Cablegate: Indian Economy: The View From Singapore

This record is a partial extract of the original cable. The full text of the original cable is not available.



E.O. 12958: N/A

1. Summary. On October 15, 2004 visiting Economic Officer
Brian Briscombe -- who was wrapping up a week-long trip to
Delhi, Mumbai and Hyderabad -- and embassy officers held a
series of meetings with private sector analysts to discuss
the Indian economy. While all expressed optimism about
India,s future prospects, they also acknowledged serious
problems, near-term resolution of which will be necessary if
India is to continue to grow at its current pace. The
Singapore-based analysts identified the financial system, the
government deficit, and the lack of political commitment to
free market economics as key obstacles to India,s future
economic growth. Singapore's trade with India grew 54
percent in the first half of this year -- faster than with
any other partner -- and the Singapore government is taking
an active approach to boosting trade and investment links.
End summary.


2. All of the analysts agreed that the GOI needs to further
liberalize its trade and investment regimes in order to
maintain the country,s current high rate of growth.
According to Sailesh Jha of Credit Suisse-First Boston, India
is "early cycle," i.e., it is currently experiencing the
burst of growth common after the initial introduction of
broad based liberalization (similar, he said, to the
situation in Southeast Asia in the early to mid-1990s), but
it will need to do much more to make high growth rates
sustainable. He noted that average tariff rates are still
quite high, as is government involvement in the economy.
While some technocrats recognize that further liberalization
is necessary, politics make adoption and implementation of
further reforms difficult. Dominique Dwor-Frecaut of
Barclay,s Capital said that no one in India is actively
advocating freer markets or more incentives to attract
foreign direct investment, because of political
sensitivities. While liberalization will continue, it
remains a very slow process, she said. Arjuna Mahendran,
Chief Economist and Strategist, Credit Suisse, echoed
Dwor-Frecaut's sentiments when comparing China's and India's
respective economic performance. He noted that, if faced
with a choice, Indians would prefer to maintain their current
political institutions (and by extension their "more
democratic way of life") than to "sacrifice" these in pursuit
of more rapid and consistent economic growth (as in the case
of China).

3. Dwor-Frecaut noted that the rapid rise in importance of
India's services sector is not due only to the competitive
advantage of its skilled workforce and English language
ability, but also because the services sector developed too
quickly for bureaucrats to stifle it through over-regulation,
as they did with manufacturing. She identified the country's
labor laws in particular as a critical area for reform in
order to attract FDI in a broader range of sectors. Jha said
that India will need to develop its manufacturing sector to
create needed jobs, and argued that the idea that India can
dominate services and leave manufacturing to China is wrong.
China will become increasingly competitive with India on
services, he said, as English language skills there continue
to improve, and India can compete on manufacturing: it has
many of the managerial and technical skills that are
increasingly scarce in China.

The Financial System

4. All of our interlocutors agreed that the financial sector
will constrain future growth. State-owned commercial banks
prefer to invest in government debt or government-owned
corporations rather than lend to domestic businesses.
Sailesh Jha argued that so far, this crowding out of domestic
investment has not been a serious problem as domestic firms
do have access to external capital sources, although this
could change if global demand for emerging market debt dries
up. Dwor-Frecaut noted, however, that while larger firms
have the option to seek external financing, smaller firms do
not. As a result of this lack of access to credit and
stifling government regulations, small domestic investors are
being forced into the large informal sector. She argued that
the GOI will not be able to make needed reforms and privatize
the state-owned commercial banks until the government is less
dependent on the banks to finance its deficit.

5. Van Anantha-Nageswaran of the Libran Fund was more
upbeat. He argued that while balance sheets are currently
too "healthy" for the public sector banks to be shaken out of
their complacency and encouraged to undertake risk-base
lending to the private sector, private banks are starting to
gain some market share and are doing some risk-based lending
to domestic business themselves. While he said the
government could be doing more to promote the emergence of
private banks, it is happening slowly on its own, injecting a
bit more competition into the financial system. This trend
is still nascent, he said, but it could ultimately force
public banks to rethink their way of operating.

The Fiscal Deficit

6. None of the analysts were particularly alarmed about the
budget deficit, although they do consider it a vulnerability
for the Indian economy in the medium term. Jha said that in
the short term (12-18 months) it is "irrelevant," because it
is not impinging on the liquidity of the financial system or
pushing up interest rates. Both Jha and Anantha-Nageswaran
noted that because the mix of government debt is changing --
the GOI relies increasingly on domestically-issued debt and
continues to be able to refinance at low interest rates --
there is little chance of an external crisis. Jha and
Anantha-Nageswaran also said that the government,s
expectations of a shrinking deficit were somewhat
unrealistic. Jha said that Delhi,s hope of widening the tax
base in the services sector would be difficult to implement,
and Anantha-Nageswaran argued that there had been little
improvement in the government,s political will to increase
tax collection, with most gains in revenue coming from
administrative efficiencies rather than policy changes.

7. Jha said that the deficit becomes more worrying over the
medium term; if inflation continues to pick up and there is
no monetary tightening by the government, the deficit could
pose a risk to growth. He argued, however, that the
government can always spend its considerable reserves in a
cash crunch. Anantha-Nageswaran emphasized that the quality
rather than the quantity of the deficit is worrisome; if the
GOI was spending on infrastructure and education, the deficit
would be less worrisome because it would contribute to growth
and hopefully a virtuous cycle which would allow India to
grow out of the deficit. Instead, India,s infrastructure is
famously poor, and the government is spending not on
infrastructure and other capital investments, but on the
administrative costs of maintaining a large bureaucracy.
P.K. Basu, Managing Director, Robust Economic Analysis,
similarly lamented the inadequate level of investment in
infrastructure, noting that one of the Indian economy's
brightest stars -- the software industry centered around
Bangalore -- has been so successful in part because it has
limited infrastructure investment needs beyond office space,
electricity and optical fiber. Other industries, he
stressed, are not so lucky.


8. Although they recognize the many challenges for India's
economic development, all of the analysts we spoke to believe
that India will continue to deliver a high growth story.
Their enthusiasm is shared by the Singaporean business
community and the government, who hope to capitalize on
India's growth and expanding ties to East Asia. India has
become Singapore's fastest growing trading partner, with
two-way trade increasing by 54 percent in the first half of
the year. In typical Singaporean fashion, the GOS is leaving
little to chance, and is actively promoting economic links
with India, in part to balance out its reliance on ties to
the U.S. and China. The GOS hopes to complete negotiations
of the Singapore-India Comprehensive Economic Cooperation
Agreement by next year, and Temasek, the GOS's investment
holding company (run by Ho Ching, wife of Prime Minister Lee
Hsien Loong), has become one of India's largest private
equity investors, funneling close to $1 billion into the
Indian economy in less than a year and opening its first
office outside Singapore in Mumbai, according to recent press
reports. Not content to be a silent partner, Singapore also
offers the GOI plenty of advice. Singapore's Trade and
Industry Minister, for example, who is in New Delhi this
week to attend the India ASEAN Business Summit, made a speech
on October 20 urging India to conclude FTAs with ASEAN
countries to quicken its integration with Southeast Asia, and
said that the GOI needs to remove non-tariff barriers, adopt
mutual recognition of standards and investment guarantee
pacts, and streamline new business registration procedures in
order to encourage investment.


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