Seismic changes emerging to shape India's political economy: Subbarao

AS the new government of Prime Minister Narendra Modi tries to rev up India's economy, a pattern of seismic changes - or "mega-trends" - is emerging and shaping the country's political economy, according to the country's former central bank chief. And understanding these big but gradual changes is crucial to deciphering the future direction of the world's second most populous nation, Duvvuri Subbarao said in a recent lecture at NUS Business School.

Mr Subbarao, who was governor of the Reserve Bank of India for five years from 2008 to 2013, said these mega-trends are what make up the "big picture" of India's transformation.

"Look at an Impressionist painting. Up close, all we see are brushstrokes in a variety of shades and shapes. It is not until we take a step back that we see the big picture in all its artistic clarity," he said.

MANUFACTURING, GLOBALISATION AND DECENTRALISATION

The first of these mega-trends is a manufacturing revolution. India needs such a revolution not only to uplift its economic growth, but to generate jobs for hundreds of millions of young people who are joining the labour market every year, noted Mr Subbarao.

At the same time, another key mega-trend that will shape India's future is decentralisation, according to Mr Subbarao, who is also Distinguished Visiting Fellow at the school. While this process has been underway since independence and strengthened through subsequent amendments to the Constitution, it is going to get much deeper, he added, and for this it needs the active cooperation of state governments.

The third trend is globalisation. While India has been integrating with the world for the past several years, that integration is going to get deeper - notwithstanding the cost it has had to pay.

"There will be a realisation that globalisation comes with costs and benefits, and those benefits, in the long run, outweigh the costs," Mr Subbarao said. "Thus, when I say that globalisation is going to deepen, what I mean is that India's trade will increase, and even on the capital account, India will become more open."

In the same vein, decentralisation - not just at the state level but also at the sub-state level - is going to be another key trend, alongside a shift in the terms of trade towards the rural economy, he added.

WAGE GROWTH

Rising food prices as compared to non-food prices indicate a positive trade shock for the rural economy by way of higher farm incomes, Mr Subbarao told the audience. At the same time, he noted, annual rural wage growth has consistently been in double-digits between 2008 and 2013.

"While no comprehensive or official urban wage data is available, it is likely that rural nominal wage growth has outstripped that of urban wages over much of the last decade."

Mirroring this, rural land prices too have been rising faster than urban property prices in recent years.

Among factors that have brought about the shift in the terms of trade in favour of the rural sector, he said, was the economic liberalisation started in 1991, removing protection for some sectors of the economy that had been at the expense of the rural sector.

THE RURAL SHIFT

In addition were the affirmative action policies of the government, under which conscious effort, partly politically motivated, was made to shift purchasing power to the rural sector. Food, fertiliser, power for agriculture and diesel were all subsidised by the state.

Additionally, there was an increase in the minimum support prices for staple grains to encourage cereal production for food security, which became a major stimulus to the rural economy, and there was a surge in rural wages as a result of an employment guarantee scheme which provided 100 days of guaranteed employment at government-mandated minimum wage.

"The first, and by far the most important, implication of the shift in the terms of trade in favour of the rural sector is that the reduction in rural poverty has been faster than urban poverty," Mr Subbarao said. "Between 2005 and 2012, both rural and urban poverty declined, but rural poverty declined much more sharply than urban poverty."

The second big implication, he said, is that food inflation has become structural. With increasing incomes, there has been a shift in consumption from cereals to protein - from rice and coarse grain to meat, eggs, pulses, vegetables, milk, and fruit.

Large investments are needed for protein production to catch up, he added, while pressure on food has also set off a wage price spiral, which has worsened due to lack of productivity improvement.

Another mega-trend Mr Subbarao notes is what he calls contrarian demographic dynamics.

SKILLS CRISIS

While all other major economies have hit inflexion points on their demographic dividend, India is the only large country for which the inflexion point is in the future - most likely around the year 2040, he said.

With millions of new people entering the job market every year - the young and also the rising participation of women in the labour force, India needs a revolution in the manufacturing sector for job creation.

But he said India faces a number of challenges in engineering such a revolution, not least a major skills shortage, which he described as being "no longer a problem but a crisis". For example, he said, of the 350,000 engineers coming out of college every year, barely a quarter are employable.

Another major obstacle is infrastructure, with India's frequent infrastructure bottlenecks creating a significant drag on manufacturing competitiveness and therefore dis-incentivising investment into the sector.

"It is estimated that India needs US$1.5 trillion worth of investment for its infrastructure development," Mr Subbarao said. "Finding that money is going to be an uphill task."

This article was first published on NUS Business School's Think Business portal (thinkbusiness.nus.edu)