Sunday, August 14, 2011

India’s Economic Independence: Minimal Imports and Maximal Exports

I feel privileged to script this post on India’s Economic Independence, coinciding with India’s sixty fourth anniversary of its historic independence on August 15, 1947. This also happens to be my one hundredth post in my strategy blog titled “Strategy Musings”. Starting on October 22, 2008 with my first ever blog post titled “Infrastructure Strategy: Key to Economic Revival” it has been a highly compelling and satisfying journey of a hundred serious essays on corporate strategy, competitive strategy, strategic management, leadership strategy, organizational behavior, economic strategy, general management, leadership tributes, corporate governance, entrepreneurship, ethics and values, operational excellence and several other domains of interest in strategy and economy. Each of the blog posts has sought to acknowledge and review some of the greatest prior art on each subject while adding a substantial new body of knowledge through my original thinking. As a result, in a relatively short span of less than thirty five months, the 100 strategy essay portfolio of around 3.5 million words has been created with diligence and dedication to develop and institutionalize multidisciplinary knowledge in the field of strategy. I would like to believe that this level and intensity of serious essay writing in the field of strategy, in the relatively short span of time is probably unparalleled in the sphere of digital blogging or physical publishing.  

The current blog post is not merely thematically appropriate in the context of India’s celebration of the country’s Independence Day but also strategically essential, even more so, for imbuing the true meaning of independence for the Indian society. After over six decades of independence and nearly two decades of economic realization India has come into global reckoning for its competitive capabilities in a wide range of domains, not limited to information technology; and more significantly is being positioned as the third largest economy by 2035. It would, however, appear that much of the proposition is based on the near doubling of growth rate in the gross domestic product (GDP), and not based on the ability of the Indian economy to grow without foreign direct investments or import of foreign technologies, and with organically generated trade surpluses, savings, capital formation and indigenous technologies. India, as an economy, and its stock markets as a barometer of industrial health have been acutely dependent on foreign investments whether in primary industrial activities or secondary stock markets. The key question is whether the broader economic fundamentals of India are truly robust and whether the industrial parameters are genuinely self-sufficient. This blog post argues that India’s independence has true meaning with only economic independence and identifies the essential route to achieving it with positive trade balance.
Macroeconomics of India’s growth
India’s growth story rests on its vigorous GDP growth rates. The world first took note when India posted a record GDP growth rate of 9.6 percent in 2006-07, and followed it up with a similar growth rate of 9.3 percent in 2007-08. Even in the highly turbulent period of global meltdown, the Indian economy continued to post high growth rates of 6.8 percent in 2008-09 and 8.0 percent in 2009-10. However, there is concern that the growth is now projected to hover around the same levels at 8.5 percent in 2010-11 and at 8.2 percent in 2011-12, despite the relative easing of global liquidity and the global recognition of India’s global potential. In the context of the concerns of sovereign debt globally, India’s public debt as a percentage of GDP has been 56 percent, well below the level of even advanced nations but certainly needs to be improved further. India’s external debt as a percentage of GDP has hovered at around 18 percent and this also needs improvement. Accelerated inflation, decelerated investment and slowed down reforms have contributed to the slowdown in GDP growth rates over the last two years. Inflation ought to be lower than 6 percent while it has been in excess of 10 percent. Fixed investment rate has to be more than 33 percent of the GDP while it has been lower than 30 percent. Domestic savings rate of more than 40 percent of the GDP is desired while the recent rate has been less than 34 percent. The combination of the target rates in the three structural parameters would have resulted in GDP growth rates in excess of 9 percent while the actual rates have fetched lower GDP rates of around 8 percent.  
The key sectors of the Indian economy comprise agriculture, mining, manufacturing, energy, construction, financial services and non-financial services, each with allied activities in the respective folds. Amongst all the sectors, agriculture has been a laggard in growth rates, with volatility related to high or low rainfalls, relative to the other sectors. A simple econometric model suggests that if the various sectors of the Indian economy achieve simultaneously the individual sector peak rates achieved in any of the last five years, such as 6.5 percent in agriculture, 7.5 percent in mining, 14.5 percent in manufacturing, 9.5 percent in energy and water, 11.0 percent in construction and 14 percent in financial and non-financial services each, the overall GDP growth rate of the Indian economy would be in excess of 12.0 percent per annum. Simultaneously, central and state finances have to be managed such that social sector investments and subsidies are appropriately cross-managed, oil sector charge on the economy is minimized, public debt is kept under check, and revenue leaks and expenditure spillages are avoided. A robust macro-economic framework which maximizes sector growth rates, maintains inflation at moderate levels, spurs domestic savings and enhances gross fixed investment is essential to keep the economy on the high growth path.
Need for microeconomic strengths
Macroeconomic strengths of a nation are a resultant of its microeconomic vitality. While macroeconomic policies do have an impact on the microeconomic fundamentals, be it industrial output, consumption patterns, savings and expenditure profiles and foreign trade balance, microeconomic fundamentals have a unique input mix and output profile. At the core of microeconomic vitality is the level of intrinsic industrial competitiveness. Microeconomic vitality is reflected in terms of positive trade balance. The higher the positive trade balance, the higher is the microeconomic strength. India’s liberalization model which is based on large bouts of foreign direct investment for primary industrialization and high levels of foreign institutional investments for market capitalization of industries does not necessarily lead to intrinsic microeconomic strength. Despite high economic growth rates, India has been having continued trade deficits over the years. Though in July 2011, India’s exports registered a steep 81.8 percent growth to touch USD 29.3 billion, the imports also increased by a hefty 51.5 percent to USD 40.4 billion, resulting in a net negative trade balance, or trade deficit, of USD 11.1 billion. Cumulatively too, in the period April-July 2011, exports grew by 54 percent to USD 108.3 billion and imports grew by 40 percent to USD 151 billion, resulting in a cumulative trade deficit of USD 42.7 billion.
Much of the recent growth in exports has been derived from a sterling performance of sectors such as engineering, petrochemical products and gems and jewellery as well as greater channeling of exports to Africa and South America. The model of FDI triggered industrial development has its own contribution to microeconomic sub-optimization. Many times FDI is accompanied by massive imports of technologies, equipment and key input materials as well as repatriation of profits leaving the net capital retention in the country at a minimal level, possibly limited to the low levels of value addition in the country and meager profit levels. This has been well demonstrated in a host of import dependent industries from automobiles to oil exploration. This, of course, is not in any way inimical to the national interests per se, and is actually positive for the number of new jobs such FDI creates for the economy and the society. However, the several multiplier impacts of greater generation of local value addition through indigenous technologies, equipment and materials would be unquestionably higher. Low operational cost curves based on greater indigenous inputs would lead to greater industrial competitiveness, and positive trade balance. Macroeconomic policy should go beyond gross growth rates and identify ways and means by which microeconomic fundamentals of the economy and industry can be strengthened.
Competitiveness handicaps
India’s competitiveness handicaps follow the initial post-independence strengths. While the socialistic policies set by India’s first prime minister Pandit Jawaharlal Nehru have been criticized by many a liberalization expert, there is no doubt that the early policies were indeed instrumental in creating the basic industries of steel, engineering, machine tools and aerospace in the public sector. Where the policies erred were in terms of severe capacity regulations, bureaucratic controls on every aspect of industry and business, denial of similar opportunities for the private sector, and the shared diffidence of both the industry and the government towards fundamental innovation, high precision, quality and reliability and pricing to enable continuous reinvestment. Another two major gaps were in terms of ignorance of the need to create a similar base in the electronics, telecommunications and computer hardware on one hand and non-application of modern preservation, mining and extraction technologies to utilize the country’s abundant onshore and offshore natural resources for self-sufficiency and competitiveness. As a result, India’s competitiveness became to be dependent on import of technologies, equipment and quality materials. This dependency cycle does not seem to have been broken despite the two decades of liberalization. For example, while the Indian automobile industry now appears to be scale-optimal and self-sufficient, each new generation of vehicles in the premium sector comes with high import content.
Today, the policy makers and strategists must seriously debate if the continued import dependence is still a function of scale, matter of user mindset or simply lack of dedication to development of world-class technologies and equipment which result in high quality and rigorous precision. Several Indian industries today, from automobiles to pharmaceuticals, from construction to transportation and distribution to retailing have aggregate scales of operation ranking among the top 5 to 10 rankings in the world, in physical volume or unit terms. It is time that the basic producers and the end-users, whether of materials or equipment, collaborated to localize technologies, equipment and materials in advance to support new generation products. This would also require a move away from a total reliance on cost to a reasonable positioning for value; for technology also demands its price to innovate and manufacture to high standards. In a more perfectly globalized world, which would occur when the BRICS countries achieve the developed nation status, competitiveness would not be solely on the basis of manufacturing commoditized products for the current developed nations at low costs. Rather, it would be in terms of having alternate innovator products, developed, manufactured and marketed, simultaneously in a larger basket of nations, just as it currently occurs amongst US, EU and Japan. To be illustrative, if a new generation of iPad were to be made five or ten years later there would be a very good possibility of such a breakthrough product being designed and manufactured, through respective innovative technologies, in each of the BRICS countries as much as in US, EU or Japan.    
Minimal imports, maximal exports
If India needs to be strong on both macroeconomic and microeconomic fundamentals, the government and the industry would need to pursue a strategy of minimal imports and maximal exports. For example, the entire import basket needs to be scrutinized to classify the products in terms of scale of demand and feasibility of import substitution. In the liberalized economy a whole lot of goods are being lavishly imported to meet the needs of a consumption oriented economy. From furniture to fixtures and from tiles to textiles, importation has become a lifestyle trend. India has in it all the capabilities to reverse such trends and become actually a net exporter of such items through higher emphasis on design and manufacture for precision, quality, and finishes. As India grows, several sectors such as infrastructure and transportation would be upgraded with overseas participation. Due care must be taken to provide a level playing field to Indian companies to participate in this development space. Similarly, in the precision equipment space, Indian industry must be prepared to make the necessary investments to develop and produce precision machine tools and other equipment as well as dies and tooling, and jigs and fixtures. Indian industry must not only embrace newer materials but also introduce modern material casting, forming and machining technologies to reinforce the edge in electrical, electronic and mechanical industries.
Similarly, the entire industrial basket needs to be reviewed to maximize exports. The experience of Japan and Korea suggests the need for an export oriented industry in India which derives at least 50 percent of its total output from direct exports or distributed production in several host countries. The biggest challenge in a new export paradigm for India would be the strengthening of small, medium, large and mega enterprises with clearly differentiated strengths and responsibilities. Today’s environment encourages the small and large enterprises in India to compete with each other in the same market space, the former only on price and the latter only on features. For example, it is not uncommon to see the largest integrated national pharmaceutical firm and the smallest formulator of medicines to compete in state tenders for medicines. In the bus body building, roadside garage builders and technology-intensive bus makers compete for the same space of transport operators. The current mindlessly fragmented and competitive industry structures of India need to be redefined with mega and large corporations utilizing medium and small enterprises for provision of systems and components. By this system, components and systems of low overhead small and medium enterprises would remain cost-competitive and get integrated within the global manufacturing and marketing capabilities of large and mega corporations for a win-win global export impact. For example, in this system the large scale textile firms such as Raymonds, Digjams and Reliances on one hand and the small scale apparel makers of Tirupur, Coimbatore and Ahmedabad on the other hand would not compete with each other in the same global markets; instead the latter would form a part of an integrated export value chain that provides greater competitiveness for the larger firms  
Trade surplus as a comparative advantage
Michael Porter proposed that just as firms seek and possess competitive advantage, nations are often endowed with and possess comparative advantage as a national phenomenon. For example, Brazil and Colombia may possess comparative advantage in coffee while China and India may possess similar comparative advantage in tea. If India needs to be successful in its quest for global economic dominance despite similar competitive aspirations from other countries the governmental policies and industrial strategies must target generation of trade surplus in each industry not merely as an industrial or corporate competitive advantage, but more as a national comparative advantage. Though export-import balance may seem like an industry or firm level competitive capability, it has a larger macroeconomic advantage. Sustained and continuous trade surplus enables the nation and industry to generate the surpluses needed to reinvest in product innovation and facility upgrades without dependence on external aid or overseas investment which invariably come with tie-in imports. Cumulative trade surplus, accumulated at the rate of say just USD 15  billion per month (as opposed to current trade deficit of USD 10 billion per month) would lead to current foreign exchange reserve level of USD 317 billion in less than two years even without any FDI inflow at all.
More than the macroeconomic numbers, the industrial strength and vitality that gets established through a trade surplus situation provide a virtuous cycle of innovation and manufacturing for global marketing advantage for India. It is possible that an export oriented economy will be sought to be equalized in the global foreign exchange scenario through an appreciating Rupee; however, the benefits of continuing trade surplus far overweigh the risks. For example, trade surpluses coupled with FDI could lead to high gross investment levels of over 50 percent of GDP, as opposed current 30 percent odd levels. Competitive and expanding industrialization would lead to greater urbanization, and spread of urban lifestyles into rural areas as is happening in China, leading to greater number of jobs and increased incomes and consumption profiles. A strategy of minimal imports with maximal exports requires all-round improvement in infrastructure - educational, residential, medical, transport, energy and telecommunications - based essentially on indigenous equipment as much as possible. This would help the nation be not only more productive but also enlarge the price-cost gap for the benefit of infrastructure operators, and enhance the trade surplus for the benefit of the nation.
India’s tryst with destiny
Pandit Jawaharlal Nehru, India’s first Prime Minister, in his speech to the members of the Constituent Assembly at the midnight of August 14, 1947 spoke of India’s tryst with destiny. Nehru’s speech that night ranks as his best speech ever, full of passion and dedication, with continuing relevance, as some extracts reproduced below show.  
Long years ago we made a tryst with destiny, and now the time comes when we shall redeem our pledge, not wholly or in full measure, but very substantially. At the stroke of the midnight hour, when the world sleeps, India will awake to life and freedom. A moment comes, which comes but rarely in history, when we step out from the old to the new, when an age ends, and when the soul of a nation, long suppressed, finds utterance. It is fitting that at this solemn moment we take the pledge of dedication to the service of India and her people and to the still larger cause of humanity. At the dawn of history India started on her unending quest, and trackless centuries are filled with her striving and the grandeur of her success and her failures. Through good and ill fortune alike she has never lost sight of that quest or forgotten the ideals which gave her strength. We end today a period of ill fortune and India discovers herself again.

That future is not one of ease or resting but of incessant striving so that we may fulfill the pledges we have so often taken and the one we shall take today. The service of India means the service of the millions who suffer. It means the ending of poverty and ignorance and disease and inequality of opportunity. The ambition of the greatest man of our generation has been to wipe every tear from every eye. That may be beyond us, but as long as there are tears and suffering, so long our work will not be over. And so we have to labour and to work, and work hard, to give reality to our dreams. Those dreams are for India, but they are also for the world, for all the nations and peoples are too closely knit together today for anyone of them to imagine that it can live apart. Peace has been said to be indivisible; so is freedom, so is prosperity now, and so also is disaster in this one world that can no longer be split into isolated fragments.
The future beckons to us. Whither do we go and what shall be our endeavour? To bring freedom and opportunity to the common man, to the peasants and workers of India; to fight and end poverty and ignorance and disease; to build up a prosperous, democratic and progressive nation, and to create social, economic and political institutions which will ensure justice and fullness of life to every man and woman. We have hard work ahead. There is no resting for any one of us till we redeem our pledge in full, till we make all the people of India what destiny intended them to be. We are citizens of a great country, on the verge of bold advance, and we have to live up to that high standard. All of us, to whatever religion we may belong, are equally the children of India with equal rights, privileges and obligations. We cannot encourage communalism or narrow-mindedness, for no nation can be great whose people are narrow in thought or in action. To the nations and peoples of the world we send greetings and pledge ourselves to cooperate with them in furthering peace, freedom and democracy. And to India, our much-loved motherland, the ancient, the eternal and the ever-new, we pay our reverent homage and we bind ourselves afresh to her service. Jai Hind [Victory to India].
As India completes sixty four years of independence and enters the sixty fifth year, it is evident that the great role for India, envisaged by Mahatma Gandhi, the Father of the Nation and Jawaharlal Nehru, the architect of the modern India, is getting to be fulfilled. There is still substantial work to do. Indian independence can fulfill its full potential only with economic independence, marked by a disease-free, strife-free and happy nation. Some thoughts of this blog post, scripted with best wishes for a happy, independent India, that focus on innovation in design and manufacture to achieve global competitiveness through precision, quality and finishes, should make India economically independent, and provide real fulfillment for the dreams and aspirations underlying in the Indian independence.
Posted by Dr CB Rao on August 14, 2011  



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