A chance meeting with reform-minded Indian politician Chandrababu Naidu in Silicon Valley two years ago convinced Prasad Yenigalla, a young Indian engineer, that he should return home. In November last year, he started his company, Vantel Technologies, an incubator of IT products, in Hyderabad. Today Vantel employs 85 people and has developed half a dozen switching products that Prasad hopes to sell to global telecom giants such as Lucent Technologies, Nortel Networks and British Telecom. The company launched an IPO in June this year and is listed on the Bangalore and Hyderabad stock exchanges. Prasad sees no disadvantage in his company’s being located in India even though it is in the competitive global IT products business. “On the contrary. The right skill sets are easily available here. As for lifestyle changes, in the valley I spent most of my time at home or workplace, so it hardly makes a difference. “That young entrepreneurs such as Prasad find enough hope to return home and set up businesses is a measure of how much has changed in India.
It is tempting to paint a picture of boundless optimism from the bustle and enterprise to be seen in such places as Electronics City near Bangalore, Hi-Tech City outside Hyderabad or Gurgaon near Delhi. Clearly, India does not lack enterprise. According to the IMF’s World Economic Outlook, India has been one of the 10 fastest-growing economies over the past two decades. GDP has grown by an average 6% since 1992 when economic reforms were introduced.
But India’s politicians have so often failed its people that, as minister in charge of disinvestment Arun Shourie puts it, the country is a contrast between “a resilient society and an inert state.”
After a balance of payments crisis in 1991 inadvertently set India on the path of economic reform, the transition from a controlled economy to a market-driven one appears to have lost steam in the mid-1990s.
The Congress party, which initiated liberalization and ruled India for most of its post-colonial history, went into political decline. Former prime minister Narasimha Rao and former finance minister Manmohan Singh, key figures in the reform process, have disappeared into political oblivion.
Congress eclipse created a political vacuum. A string of hung parliaments and shaky coalition governments struggled for political coherence, then collapsed. Says Sanjaya Baru, an economist: “The Congress party ruled India for 40 years by controlling the two most populous and politically dominant states of Uttar Pradesh and Bihar in the north. After its decline, the BJP could not quite fill that space.” Instead India’s disparate regional parties began to exert a clout that was disproportionate to their actual political base, mostly caste and community affiliations. Some see their rise as a legitimate urge towards federalism in an overly centralized state.
Unlikely champion
The Bharatiya Janata Party emerged as the unlikely champion of the regional parties in its bid for power. It now manages a disparate coalition of some 16 regional parties ranging from the DMK and Shiv Sena in the south to the National Conference and Akali Dal in the north. “Indian parties are learning the rules of coalition politics,” says BJP’s Shourie. “Some mistakes may happen (such as when regional party leader Jayalalitha toppled the government by one vote only to get a drubbing in the election last year); but what is important is that a principle is established. The culture of coalitions is being internalized.” India is, perhaps, the world’s noisiest democracy.
Powerful state leaders such as Chandrababu Naidu, chief minister of Andhra Pradesh and a key ally of the BJP, have an important say in what goes on in Delhi even though his Telegu Desam Party is not part of the government there. “We have entered an era of coalition politics at the centre and all parties must live with this,” says Naidu. An ardent reformer, he is battling the Congress party in his home state over the cut in electricity subsidy (see box) and charges that the central government punishes better-performing states by giving them less money.
The BJP’s ideology is seen by some as antithetical to India’s pluralist democracy. India’s minorities and liberals distrust the party’s divisive politics and that of its mentor organization, a right-wing Hindu nationalist group called the Rashtriya Swayamsevak Sangh. But the politics of power have wrought an amazing change in the party in recent years. It is now paternalistic towards minorities and in early August initiated negotiations for peace with armed Muslim separatists to resolve the Kashmir row. Few can even remember that this party once promised to build a Hindu temple in north India on the spot where a mosque was demolished some years ago.
A party that might seem politically incorrect for India may be good for business. “It has none of the socialist baggage that dogs the Congress party. For that reason business likes the BJP,” points out a businessman. The party appointed a prominent Indian businessman, Viren Shah, as the governor of the left-ruled state of West Bengal. “Nehru’s socialism brought India to ruin,” says the CFO of a leading software company in Bangalore. “It bred a parasitical capitalism that made shoddy scooters and cars.”
In May 1998, when the BJP-led government decided to flex India’s nuclear muscle, the country faced political isolation. The US imposed economic sanctions and many predicted doom for its economy. Yet, two years later, the US and India, estranged democracies as some now call them, got cosy during president Bill Clinton’s visit to India in March this year. The US sees India as an emerging economic power and a potential counterpoint to China in south Asia as well as an ally against perceived Islamic terrorism in the region.
That visit signalled a strategic shift by India from its Cold War alignment with the Soviet Union. That a Hindu nationalist-led government courted and won the approval of the west did no longer seemed incongruous.
But as the BJP pushed aside ideology for pragmatism, its mentor, the Rashtriya Swayamsevak Sangh, rose to protect the faith. The RSS’s new leader, K Sudarshan, warns it of the dangers of wooing foreign multinationals and other members of its extended family such as the Swadeshi Jagran Manch flay its privatization programme. BJP’s Shourie, a former editor and ideologue for the party, makes light of these differences. “The RSS is making the transition from being an inward-looking organization born in a situation where it was constantly under siege,” he says. Prime minister Atal Behari Vajpayee has managed to check the hard-liners in his party so far.
The BJP saw that the key to political longevity was a well-managed economy. It had inherited a troubled one. GDP growth had slowed for two years after peaking to over 7% in 1996 and the government’s fiscal deficit was rising sharply. Previous governments had failed to prune subsidies, estimated at 10% of GDP, or improve tax collection, stuck at around 9% of GDP. The Asian crisis erupted soon after and the government quickly had to restore investor confidence. It passed a law to privatize insurance last December and sold the first state-owned company, Modern Foods, to a Unilever subsidiary. Early this year finance minister Yashwant Sinha cut the subsidy on pension fund savings and declared that the government would reduce its stake to 26% in non-strategic companies. The economy grew by 6.8% last fiscal, up from 4.7% in the previous year.
But the government’s fiscal deficit, estimated at 10% of GDP, and high real interest rates, could choke that recovery. Reserve Bank of India governor Bimal Jalan raised interest rates in late July, just four months after he dropped them, to arrest a slide in the value of the rupee against the dollar. Inflation has edged up to over 6% and a higher oil import bill is widening the trade deficit. Further tightening of interest rates by the US Federal Reserve could lead to an outflow of foreign portfolio investments. They pulled out around half a billion dollars from Indian stock markets in June and July. Dominic Price, head of JP Morgan in India, says that the government must allow interest rates to fall if it wants to achieve economic growth rates of over 7%. “If the government overshoots its target for market borrowings this year, its credibility will be permanently eroded,” he warns. Finance minister Yashwant Sinha seems confident that he will not (see interview), but the markets are not so sure.
The government balks at the idea of downsizing. It currently employs around 4 million people, organized by powerful and entrenched trade unions. BJP’s Shourie blames “India’s weak political class” for diverting development expenditure towards paying salaries to government employees.”
Though India’s ranking in the Human Development Index rose by 10 notches to 128 in the past decade, it still ranks behind Lesotho and Iraq. Suraj Kumar, an economist at the UNDP in Delhi, points out: “India’s improvement in ranking was driven by a higher growth in GDP, not an improvement in education or health. The government’s budget constraint is squeezing spending on social sectors.” Not a good move for a country that prides itself on the quality of its human resources.
“Just as external bankruptcy [the 1991 BoP crisis] brought in liberalization and ended the licence raj, the internal bind of public finance will eventually downsize the government,” says Shourie. Government employees are a discredited lot today and state-level politicians such as Ashok Gehlot in Rajasthan, who stood up to them, got public support, he points out.
India also pays the price for being a democracy. Its politicians must sell reforms to voters. Few are long-sighted enough to do this so progress is painfully slow. Some say that democracy is a handy excuse for those whose interests are entrenched in the old order. US energy giant Enron faced over 30 lawsuits and a much-publicized cancellation of its purchase contract with the state electricity utility before it could build a power plant at Dabhol in the western state of Maharashtra.
It took over three years of acrimonious debate to get the insurance bill through parliament. Nine years after the government began selling shares in state companies, it has privatized only one bread-making company. Of the $51 billion in foreign direct investment that was approved since 1991, just $15 billion actually came into the country. Says Sanjay Bhatnagar, CEO, Enron India, “We like India’s democracy, the checks and balances it provides. But we would also like to execute our projects unhindered and would like various parts of the government to talk in a co-ordinated manner.”
Says Jayanth Varma, a senior official at the Securities Exchange Board of India who helped reform the Indian stock market: “Brokers often ask us why we want to change what has worked for the last 100 years. India has the luxury of size where, despite being a closed underdeveloped economy, you can think that you are the centre of the world.” Competition from the modern National Stock Exchange turned India’s century-old bourse, Bombay Stock Exchange, into an eager reformer.
Enron’s Bhatnagar seems confident that the rising aspirations of 200 million Indian consumers will force the pace of change. “Money has no colour today. People are exposed to cable television and the internet and want a better life. Consumers want more bandwidth and that will force the government to remove all restrictions.”
Says BJP’s Shourie, “Foreign investors know that despite all the heckling that goes with every decision, there is a consensus on reforms. The last five governments have all moved in the same direction with the same reform agenda.” Naina Lall, senior vice-president, Morgan Stanley, agrees, “There was never a problem with the direction of reforms in India, only the pace.”
If India does accelerate reform and economic development, IT will be the launch pad. Just as China flooded the world markets with cheap electronics, and Taiwan with its chips, India could do it with IT skills. At present, exports of software services are a modest $4 billion but are growing at over 50% a year. IT-enabled services and entertainment software, two burgeoning sectors, could make that figure grow dramatically.
Ironically, India’s much-sought-after IT skills grew out of a colonial legacy that gave Indians an English education and a socialist one that made technical education accessible to them. India produces 240,000 engineers and management graduates each year, and is estimated to have the second-largest pool of English-speaking scientists and technical professionals in the world.
Faced with an IT skills shortage, countries such as the US, UK, Ireland, Germany, Japan and Finland are wooing Indian IT professionals abroad. India’s software companies thrive on outsourced services and venture capitalists are busy creating a technology corridor between Silicon Valley and India where capital, ideas and information can flow freely.
India’s growing clout in software is helping companies such as Chennai-based Pentamedia and Mumbai-based Crest Communications break into the global 3D animation software market. Crest recently bought Los Angeles-based Rich Animation Studio and is producing the first India-Hollywood animation movie. Amit Khanna of Reliance Entertainment says that India’s IT skills combined with its prolific movie-making and television software skills could make it a global player in the entertainment business.
Another huge opportunity for India has opened up in IT-enabled services. Data processing, call centres and medical transcription services are being outsourced to companies in Gurgaon, Hyderabad or Bangalore. Says Nandan Nilekani, managing director at Infosys, a leading Bangalore-based software company: “India can be the back office to the world. And the beauty is that IT-enabled services tap a skill base that is different from software services.” Indian companies hire English-speaking graduates at a fraction of western salaries.
High cost of telecoms
Two things, however, could spoil the party. The first is India’s state-owned telecoms monopolies, which control international and national long-distance telephony. Not only is the cost of telecoms services in India much higher than globally but there is a shortage of supply of bandwidth, critical for the IT industry. International bandwidth can only be purchased by VSNL, the government telecoms monopoly, which takes six months to deliver it and sells it at four times international prices. In July, newspapers quoted the prime minister as saying that private ISPs might be allowed to buy bandwidth freely. Those reports drew adverse comments from officials in the powerful Department of Telecom.
A heartening factor is that the states, which stand to gain most from new jobs and investments, are putting pressure on the central government. A conference of state-level IT ministers in Delhi in July was attended by no fewer than 14 chief ministers. Soon after, the government announced that national long-distance telephony will be opened up. Also, telecoms deregulation brings in big bucks in the form of licence fees.
The second pitfall could be if India were to fail to meet the growing demand for IT professionals by not investing in technical education now. Sudheendra Kulkarni, an official in the prime minister’s office, says that efforts are under way to double the intake of students in Indian institutes of technology and set up 50 more mini IITs.
An international business school and a joint management school with Carnegie Mellon University in the US are being set up in Andhra Pradesh.
In Hyderabad, a two-hour flight from Delhi, ideological issues seem distant, if not irrelevant. Hoardings selling courses in Java programming, the latest mobile or internet services crowd the air, and huge shopping malls with names such as Lifestyle tell of a new-found prosperity. Randip Sudan, special secretary to chief minister Chandrababu Naidu, talks of how this once backward state is using IT to leapfrog ahead. Peering into his digital diary, he declares that software exports from the state doubled last year to Rs10.5 billion ($230 million), behind only Bangalore and Noida. Over a cup of tea, the London School of Economics trained bureaucrat reels off stories of how Naidu’s slick PowerPoint presentations won over investors such as Bill Gates and Jack Welch and how his weekly video conferences have helped reduce gastro-enteritis in the state.
“Seeing states compete with each other for foreign investment is what gives us the most sense of hope. Earlier we struggled to push investments in, now the states are pulling it in,” says Bhatnagar of Enron, one of the largest foreign investors in India. Companies such as Enron and Reliance plan to lay a fibre-optic network in the IT-advanced states of Karnataka and Andhra Pradesh.
In a paper presented at Stanford University, Montek Singh Ahluwalia, a former finance secretary and one of the key figures behind India’s economic reforms, argues that states such as Gujarat and Maharashtra grew fastest and benefited the most in the post-reform years. He reckons that after the government abolished industrial licensing, it could no longer push investments into backward regions and private investment has gone to states that are more investor-friendly. “The uneven economic development of states will grow with reforms and that is not a bad thing. The prosperity of the advanced states will spur the laggards,” he says.
It could also have far-reaching political consequences. Three of India’s most IT-savvy states, Karnataka, Andhra Pradesh and Tamil Nadu, which also have a large educated English-speaking population, are in the south. Their growing prosperity could tilt the balance of power away from politically dominant states such as Uttar Pradesh, which has provided India with most of its prime ministers including the present one.
Most agree that there will be no dramatic surge towards reform in India. But there is growing hope that its hapless politicians, egged on by impatient voters, will move in the right direction. As one bureaucrat puts it: “Just as in Kathakali [a traditional Indian dance form], there will be much noise, and fierce gestures, but very little movement.”
Finance minister and crisis manager
India’s finance minister, Yashwant Sinha, is no stranger to a crisis. In an earlier stint as finance minister, he steered his country through a difficult balance of payments crisis in 1991. He was again the finance minister when the Asian crisis broke and economic sanctions were imposed on India. Now he faces the tough tasks of downsizing government and pushing through the first real attempt at privatization. When he met Euromoney in late July, he seemed confident that he could accomplish both tasks.
India seemed relatively unscathed by the Asian crisis. You have set a GDP growth target of 7% to 8%. What are the big challenges that India must face to achieve that?
We were not totally unaffected by the Asian crisis. We had a crisis of our own – there was a slowdown in trade and capital flows to India. International sentiment was depressed and the economy was slowing down prior to the crisis.
In order to propel growth to over 7% we have to directly attack poverty, particularly in the rural areas, and create new jobs. If you look at the sectors that contribute to our GDP, 25% comes from agriculture, 25% from industry and 50% from services. Nearly 60% to 65% of our people live off agriculture and we have to improve their purchasing power. We have to improve the value added in agriculture by improving the quality of rural infrastructure, for instance. We are working at improving the supply of drinking water and connectivity in rural areas. We have taken up several projects to build highways, homes and set up IT-enabled services and we will continue to improve the human resources of India.
How do you propose to get $10 billion in foreign direct investment every year when current inflows are about a fifth of that amount?
We want to improve the flow of foreign direct investment mainly by removing the hassle factor. We have moved several industries to the automatic approval route, plugged the sectional gaps and follow-up with the state governments to speed up the process.
Will the government make the rupee convertible on the capital account?
The Tarapore committee on capital account convertibility has set out the preconditions for that process. We have taken several steps to make it easier for Indian companies to acquire companies abroad. They get automatic approval for up to 10 times their export earnings. Several factors must fall in place for complete convertibility. We know what has to be done and will wait for the convergence of factors before we do it.
The fiscal deficit has emerged as one of India’s most intractable problems. How will you contain government expenditure?
The Expenditure Commission is looking at ways to rightsize government. We are committed to a zero-based budget and the fiscal responsibility law that is being drawn up will enable government to order its expenditure according to the resources it has. All of these should introduce some discipline on government borrowing.
Will the government move to cut subsidies?
Subsidy for the poor will have to continue. Our attempt is to target it better and streamline delivery so it reaches the poor. The Expenditure Commission has submitted its report on food subsidy. We have already begun indexing the prices of foodgrains supplied by the public distribution system to the minimum support prices that the government pays to farmers.
Your government promised a new thrust to privatization. Yet the list of companies that you put out in June for privatization has no gas or oil company and the market seems disappointed.
We do not pick companies to please some individuals. Nor are we influenced by anyone’s impatience. We have a definite plan in mind and we will move towards that. Privatization is not a budgetary exercise but must also involve reform of the public sector and better utilization of assets. We will use the money raised to retire high cost debt, restructure the public sector and invest in the social sector. We hope to raise Rs100 billion [$2.2 billion] this year by sales of strategic stakes in public companies.
The current upturn in the economy depends on low interest rates. Yet the government’s large market borrowings threaten to push up interest rates.
The Reserve Bank of India is looking at this issue [a week later the central bank put up the bank rate sparking a rise in bank lending rates], particularly since interest rates in the US are hardening. We hope not to overshoot the target for market borrowings set for this year.
Selling voters on reform
In the plush VIP waiting room outside the chief minister’s office in Hyderabad, a group of Japanese businessmen wait patiently for an audience with Chandrababu Naidu. In halting English, one of them explains to a local bureaucrat that Japan desperately needs 10,000 software engineers from India. Naidu is scheduled to visit that country in October, the bureaucrat tells them. After a brief audience, the businessmen are bundled into a large auditorium to watch an e-government at work – a weekly video-conference that Naidu hosts with collectors from all over the state.
Naidu seems more like a sovereign head of state than the head of a somewhat backward province in southern India, Andhra Pradesh. Many believe that he bypasses Delhi by lobbying rich, well-connected Andhraites in America. The first loans that were cleared by the World Bank months after the US imposed economic sanctions on India in May 1998, went to his state. US president Bill Clinton was persuaded to stop by at Hyderabad on his visit to India last March, even though many expected him to go to Bangalore.
But Naidu’s crowning moment came last year when he got re-elected in the state elections with a mandate that allows him to push ahead with reforms and provides a useful lever with which to mould policies of the government in Delhi. Along with the BJP, an ally, he controls 36 out of the 42 seats in his state.
As one Delhi bureaucrat points out, Naidu is the first Indian politician to put his reform agenda before voters and win. In contrast, two reform-minded former finance ministers, Manmohan Singh and P Chidambaram, lost their seats. Ask him how he did it and Naidu’s answer is simple, “People want performance and that is possible only through economic reforms. All states face a fiscal crisis today and slogans are not what people want.”
But angry consumers don’t like the steep hike in electricity tariffs that Naidu has just announced. Led by the opposition Congress party, they have disrupted several of his meetings recently. Asked how he proposes to deal with them, Naidu says, “We have to educate them about why subsidies cannot continue. The subsidy bill for the power sector alone is over Rs20 billion. They must be made to understand that it is better to pay more now rather than not have power at all. I am convinced that this can be done. My measures are being opposed today, but if the present situation continues there will be no power available and then the criticism will be much worse.”
His critics also accuse him of doublespeak on subsidies. They accuse him of distributing free LPG cylinders to get votes in the last election, and that his party opposed the finance minister’s measures to cut the fertiliser subsidy early this year. There is enough of the politician in Naidu’s reply, “Subsidies have to be phased out over time. Measures to increase the purchasing power of people should be taken first.”
Creating new jobs and economic prosperity is his way to silence opposition to subsidy cuts.
Does he think that coalition governments have weakened India’s claim to becoming an economic power?
Naidu is firm that coalition governments are here to stay. “Foreign investors might be skeptical of coalition governments but India is too big a market for them to ignore. It is up to us to make it attractive for them to invest here.”
And that is something he has set out to do. His bureaucrats tell you of how America’s business icons such as Bill Gates and Jack Welch were persuaded to invest in Hyderabad after they met Naidu. Microsoft set up its second product development centre outside the US here in 1998 and employs 70 software engineers.
GE Capital, one of the first companies to tap India’s potential in the IT sector, is setting up a giant processing centre here at Hi-tech City that will support its customer service centres in the US. It will reportedly employ over 3,000 people. HSBC has set up a data processing hub that services its mortgage loans in the UK.
Says Randip Sudan, special secretary to Naidu, “IT enabled services is the next big opportunity that will bring investments and create jobs in India.”
About a fifth of the 106,000 kilometre fibre-optic network in India is in Andhra Pradesh, he says, and Reliance Industries will invest Rs20 billion to lay another 6,000 kilometres.
