India's ratings plateau?

The S&P recently put India on the watchlist for a ratings revision downwards from its current investment grade. Without debating the merits of the downgrade, there is a troubling trend from this, especially when comparing our ratings trend to that of other emerging economies.

The graphic below, a composite measure of the ratings of all the three major rating agencies, shows that India moved up to investment grade rating in January 2007. However, unlike all its other partners, in a fairly accurate reflection of the political paralysis that has gripped the country, it has remained there for the past more than five years.
 

The politics of the monetary policy debate

The Reserve Bank of India (RBI) has finally succumbed to the increasingly mainstream demand for lowering interest rates. In its mid-quarterly monetary policy review, it has lowered the repo rates by a substantial margin of fifty basis points.

Conventional wisdom would have it that the RBI makes its interest rate decisions on objective considerations based on clearly defined parameters. Even assuming the inevitable discretionary judgement that goes with such decisions, the broadly technocratic nature of such decisions are widely accepted. It is also assumed that these decisions stabilize the economy as a whole. The twin objective is to keep inflation anchored and boost economic growth.

However, a closer analysis of this decision reveals a deeply institutionalized political and social bias. Two observations from the debate that preceded and also followed this decision.

1. In recent months, there has been a growing belief that the RBI holds the key to restoring India's economic growth. In fact, this belief has come to dominate opinion makers across the world. The apparent simplicity of tweaking a single number, the repo rate, to alter the fortunes of the economy has obvious attractions to all parties - academicians, businesses, governments, and media. It provides an easy opportunity for all and sundry to weigh in with their two ounces of wisdom. Unfortunately, it also takes away from focussing on the real issues at hand and holding governments accountable for their role in restoring economic growth. It takes the pressure off from governments in having to deal with more fundamental structural distortions and need for more reforms.

This impression is also reinforced by a cognitive bias, the availability heuristic. The RBI's interest rate decisions are discrete and high-profile events, very frequently deployed (especially in the past few years), and is associated with clear economic growth implications. Rate hikes increase the cost of capital while reductions have the opposite effect. It therefore becomes very easy for everyone to associate a tight monetary policy stance with growth suffocation.

2. The inflation Vs growth trade-off in monetary policy management, in the Indian context, has critical political overtones. Corporate India is directly and immediately hurt by the high interest rates. It therefore becomes natural for them to lobby aggressively to lower interest rates. They argue that the downside risks to economic growth associated with higher rates are much higher than its corresponding inflation risks.

However, monetary loosening, especially when inflationary forces remain unhinged and the economy is running at its potential output frontier, poses significant inflation risks. And inflation, as the episodes of runaway spikes in food prices in recent years indicate, can very adversely affect the poor. They disproportionately bear the costs of inflation compared to the non-poor and corporates.

In simple terms, leave alone its technical merits, a rate cut now reflects a conclusive preference for one political view over another. The balance sheet squares up clearly - high interest rates increases the cost of production for corporate India, while inflation has only marginal immediate impact; inflation hurts the poor directly while the effect of high interest rates is negligible. In terms of the magnitude of short to medium-term effects, lowering of interest rates and a possible rise in inflation will impact the poor more adversely than corporates and non-poor.     

3. Finally, as I have blogged earlier, RBI's recent tight monetary policy stance goes much beyond inflation control. In recent years, the Indian economy has been growing at a rate much higher than its potential GDP growth rate. In the absence of policies and investments that ease supply-side bottlenecks, this potential growth rate has remained stagnant. Therefore, it became necessary for the RBI to cool down the economy, so as to prevent the build up of inflationary pressures. However, popular debates and mainstream discussion on monetary policy have tended to gloss over this and focus on the growth inhibiting role of high interest rates.    

In the final analysis, these prejudices and biases are reflective of the dynamics that skew the priorities in the formulation of public policies and their implementation in India.

Postscript - I missed linking to this post by Daron Acemoglu and Simon Johnson which highlights how monetary policy in the US too appears to have become beholden to the interests of Wall Street. 

India's most important structural imbalance in a graphic

A report by Deloitte has this graphic which captures the essence of India's most worrying economic-demographic imbalance.

An oversized 58% of the workforce involved in agriculture contributes just 15% to the GDP. India's biggest challenge in the coming years will be to manage the transition of a large share of this 58% into manufacturing and services. Given the already large share of services sector, manufacturing may have to absorb the major share of those moving out of agriculture.

India and emerging Asia compared

The annual Asian Development Outlook 2012 (pdf here), which talks about rising inequality in Asia, has some interesting graphics about the Indian economy, especially in comparison to its counterparts in emerging Asia.

Note the sharp fall in investment as a contributor to GDP growth in 2011. Though government consumption has contracted, so has private consumption. Interestingly, the share of private consumption has risen in China.  

The Reserve bank of India (RBI) has been easily the most aggressive Asian central bank. It cut interest rates vigorously when the recession struck and raised rates with similar aggression when inflationary pressures became unhinged. On the positive side, there exists considerable cushion for monetary easing if the RBI feels inflation is under control.

But inflation in India has been a persistent problem for the past four years. India's current inflation rate is more than twice that of any other major Asian economy. This means that the RBI will remain reluctant to indulge in any significant monetary easing anytime in the immediate future. At best, it is not likely to raise rates any further.  

I have blogged earlier that the inflationary pressures were clearly the result of an overheating economy. As the graphic shows, the Indian economy's scorching pace of growth in the mid-2000s blazed the economy well beyond its potential output frontier. Though growth has slowed, it is now merely at its potential output frontier. This is yet another reason why the RBI may desist from moving down the path of monetary accommodation. Massive investments to ease the supply side is the need of the hour.

However, the government appears to have limited fiscal space to play an aggressive role in any supply side easing. India is easily the most fiscally constrained country among all major Asian economies. This means that two things will have to happen simultaneously. One, fiscal spending on subsidies will have to be reined in and the savings routed into infrastructure, agriculture, human resource development and so on. Two, private investments will have to be catalyzed in large amounts. Foreign capital investments will have to supplement the domestic private partners in boosting private investment in the economy.
  

The graphic below highlights the nature of distribution of gains between labour and capital. In the period 1990-2007, while real wage rate did not even double, labor productivity increased three-fold, from about 80,000 to about 250,000 rupees. In fact,  the average annual growth rate of labour productivity was 7.4% during 1990–2007, while the average annual real wage growth rate was only 2%. This implies that gains in productivity were not passed on to wages and, consequently, the labor share of India’s organized manufacturing sector declined significantly.

India's fiscal crisis in graphics

It is clear that whatever the RBI does with monetary accommodation, the path towards creating conditions for sustainable economic growth lies in reining in the growing fiscal deficit.



A recent report by the Goldman Sachs estimated the combined fiscal deficit of states and center for 2011-12 to touch 9% of the GDP, easily the highest among all the major emerging economies. It attributes this high deficit to the twin problem of falling tax base and ballooning subsidy burden. The Rs 40000 Cr gap in the ambitious disinvestment target is another major contributor.



The biggest long-term concern is the low tax-to-GDP ratio. India's tax-to-GDP ratio is again among the lowest among the major emerging economies.



Worse still, after steadily rising since beginning of the last decade, it has been falling since the recession struck. And it shows no signs of having bottomed out and is expected to fall further this year.



Subsidies are the elephant in the room. The food, fertilizer and fuel subsidy bills have been rising alarmingly in recent years. Unfortunately, with the 2014 elections looming large, the prospects of structural reforms to roll-back subsidies appears bleak.

India and South Asian Region

Mostly Economics points to an IMF working paper that examines the trends in inter-regional trade within South Asia and the impact of India's economic growth on her neighbours.

Government transfers from India, both grants and loans, especially to the smaller countries like Bhutan, Nepal, and Maldives are significant. However, the level of private sector integration - apart from remittance flows of migrant workers in India, especially of workers from Bangladesh, Maldives, and Nepal - has remained small. A major source of spill-over from India is in human capital formation arising from students studying in India, administrative capacity building, and Indian support for health and education sectors in these countries.

The estimation suggests that an increase in growth in India by 1 percentage point is correlated with a rise in growth in South Asian Countries (SAC) economies by 0.37 percentage points... (other studies) show that a 1 percentage point increase in GDP per capita growth in South Africa is correlated with a 0.5–0.7 percentage point rise in growth in the rest of Africa for the period 1980–99. They also find a 1 percentage point increase in China’s growth is correlated with an average of 0.5 percentage point increase in the growth of the rest of the world for the last two decades, with potentially larger effects for Asian countries.

India's trade, both as a share of global trade and in absolute volumes, has multiplied in the last decade and half. However, even as its trade with all emerging economies and regions have grown dramatically, its trade with its neighbours has remained stagnant.



The Southern African Customs Union (SACU) has aided the closer integration of the five regional economies and helped the smaller countries benefit from South Africa's economic vibrancy. In fact, since trade is tariff-free within the region, South Africa accounts for more than 80 percent of the imports of the smaller members of the South Africa Region (SAR). But they have been also able to build solid export markets outside South Africa. In contrast, the share of trade of India's SAARC neighbours has been very small. While the trade shares of Afghanistan and Pakistan are understandable, the relatively small share of trade that Sri Lanka and Bangladesh have with India is surprising.



Infrastructure, especially energy, railways, and telecommunications, offers exciting opportunities for co-operation between these economies. The smaller economies could benefit immensely from leveraging India's expertise in these sectors. While the Indian government will have to facilitate the strengthening of this mutually beneficial partnership with long-term loans and other forms of aid, India's private sector may have to seize the opportunities that are slowly emerging in these countries. Some form of strategic diplomacy to deepen such links is the need of the hour

Closer economic relationship will not only add another, probably critical, growth dimension to these economies, but also help alleviate the mistrust that characterize political relationships among countries in the region. For India, it will lay the foundation for smoother relationships in its "near abroad" so that its more ambitious global ambitions can be pursued.

India's non-inflationary growth rate

The RBI Governor D Subba Rao candidly admitted that India's non-inflationary economic growth rate was 7%. In other words, in order to grow beyond 7% without stoking high inflation, India should take steps to ease supply-side constraints like infrastructure bottlenecks, food production deficiency, labour supply shortages and so on.

In this context, a linear extrapolation of India's GDP growth rates since 1951 reveal that the current trend growth rate may be at about 7%. It is obvious that the economy has been growing above the trend growth rate for a some time now, thereby stoking the inevitable inflationary pressures.



If this trend growth rate has to move upwards, it is important to increase the productive capacity of the economy. This can be achieved only with increased investment activity, especially in fixed capital formation. However, on both counts, investment rate and gross fixed capital formation, the Indian economy has been doing badly since the onset of the recession.

Indian economy - A status report

The good news first. India's 10 year bond yields have started falling since November 2011 in anticipation of lower inflation and reduction in repo rates.



Since later December 2011, the equity markets have staged a smart rally. The volatility indices like the India VIX too appears to be moving towards the trend rate.



Another sign of the stability returning to the markets is the exchange rate. After its steep decline since March 2011, the exchange rate has been appreciating since the second half of December 2011.



The bellwether HSBC Purchasing Manager's Index (PMI) has been improving since November 2011. The composite index for January which covers both the manufacturing and service sectors rose from December’s 54.7 to 59.6 to signal the sharpest increase in activity in nine months.



However, there are certain disturbing signals. Though India's core inflation rate (Thanks Mostly Economics)appears to be trending downwards, it is well above the comfortable 4% range.



The overall economic outlook, while looking up, is some distance away from normalcy. India appears to have had a double-dip economic slowdown since the Great Recession struck the world economy. Starting 2008, the economy has declined twice and the last quarter of 2011 may be the second trough.



Industrial production too has mirrored the fate of the GDP with two troughs during the same period.



Of greatest concern, as highlighted in the recently released report of the Prime Minister's Economic Advisory Council is the declining rate of investment, savings and gross domestic fixed capital formation. None of these important indicators have recovered from the 2008-09 slowdown.

Potential for high speed rail corridors in India

FT charts the high-speed rail (HSR) networks across the world. China is the runaway leader with 37% of the total global operational HSR track. However, if its pipeline of projects under construction are added, it will have more HSR track length than all other countries combined! Among HSR under construction, EMs count for over 60% of the total track being built.



India does not have any HSR track under construction, nor anything in reasonably advanced stages of planning. Rail transit policy making in India, it appears, is taken up with metro rail systems, with even small cities preparing grandiose projects for metro-rail systems.

In this context, HSR offers exciting possibilities for promoting economic growth and laying the foundations for the creation of large growth corridors. Despite the significant successes achieved by the National Highways Authority of India (NHAI) with the construction of the Golden Quadrilateral road network in the past decade, roads cannot form the basis for integrating regional growth clusters.

Ahmedabad-Mumbai-Pune, Delhi-Lucknow-Patna, Delhi-Chandigarh-Amritsar, and Chennai-Bangalore-Hyderabad are four promising HSR corridors. HSR services in these routes, which connect important industrial and commercial centers, have the potential to underpin economic growth by harnessing the increasing returns from geographic integration. The HSR will provide greater integration among the large population clusters in these corridors. It will integrate labour markets and strengthen the existing manufacturing and services base in these corridors.

In this context, the Kerala's government's proposed 580 km, Rs 1.18 lakh Cr HSR corridor between Thiruvananthapuram and Mangalore, which would reduce travel time more than four-fold to around three hours, is an excellent proposal. Instead of wasting its scarce resources pursuing a metro-rail link for Kochi, the Kerala government would do well to vigorously pursue this by upgrading the existing rail network into HSR in a phased manner. Given its narrow-strip geography and urban demographics, Kerala would stand to benefit immensely from such rail links.

India's economic challenges

Martin Wolf has an excellent op-ed in FT, which highlights how India and China have decoupled from the developed economies during the Great Recession.



He makes the point that, even with possible future global shocks, the biggest challenges to India's growth remain internal.

Thoughtful Indian observers are well aware that the principal obstacles to rapid economic development are internal, not external. Among obvious constraints are failures of governance, including wasteful spending on subsidies at all levels of government, a dire record on the provision of education and health to the bulk of the population, rigid labour laws, inadequate infrastructure and costly restrictions on efficient use of land.

He advocates a cautious opening up of the financial markets,

First, the financial system is capable of generating huge instability and needs to be watched. Second, the integration of India into the global financial system has to be managed carefully. Huge crises may be socially and economically manageable for high-income countries. They would be grossly irresponsible for a country like India.

A graphical story of the Indian economy in 2011

For sometime now, high inflation has been the central concern about the Indian economy. Inflation rate, driven by run-away food prices, have remained at a very high plateau throughout the year. Core inflation too has been hovering at the 7-8% range, indicating that inflationary expectations have become embedded into the economy.



In response, the RBI has been tightening monetary policy. Since March 2010, it raised interest rates in baby steps 13 consecutive times.



The bank credit growth has declined continuously reflecting the tight credit market conditions. Commercial credit off take has been an inevitable casualty.



The benchmark 10-year government bond yields too have moved upwards, though it appears to be now on its way down in anticipation that the tightening cycle has ended.



It is now strongly believed that the sustained increase in interest rates has started to badly hurt economic growth. The monthly industrial production figure has been on continuous decline since April. The most shocking news was the revealation that industrial production contracted in Novemeber.



The quarterly GDP growth rate has been falling continuously for the past seven quarters and the slowdown gathered momentum this year. Suddenly, the near double digit growth rates, which was being taken for granted, appears distant.



The rupee started an alarming fall from August, reflecting both the global economic uncertainty and also the weakening economic prospects of India.



Reflecting the underlying economic weakness, the equity markets too have been on a continuous downward slide. In fact, Indian equity markets have been one of the worst performers across the world.




Among the major economies, India's inflation rate and interest rates are easily the highest. Its current account deficit too is the highest among all major conomies. Graphics for inflation, interest rate and current account deficit are shown below.







It is therefore no surprise that business confidence has plumetted. The the NCAER-MasterCard Worldwide Index of Business Confidence, which measures the level of optimism that people who run companies have about the performance of the economy and how they feel about their organizations’ prospects, has declined to 125.4 in October of 2011 from 145.2 in July of 2011.

Why the retail trade issue is more nuanced?

So India has, atleast for now, turned its back on retail trade liberalization. It has been rightly criticized for this decision since the case for liberalization has been widely discussed and is largely obvious.

Alex Tabarrok weighs in with the argument that if it is to improve the standard of living of its people, India needs workers to move from less productive sectors like farming, retail, and so on to other more productive and higher value added industries, and retail trade liberalization hastens this process. I agree with the first point. The second, about retail trade liberalization hastening the process, though may be more contentious and needs a more nuanced appreciation.

It is surprising that Alex does not explore the argument further since he does acknowledge the perils of liberalization - the painful labour market transition and the fact that, atleast immediately, the losers generally outnumber the winners. He simply confines his analysis to a standard line - transitions always involve some pain; creation always involves some destruction; growth always involves change; the alternative, however, is stagnation.

I think this is pretty lazy, even specious, scholarship. Unfortunately, it is also widely prevalent in academic discussions on reforms. There is a reluctance or inability to think through the real world problems that come in the way of pushing through such reforms, especially in democracies. It is all the more surprising since these supporters do identify the potential challenge. But they refuse to think beyond stage one.

The case for any liberalization measure proceeds something like this. First trumpet the benefits of liberalization. Then gain enough support to liberalize regulations. The benefits start to flow, but accompanied by the pains of transition. Then rationalize that any liberalization will have losers, who may even be large in numbers, but "today’s losses and gains are fleeting, the permanent winners are the workers and consumers of the future who will know only the benefits of productivity".

India's tryst with retail liberalization has resonance with similar structural transformations across other sectors, both in India and elsewhere. The fundamental issues bear striking similarity with the conditions when China liberalized its markets and encouraged foreign investments. The newer firms ended up competing with large and uncompetitive public sector units (PSUs) thereby generating the risk of lay-offs by these PSUs. The US economy too, as Joe Stiglitz pointed out in his New Year essay in Vanity Fair, faces a similar labour market challenge as it transitions from manufacturing to productive services.

In all these cases, the key to successful transformation is the effectiveness in managing the losers or those displaced during the process. Traditionally, academicians and policy makers pay disproportionate attention to the reforms themselves while ignoring the more important issue of getting the mechanics of the transition process right. What needs to be done to rehabilitate those affected by the changes? What are the immediate and medium-term measures?

As democracies become increasingly politically divisive, effective rehabilitation strategies will become even more important if governments are to push through such reforms. China appears to have managed the transition effectively, albeit less efficiently. It kept the large and failing PSUs running with heavy state support. The spectacular economic growth in other sectors helped the government with the resources required to backstop this transition hemorrhage without curtailing the progress of the reforms. Now that the transformation has stabilized, the government is slowly removing its support for the PSUs.

Since the pains associated with the transition invariably comes in the way of the effective implementation of the reforms, it is critical that the mitigation cum rehabilitation plan gets the required focus. However, assuming that governments rarely get the transition plan right, a second best option would be, as the Chinese have done, to let the existing public systems continue to maintain life-support till the transition takes strong roots. While this has its costs, it will mitigate the hardships and ease the reform path.

In India's case, it is important that those likely to be displaced from retail trade be absorbed elsewhere in the labour market. This will not happen by itself and merely through the dynamics of economic growth and resultant job creation. It will require enabling policy frameworks and massive investments in education, especially in the acquisition of vocational skills. It will also require policies that encourage the creation of large enough self-employment opportunities.

Most importantly, it will need a universal social safety system that can atleast partially cushion those losing out from the bitter pain and social dislocation that follow. In any case, this social safety net is an essential pre-requisite for cushioning those most vulnerable from the vagaries of liberalization and increasing integration with the global economy. Unfortunately, the opportunity to establish a comprehensive social safety net is being side-tracked by the obsession with populist, inefficient and even wasteful piece-meal interventions.

Income inequality and sustainable growth

Eduardo Porter points to the work of IMF economists Andrew Berg and Jonathan Ostry that questions the sustainability of economic growth in conditions of widening inequality. They argue that "sustainable economic reform is possible only when its benefits are widely shared".

They found that in high-inequality nations spurts of growth ended more quickly, and often in painful contractions. They find that a 10 percentile decrease in inequality (represented by a change in the Gini coefficient from 40 to 37) increases the expected length of a growth spell by 50 percent.





They also found that income distribution contributes more to the sustainability of economic growth than does the quality of a country’s political institutions, its foreign debt and openness to trade, the level of foreign investment in the economy and whether its exchange rate is competitive.



The graphic below highlights why widening inequality is a much greater cause for concern in the US



Extreme inequality and its rapid widening is especially bad for developing economies like India, which are even otherwise vulnerable to supply and demand-side business cycle shocks. As Porter briefly mentioned, such widening inequality has implications which go beyond economic stability. It threatens political stability and forces democratic governments down the slippery slope of political populism.

I am inclined to believe that the rapid explosion of competitive populism in India in recent years is in no small measure due to the rapid rise in income inequality and the perceived need for governments to placate increasingly alienated and disgruntled voters who have come to believe that they are being short-changed in the sharing of benefits of liberalization and globalization. As the inequality gap widens further, the propensity for competitive populism will only increase.

This creates a policy gridlock, a low-level equilibrium, from where governments find it difficult, fiscally constrained, to meaningfully address the critical issues that determine sustainable economic growth. Among other things, it contributes to the stifling of reforms and the weakening of governance.

India's growth dilemma in a graphic

I am labouring this point. Cities are already India's economic growth engine. In the years ahead, they are estimated to contribute 70% each of the national economic growth and all new jobs created. But rural India, where 65% of the population lives, takes up the major share of public spending and administrative energies. The graphic below summarizes India's public policy priorities.



This skewedness may be guilty of killing the goose that lays the golden eggs. India needs to grow near the double digit rate so that its tax revenues and new jobs created grow fast enough to meet the massive and growing demand. Higher tax revenues would provide governments with the necessary resources to expand public investments, both in rural and urban areas. Faster pace of job creation would provide adequate opportunities to accommodate the rapid additions to the workforce. It would ensure that the danger of our demographic dividend turning sour is averted. And, as I have blogged earlier, transfers are a function of tax revenues. Higher the tax revenues, more the resources available to reduce poverty and mitigate any rise in inequality through effective redistribution policies.

Unfortunately, both state and district-level public policy and public spending (investments and welfare spending) are disproportionately focussed on rural India. Much more needs to be done for rural development. But a more effective strategy to achieve that objective would be to strengthen the urban growth and job creation engine and then utilize the resultant growth in tax revenues to promote effective rural development.

Stylized Facts on Indian Economy

Arvind Subramanian and Utsav Kumar have certain stylized facts about recent economic growth trends in the Indian economy.

1. Putting to rest the debates and concerns about economic growth in an open and liberalized economy, economic growth was faster in the 2000s than the 1990s in most states. Rajasthan, West Bengal, and Himachal Pradesh were the only laggards. The growth rates in many of other states more than doubled in the 2000s.



Conversely, this also meant that these state economies were more exposed to the global economic factors. Therefore when the world economic slowdown struck, the faster growing and more globalized states were more adversely affected.

2. One of the common features of economic growth is that as economies liberalize and growth picks up, a trend towards covergence takes hold. The poorer states, by virtue of growing faster than the richer states, start catching up with the latter’s level of income. This convergence is also critical towards promoting a consensus on liberalization and reforms and also sustaining the high growth rates.

Unfortunately, a regression of the average annual growth rates across all states and initial percapita income of 2001 reveals little convergence. In fact, it shows that richer states on average grew faster so that the inequality across states is actually increasing. This relationship holds for different time periods and different state sample sizes. It should sound a note of caution for policy makers that the robust growth in the traditional laggard states in the last decade is not enough to promote the much-needed convergence.



3. The biggest concern is the possibility that one of India's greatest strength, its young workforce (demographic dividend), could also turn out to be its biggest problem. In the last decade of 20th century, this beneficial impact of this favorable demographics was favorable in the economic growth trends as seen from the graphic below.



However, the picture appears to have reversed in the first decade of the new millennium. Economic growth has been found inversely correlated with the working age population growth rates among the various Indian states.



The biggest concern states in this regard are Rajasthan, Bihar, UP, Assam, and Madhya Pradesh where the demographic dividend is in serious danger of turning sour. In many respects, this reversal of trend over the last decade is one of the biggest challenges facing India. Unfortunately, the policy paralysis of recent years means that it is in serious danger of being overlooked.

The retail liberalization debate

The decision by the Union Government of India to liberalize Foreign Direct Investment (FDI) norms in multi-brand retail trade has sparked off an intense debate about fears of the WalMartization of India and massive job losses in the trading sector.

The liberalized retail norms include 100% FDI in single-brand retail, and 51% in multi-brand retail. Among other conditions, the liberalization would be implemented in million-plus cities in first phase, fresh farm produce cannot be branded and 30% of the inputs have to be sourced from small enterprises, and multi-brand entities will have to bring in an investment of $100 million. Retail constitutes a $430 bn market in India, with organized retail forming just 10% of the total and being confined to the larger cities. It is estimated that 30-40% of fresh produce goes waste and more than half of this can be brought to the market if the proper farm-to-fork infrastructure is in place.

There are primarily five stakeholders in retail market - organized retailers, unorganized retailers, farmers/producers, consumers, and governments. It is easy to rationalize the benefits for governments (infrastructure investments), consumers (choice and better quality of produce), and producers/farmers (better prices). Given the precedence of other markets which have been liberalized, it is safe to argue that organized retailers too will adjust to the changes, improve their productivity, embrace newer technologies and processes, and become more competitive. This means that the concerns about the liberalization of retail trade can be mainly confined to the unorganized retailers. The debate should therefore be focused on its impact on them and what can be done to mitigate it.

There is a need for careful strategic thinking on the details of this liberalization policy with regard to its impact on the unorganized retailers. How do we calibrate the first wave of liberalization, so that it is initially restricted to those areas - places and products - least likely to affect them? What should be the sequence of opening up so as to minimize its adverse consequences? What should be the conditions imposed on the retailers permitted to enter Indian markets? Discussion and analysis of the liberalization that addresses these issues will considerably enrich the debate and is certain to increase the effectiveness of policy making itself.

It is unfortunate that the mainstream debate in electronic and print media on the issue has been dominated by ideological sabre rattling. There has been very little objective empirical analysis of the underlying market trends. For example, given that the central concern is about the impact on unorganized retailers, certain questions follow. What is the share of these retailers in the cities proposed for liberalization in the first phase? Where are the existing unorganized retailers located and who are their customers? Are those located in these areas likely to be swamped by the larger retailers? What is the market share and structure of existing organized retailers in these cities? Who are the typical customers of the organized and unorganized retailers?

In fact, atleast in non-food retailing, the trend towards organized retailing has already moved far ahead in many states. For example in the southern states like Kerala, long the bastion of left-wing parties, the ubiquitous chain of Margin Free shops may have already marginalized the traditional mom-and-pop stores in all but the smaller villages. The widely acclaimed Rythu Bazars in Andhra Pradesh, which seek to offer producers an opportunity to directly market their farm produce, carry within them the seeds of crowding-out middlemen and unorganized retailers of perishables.

In the larger Indian cities, the big box Indian retail chains have already captured a major share of the market from unorganized retailers. Even without foreign competition, the Reliances, Mores, and Food Bazars are already expanding aggressively into neighbourhoods within smaller cities and towns and displacing the unorganized retailers. This trend will only continue apace. However, even with this assault, given the sheer size and diversity of the markets in urban India, neighbourhood mom-and-pop shops, with a long history of personal relationships, are likely to adapt and survive.

There is an important difference between the business models of big box retail chains in India and those in US and Europe. The market for big hyper-markets and malls in India is limited for variety of reasons - cost of space within cities, limited space availability, opportunity cost associated with shopping in these often distant shops etc. In the circumstances, the preferred model of expansion will be through smaller franchises spread out across the city. In this, the domestic organized retailers have already taken the pole position and the entry of foreign retailers will be significant more for the intensified competition among them rather than for the marginalization of small unorganized retailers.

At a purely intuitive level, a carefully calibrated liberalization of retail trade, with the first phase restricted to a handful of big cities, appears to be an excellent strategy. Given the massive size of markets in these cities, it is certain to generate a significant impact on the incentives in the downstream production and procurement segments. The infrastructure investment requirement will mean that it will spur substantial investments in cold storages and go-downs, transport logistics and so on.

Farmers will be able to deal directly with these large procurers (who and their agents can be held accountable), instead of the fragmented and largely invisible intermediaries, and thereby get better prices for their produce. Consumers will benefit by way of choice and better quality. All these developments take place at the back-end of the production-consumption chain. The impact on retailers will be taking place in cities where that impact is already felt and would have deepened, albeit less efficiently and more slowly, with already expanding domestic retailers.

This entry of retailers presents a great opportunity to deploy randomized control trials (RCTs) to a natural setting. For example, given that it would be implemented only in a few cities, it would be possible for researchers to locate or design an RCT setting. The impact of the entry of foreign retailers can be evaluated objectively to arrive at answers to some of the questions raised earlier in the post.

Update 1 (6/12/2011)

Good story in the Times. Barely 6% of India’s $470 billion in retail sales takes place in organized retail stores, in contrast to more than 20% in China, 36% in Brazil, and 85% in the United States.

I also feel that shopping habits may be an important factor in how customers take to retail liberalization. People use the big retail malls for large, monthly or weekly-once, purchases. For a number of reasons, the local kirana shop would be convenient for smaller purchases. How many people in India make bulk purchases? It would be surprise if more than a small share of people would be making such bulk purchases. And these people, with or without foreign retailers, would, in these million-plus cities, by now have already gravitated to the Indian retailers.

The government-private interface for India's rich and poor

A strong perception has been gaining ground in the mainstream debates that private sector in India has acquired enough strength to replace the government in many areas. However, this impression may not quite match up with the reality of life for the overwhelming majority of Indians.

The graphic below tries to summarize the respective roles of the government and the private sector in the lives of the three categories of Indians - those in the bottom half of the income ladder, the elites, and the remaining population.



As can be seen, the government interface for the corporate elites is limited to facilitating the regulatory and other clearances required to run their businesses. And even this role is receding as the economy becomes increasingly deregulated. In contrast, the government continues to play the overarching role in the lives of the poorer half of Indians (and even the others excluding the elites).