handle processing for as little as $5 an

hour, compared with five or ten times that figure abroad. It is also

looking to process medical research done in India, which is often

not properly analyzed and stored. "Every day there's a new epidemic

in some part of the country," says managing director Rudrabhatla

Ramkumar. "Disease and fighting it are among our core competencies."

 

"I'm increasingly heartened by the microeconomics," says Sumantra

Ghosal, a London Business School professor who regularly visits

firms in Mumbai. "More and more private companies are becoming world-

class." But Ghosal is less sanguine about the macro

side. "Politics," he says, "makes it anybody's guess."

 

Prime Minister Atal Behari Vajpayee of the center-right Bharatiya

Janata Party seems to favor continued liberalization. But he leads

an increasingly unpopular 19-party coalition stuffed with people

hostile to the idea. For example, the Labor Ministry appears to be

already backtracking from a decision announced in February to amend

a 55-year-old law giving the government final say over whether

companies with up to 1,000 employees can fire workers or close money-

losing units. Coalition members have also begun to question

provisions in the recent budget that called for more privatization

and less bureaucracy. It doesn't help that Hindus and Muslims have

been killing each other in sectarian riots, or that always-tense

relations with neighboring Pakistan have become more so since the

bombing of the Indian Parliament in December.

 

 

But even if Indians elected a more cohesive government that pledged

more economic reform, change would be slow. With its 237,687 local

and state jurisdictions, India is an administrative nightmare. Those

who run the fiefdoms all want a piece of the action. Payoffs are so

ubiquitous that India ranks 71st in perception of corruption on

Transparency International's latest list--behind China (57) and the

Philippines (65).

 

As the bureaucracy fiddles, critics of India's economic policy burn

with conviction. "Ten percent growth is not simply desirable, it's a

necessity," says McKinsey's Sankhe. "It's also attainable--if the

right new policies are implemented."

 

It's a daunting task, lifting all of India's one billion people into

the modern economy. A third of the country's adult men and nearly

two-thirds of its women are unable to read or write. Seven of ten

citizens live in 700,000 villages, many of them remote.

 

Proposals for putting fresh life in the economy have taken many

forms. Maharashtra, the state of which Mumbai is capital, is copying

China's special economic zones. On some 20 square miles a 90-minute

drive from Mumbai, Maharashtra's City & Industrial Development Corp.

is sponsoring the Navi [New] Mumbai Special Economic Zone. State

bureaucrats say they will offer investors who commit a minimum of

$100 million a business environment untouched by red tape--a tacit

admission that the rest of the country is tangled in it. Residential

complexes, hotels, hospitals, an industrial park targeting IT firms,

and a convention center have already been built. There are as yet no

takers with $100 million in hand, but the project's managing

director, Anil Kumar Lakhina, says he has had inquiries from firms

in the U.S., Singapore, Australia, and New Zealand. Maharashtra

hopes that by 2008 more than 200 enterprises from biotechnology to

auto parts will employ 534,000 people and export goods worth $2.2

billion.

 

At least some of India's grandees have also embraced economic

change. "The post-economic-reform period from '91 to 2001," says

Anil Ambani, the 42-year-old co-CEO of the Mumbai-based Reliance

Group, India's largest private business, "has been the real catalyst

for Reliance." Critics say that the secret to the company's success

was founder Dirubhai Ambani's skill in getting permits when

bureaucrats were the gatekeepers to the economy. Anil, a marathoner

who runs the company now with his older brother, Mukesh, dismisses

these critics, saying Reliance thrives on competition. (Last fiscal

year the petrochemicals, textiles, and telecommunications

conglomerate reported revenues of more than $12 billion.) But, he

says, reform has a long way to go. He ticks off a to-do list for the

government: capital account convertibility, lower interest rates,

and more funds for education.

 

There is also interest in the work of C.K. Prahalad, a business

professor at the University of Michigan. His message: "Create a

consumer market for the poor." In a 1999 essay, "Raising the Bottom

of the Pyramid," Prahalad and Stuart L. Hart, a professor at the

University of North Carolina, chided companies for focusing too much

on rich consumers. The new century's "real market opportunity," they

wrote, "is the billions of aspiring poor who are joining the market

economy for the first time."

 

Prahalad points to Arvind Mills of Ahmedabad. This textile

manufacturer realized that few rural villagers could afford its $40

jeans. So in 1995 the company introduced Ruf & Tuf, a sew-it-

yourself package that sold for about $6. It soon became India's top-

selling brand of jeans. Within three years, economies of scale made

it possible for Arvind to dispense with the kit and offer Ruf & Tuf

ready-made jeans for $9. Similarly, Hindustan Lever and Procter &

Gamble realized that cash-poor families couldn't come up with the

money to buy large sizes of shampoo or cough lozenges. So they sell

shampoo in small sachets and lozenges wrapped for one-at-a-time

sales.

 

Inspired by the Prahalad-Hart essay, Hewlett-Packard India launched

what it calls its World e-Inclusion Initiative to find new business

models for spreading PC use to India's masses. One such model

already in operation is Delhi-based Drishtee.com's (drishtee

means "vision" in Hindi) Internet-linked PC kiosk. The company has

set up about 50 kiosks in small villages, each run by a franchisee

who has received a $1,000 government loan to purchase a PC. In

Sirsa, northwest of Delhi, Alka Narang, 25, a housewife, deals with

about 35 clients a week, helping them download and complete

applications for driver's licenses and other government paperwork.

The forms are sent in bulk to district offices, but eventually they

will be filed online. Says Narang: "My business saves many farm

workers from losing a day's wages while they wait in government

queues." Drishtee is counting on India's size and the need for extra

services (e-mail, marriage introductions, low-cost e-commerce) to

build revenues. A business plan aims for 75,000 kiosks by next year.

 

A Bangalore company has gone a step further, putting computers

directly in the hands of farmers. It's called the Simputer

(for "simple computer"), and it's a low-cost hybrid of an Internet-

connected computer and a personal digital assistant. The idea

emerged three years ago when a rural banker asked Vinay L.

Deshpande, CEO of Encore Software, for a device that would improve

the security of transfers of deposits as small as one rupee (about 2

cents) from farmer to bank. Roving deposit collectors had been

cheating illiterate farmers by issuing doctored receipts. The banker

told Deshpande, "Deliver for less than 10,000 rupees [about $200] a

handheld device that can print a receipt on the spot and record the

amount electronically, and my bank will buy 1,000 of them."

 

Deshpande and six other IT experts formed the Simputer Trust and

donated their hardware-development time. In exchange, they retained

the rights to any add-on Simputer software. The latest model is a

32MB Linux-based, handheld, text-to-voice device that runs on three

AAA batteries. Selling price: $200. When a farmer touches, say, a

potato's image on the screen, a voice tells him in any one of

India's 16 official languages the latest market price. Middlemen can

no longer fool him. One Simputer typically sells to groups of ten

villagers for $20 a person. For an additional $2, each co-owner

receives a smart card to insert into the Simputer for transactions--

money transfers, e-mail, downloading MP3 songs. The first 100,000

units went on sale in April.

 

"Fifteen years ago the federal government had only one development

model for India, and that was flawed," says Prahalad. "Today there

are 20 or so models. Maybe five will work. They'll be quickly

copied. We'll see a very different India in seven to ten years."

 

Despite Prahalad's upbeat assessment, McKinsey's "imperative" of 10%

growth is more of a prayer than a promise. But there's one sign that

healthy competition might eventually prevail. Three years ago

Ahmedabad's Harold Laski Institute of Political Science closed down.

The reason: lack of funds.