Subir Gokarn: Economic reforms for sustainable growth
Presentation by Dr Subir Gokarn, Deputy Governor of the Reserve Bank of India, at the
175th Annual General Meeting of the Madras Chamber of Commerce & Industry, Chennai,
23 June 2011.
* * *
Inputs from Bhupal Singh are gratefully acknowledged.
I. Introduction
It is a great pleasure and privilege for me to be speaking at the 175th Annual General
Meeting of the Madras Chamber of Commerce and Industry. I have had the opportunity to
speak at previous events organized by the Chamber, and also interact with committee
members and the secretariat during my tenure as the chairperson of the Economic Affairs
Committee of ASSOCHAM. But, this is a special occasion and I thank the Chamber for
inviting me to speak on a topic that has been close to my heart and mind for many years
now.
An organization that has been in existence and, by all indications, thrived for 175 years
clearly knows a thing or two about sustainability. It has, presumably, through trial and error,
figured out what it needs to change and what it needs to retain in order to remain relevant
and useful to its individual stakeholders. To be meaningful, sustainable growth has to be
viewed from the perspective of the individual. Ultimately, it is individuals or households who
determine whether the growth process has benefitted them or not. In short, just as the
durability of an institution such as the MCCI depends on how effectively it serves the
interests of its members, so also does the sustainability of a growth process depend on how
effectively it serves the interests of its core stakeholders - the individuals and households in
the economy.
This is the broad perspective with which I plan to address today's topic. In what follows, I will
address four issues - food, human capital, infrastructure and financial sector development -
in which I believe reforms are critical to the sustainability of the growth process in the way I
have defined it. This is not intended to be an exhaustive list. I am acutely aware that there
are many other issues, which have a legitimate claim to be on anybody's list of reform
priorities. I have chosen my list based on my understanding and knowledge of them and not
because I believe they are decisively more important than others that have been excluded.
Nor am I claiming to offer panaceas by way of reform ideas. Given complex inter-linkages,
many solutions that may seem perfectly reasonable in a limited context break down when the
context is widened. However, despite all these caveats, I will assert that these are all critical
reform agendas and it is worth debating and refining the solutions that emerge.
II. Food
Food inflation is a significant negative feature of today's economic environment. It has a
tremendous impact on quality of life, as people struggle to maintain nutritional standards that
they had previously achieved, or give up some other forms of consumption so as to keep
themselves well-fed. For a country that legitimately believed that it had effectively dealt with
its vulnerability to food shortages in the form of the Green Revolution of the late 1960s and
early 1970s, the current situation comes as a rude reminder that solutions are rarely
permanent.
To place the current developments in context, it must be pointed out that the world economy
is itself facing problems with food prices. As Chart 1 shows, food as a category has been
following global trends in commodity prices over the past couple of years. There is a view
that this is the outcome of the larger trend towards financialization of commodities, wherein
large increases in global liquidity as a response to the 2008 crisis feed directly into higher
asset prices, including commodities. Be that as it may, the price dynamics of individual food
items, also displayed on Chart 1, suggest that there are also some commodity-specific
factors at work, which may either reinforce or counteract the broader trend. Sugar, for
example, shows fluctuations in response to current supply conditions, while wheat reflects
the effect of persistent drought in some major cultivating areas.
India's food inflation is certainly linked to global trends, particularly in relatively heavily traded
commodities like sugar and oilseeds, but, given the high degree of self-reliance in many
other commodities, domestic factors play a big role. Chart 2 shows the significance of food
inflation in the overall domestic inflation scenario. As the graph suggests, although the
drivers of inflation in recent months have been energy prices and demand pressures, as
reflected in the non-food manufactured products index, food prices contributed significantly in
the first half of 2010 and remain uncomfortably high. Apart from the direct impact on the
index, it is also likely to feed through into the wider inflationary process through higher wage
demands, of which there is some evidence.
It is generally believed that food prices are highly sensitive to monsoon performance, but this
belief has been tested over the past few years. I think there is sufficient evidence to suggest
that food prices are being driven not by transitory factors, such as rainfall, but my more
fundamental forces. Essentially, a long period of relatively rapid growth has taken large
numbers of households across a threshold at which they begin to look for nutritional
diversification. The predominance of cereals in the typical household diet gives way to
greater balance and a consequent increase in the demand for proteins - pulses, milk, meat,
fish and eggs - , vegetables and fruit. It is no surprise that these items have been the
primary causes of food inflation in the recent period.
Further, as Chart 3 clearly shows, as far as proteins are concerned there is a significant
deviation from an earlier trend, with no significant sign of reverting to the more moderate
trend, unlike non-protein items. The implication is that, as long as growth is leading to rising
household incomes, particularly at the lower end of the income distribution, the pressure on
food prices resulting from nutritional diversification will continue.
The enduring solution to persistent demand-supply imbalances in food is to rapidly increase
supply. This is exactly what the Green Revolution did. The combination of inputs that
achieved that success is well-known and some lessons may yet be relevant. The basic
principles, however, are quite clear. Production of the relevant items has to be increased,
mostly by increasing productivity. Cultivation risks have to be mitigated for farmers to find
these products more attractive. Transportation, storage and distribution efficiency have to be
increased to keep losses and distribution margins down. These may seem obvious points,
even clichés, but there is no getting around them. There will be some generic strategies and
some crop-specific ones, which makes it worthwhile to approach the problem from a wider
perspective. A first step has been taken by the Government in setting up the National
Mission on Protein Supplements, from which a concrete action plan needs to emerge quickly.
In its absence, the likely scenario is one of persistent food inflation and, from the
allimportant perspective of quality of life, persistent nutritional imbalances. This is not a recipe
for sustainable growth.
III. Human capital
India is the second most populous country in the world and will become the most populous in
a couple of decades. It is also one of the youngest and will remain so for some decades to
come. At one level, this "demographic dividend" provides an enormous opportunity. Chart 4
shows the contrasting demographic transition in India and China over the next two decades.
The Chinese growth story over the past three decades has been well chronicled and I don't
want to go into it here, except to make the point that a critical input into the sustained high
growth was the abundance of labour. Of course, other policies contributed, but they can all
be seen in terms of how they facilitated the absorption of large numbers of workers from the
farms into the factories.
The main point that Chart 4 makes is that the Chinese pool of workers is going to shrink as
the population ages over the next two decades, during which period India will add a
substantial number of workers. While China will lose about 40 million workers between 2010
and 2030 as they move past the age of 60, India will actually add 220 million workers. In
terms of competitive advantage, this is an opportunity to take over the mantle "factory to the
world", with hundreds of millions of relatively low-cost workers producing goods that the rest
of the world will consume. In fact, as Chart 5 shows very clearly, India will dominate the
global pool of workers as China's population ages, because no other country that is likely to
face the same level of labour costs as India, is anywhere close to having that number of
people. If the hub of global manufacturing is to move from China, realistically speaking, it can
only move to India, or to expand the geographic scope somewhat, South Asia
However, the mere fact that the economy has a large number of potential workers doesn't
guarantee that they will be employed in desirable, relatively high-productive, well-paying
jobs. There is nothing automatic about the process, which is what makes the other policies
that facilitate and support it extremely important. This is where some questions about India's
ability to replicate the process arise.
A basic concern is the quality of the workforce. Chart 6 provides a comparative picture of the
most basic workforce quality parameter, i.e., whether workers have been through secondary
school. Evidently, despite significant improvements in India's record, it lags a long distance
behind China and the South-East Asian economies, all of which have been, or still are,
manufacturing powerhouses. Of course, the mere fact of having finished school does not
guarantee that a worker can be productively employed. Vocational, job-oriented training may
be a necessary part of equipping workers to function. Data on these indicators are sketchy,
but anecdotal evidence suggest that this is not a very large pipeline and, in its current state,
can hardly hope to make a dent on the large numbers of potential workers today, let alone
the surge that is anticipated over the next two decades.
Partly as a result of this, but also due to some other factors, some of which will be addressed
in the next section, India's record in moving people from farm to factory has not been very
good. As Chart 7 shows, over the 1993-94 period, the structure of economic activity
changed significantly. While the share of agriculture declined, the share of services
increased and that of industry virtually remained the same. The decline in the share of
agriculture is a universal historical pattern, but the transition of the share predominantly to
services is unique to India. But, that is a separate issue. What is striking in Chart 7 is that the
transition in the workforce has been far less significant. Over 55 per cent of the workforce
remained in agriculture, with the decline in this sector's share being equally absorbed by
industry and services. In 1993-94, agriculture, with 30 per cent of GDP, was providing
employment and livelihood to 65 per cent of the workforce. By 2007-08, the same sector
accounted for less than 17 per cent of GDP, but continued to support 55 per cent of the
workforce. In short, the workforce did not restructure as rapidly as the economy did,
indicating the inability of the non-agricultural sectors to absorb workers.
How much did this impact livelihood and inequality in the economy? A simple calculation
gives some indication. Chart 8 displays the absolute and relative levels of average labour
productivity across the three sectors, agriculture, industry and services. Although these are
very crude measures of productivity differentials, the magnitudes are suggestive. The graph
shows that the average worker in industry or services is about 5 times as productive as the
average worker in agriculture, which means that the ratio of their earnings must be about the
same order of magnitude. In other words, in terms of this simple arithmetic, every worker
shifting from agriculture to industry or services would contribute four more units of GDP,
besides spending and saving more out of higher earnings.
As crude as the arithmetic may be, the point is clear. Accelerating growth in a way that is
sustainable will inevitably involve moving workers from agriculture to industry and services.
However, the past pace of transition does not provide much reassurance that the Indian
economy does this very well. Facilitating the transition is, therefore, a critical requirement for
sustainable growth. In my view, three things are absolutely necessary for this to happen.
First, there is evidence to suggest that job security regulations in the manufacturing deter
employers from hiring workers. There are clearly ways around this, but since they exist, their
deterrent effect is probably being felt. Second, if job security is eliminated, workers must
have access to a safety net of unemployment insurance. By all accounts, the Mahatma
Gandhi National Rural Employment Guarantee Scheme (MGNREGS) is providing a tangible
safety net for rural workers. It is time to think of cost-effective ways to extend safety net
access to industrial workers as a concomitant to scaling down job security regulations. Third,
large numbers of workers have to be trained and equipped to work in modern industrial
environments. Whether this is to be done through traditional schooling or alternative methods
is a matter of debate, but the primary objective should be to move from generic knowledge to
work-oriented skills. The numbers involved indicate that the whole exercise is going to be a
huge organizational and financial challenge, but it must be faced.
IV. Infrastructure
The third critical area for reforms, to my mind, is infrastructure. The problems in most
infrastructure sectors are well-known and can be summarized in a couple of sentences.
Rapid growth has raised demand for infrastructure services far in excess of available
capacity. Meanwhile, a combination of policy, regulatory and financial factors has slowed the
pace of investment in infrastructure, leading to a persistence of the gap.
We can look at this basic condition of shortage from a variety of perspectives. Charts 9 and
Chart 10 provide some indications of the gaps that currently exist. Chart 9 reinforces the
general perception of severe power shortages across the country. The Northern and Western
regions are relatively dynamic in terms of their growth momentum and the magnitude of
shortage that is estimated for them may prove to be significant drag on growth. Of course,
since the deficit has persisted for some time, most establishments look for alternatives in the
form of captive power. However, this is relatively costly, not to mention more dependent on
diesel, which then contributes to an increase in petroleum demand, which has both fiscal and
balance of payments consequences. The Chart also provides an indication of how much
distance there is to cover in providing the country a comprehensive four-lane highway
system, the absence of which is leading to huge inefficiencies in the national transportation
system.
The impact of inadequate supply of power and transport infrastructure on manufacturing
activity is quite significant. This sector, in general, is infrastructure-intensive and any increase
in costs due to unreliable or privately provided infrastructure services tends to reduce the
competitiveness of producers. Since virtually all manufactured goods are tradable, inefficient
domestic cost structures put producers at a disadvantage not only in global markets but also
in their home markets, where they have to compete against imports. This is a significant
reason why the Industrial sector's share of GDP has virtually remained the same over a long
period of time. This is in sharp contrast to virtually all other economies, particularly those in
East Asia, whose industrial sectors acted as engines of growth, resulting in a large increase
in their share of GDP over comparably long periods.
Chart 10 focuses on parameters that impinge very directly on quality of life, access to water
and sanitation. These statistics suggest that access to water is relatively high, but sanitation
is a different matter altogether. It is no comfort that on this one parameter, India and China
are quite close to each other. Over 45 per cent of India's population is estimated to be
without access to sanitation facilities, a gap that presumably vitiates many of the quality of
life improvements arising from higher earnings and better access to a range of goods and
services.
This leads to a larger point about urban infrastructure. As we look ahead at the country's
population trajectory, apart from the aggregates, it is very important to keep in mind that
there is likely to be a significant shift from rural areas to urban areas. Chart 11 provides
projections of the incremental contribution to the world urban population expected to come
from India and China over the next few decades. Evidently, Indian cities are going to become
the repository of a very large number of the young workers that the country will add to its
workforce during this period. In a situation in which cities are already reeling under enormous
pressure on all urban systems because of rapidly increasing population, their ability to cope
with even larger numbers without both more resources and significant increases in their
organizational and managerial capacities is doubtful.
In a nutshell, the infrastructure problem has two dimensions - sectoral and geographic. Each
needs distinct focus in order to arrive at meaningful solutions. As far as sectoral imbalances
are concerned, there are fortunately areas in which significant progress has been made.
Over a period of time, policy clarity has been achieved and appropriate regulatory structures
have been or are being put into place. This, in turn, has created the space for significant
private investment to flow in, typically though not always in partnership with the public sector.
In fact, for the past two years or more, infrastructure has been the largest contributor to
growth in bank credit. This has given rise to some problems, which I shall address in the next
section, but, it is a reassuring sign that new infrastructure capacity is being created.
As the supply-demand gaps in a variety of sectors close, the stress that they impose on
industrial investment will ease. Conditions will be created for new industrial capacity to be
created, unburdened by uncertain or high-cost infrastructure services. This, in turn, should
facilitate the movement of workers from relatively low-productivity agriculture to relatively
high-productivity manufacturing, provided that the policy framework indicated in the human
capital discussion are put into place.
However, the urbanization scenario raises concerns. If the ultimate goal of sustained growth
is to create enduring improvements in the quality of life of as many people as possible, this is
not going to be achieved if urban systems do not keep pace with the number of entrants.
Fortunately, there are a number of initiatives in place that at least provide the prospect for the
needed improvement. These are both top-down and bottom-up approaches. The Jawaharlal
Nehru National Urban Renewal Mission (JNNURM) is the primary example of the former, in
which the central government provides resources for urban investments, subject to explicit
accountability standards as well as resource commitments by city governments.
In the bottom-up category, many cities have launched initiatives to digitize their land records,
which immediately enhance the capacity to collect property taxes, always a significant source
of revenue for cities. Simplification of tax formulae and procedures is another aspect of urban
governance reform. Rationalization of user charges for civic services, the use of private
agents to provide some services, e.g., waste management and so on are all ways in which
cities are going about the task of improving service delivery to their current residents as well
as creating the capacity to do so for newcomers.
As reassuring and promising as all these programmes and initiatives are, they do not seem
to be at a scale matching the enormity of the challenge. A significant restructuring of urban
governance framework, which helps build the capacity to meet the challenge, is therefore a
reform priority in this domain. There is plenty to learn from the experience of other countries
where the quality of urban environment is noticeably superior to that in India. Some broad
guidelines may include, for example, greater powers to tax with a consequent decrease in
the dependence on higher tiers of government, and the creation of a professional cadre of
urban management specialists, who spend their entire career running the city and can rise to
levels of seniority comparable to other government hierarchies. Of course, cities exist in a
socio-cultural context, so no model is strictly transplantable, but that does not mean that
some widely applicable principles do not exist.
There have been other kinds of suggestions specifically in the Indian context, e.g., to convert
the larger cities into Union Territories to give them some autonomy from political economy
forces at the state level, which also tend to favour rural areas due to simple electoral
arithmetic. Such ideas are worth examining. But certainly, any means of giving cities both
greater autonomy in resource mobilization, along with greater managerial capability need to
be pursued, even if this is to be achieved within the existing federal framework.
V. The financial sector
Looking back over the past 20 years, there have clearly been massive changes in the
financial sector, which have completely changed the nature of intermediation, the range of
products and services available and the intensity of competition. This has clearly been in
sync with the overall development and structural change of the economy. The financial
sector has had the space to service the requirements of an increasing number of individuals
and organizations. However, the process is clearly far from complete. It is useful to think of
financial sector reforms as a perpetual work-in-progress, in which policy and regulation need
to create space for service providers to cater to increasing and new customer requirements,
while ensuring that existing and emerging risks are monitored and mitigated.
This topic could be the basis of a full-length speech by itself, but I clearly don't want to do
that here. I will confine myself to two sets of issues - financial inclusion and the development
of a corporate bond market.
Expanding the reach of financial services to those individuals who do not currently have
access is an objective that is fully consistent with the people-centric definition of sustainable
growth. Going by the evidence, there is a long way to go in achieving this objective. Chart 12
provides a picture of the current levels of access to different financial products and services.
Bank accounts are relatively widespread, but even in that most basic of services, the gap is
quite large. Other services have very low levels of penetration. Of course, high penetration
depends on demand conditions as well and not everyone may want or need every kind of
product or service, but, as subsequent Charts will suggest, the unmet demand for some
kinds of services may be quite large.
Chart 13 makes the point that a very high proportion of household financial assets are held in
cash, which suggest that the ability of many households to access the financial system is
low. This is, understandably, even higher in rural areas than in the urban ones. Bank
deposits are clearly providing an alternative to cash, which is a positive development, but the
room for improvement is clearly visible in the picture.
The Reserve Bank has been emphasising on expanding the access to the banking system.
The broad objective is to ensure access to all households in villages with a population over
2000 (as per the 2001 Census) by 2012. The extensive use of technology facilitates this by
allowing banks to operate virtual branches in the form of an IT-enabled Business
Correspondent (BC). This model shows some promise as it rolls out across the country, and
also some limitations. It is reasonably clear that the BC model is not infinitely scalable. Banks
have to innovate in terms of their own organizational structures and support systems to
increase the viability and sustainability of the model. But, even with all these concerns, it is a
good beginning and the generic model, with appropriate adaptations to local conditions, is
the most likely way to achieve at least minimal access to the financial system through a basic
or no-frills bank account. This is visualized as the beginning of the process; once the
customer is in the system, it can begin to address his or her other needs by adapting existing
products or designing new ones.
What other products may interest this new pool of financial service customers? One way to
gauge this is to identify the reasons for people to use financial services. Chart 14, reporting
results from a recent survey of households, provides some important insights on this.
Ceremonies or social obligations, old-age security, children's education and meeting
emergency needs are four of the most important motivations for accessing financial services.
Clearly, there is a role for insurance, pension and other long-term savings instruments in
advancing the cause of financial inclusion. It is in these segments that penetration is
extremely low. Chart 15 provides a cross-country comparison of insurance services. It
speaks for itself.
What is needed here is to develop last-mile delivery mechanisms that can take these
products from the large providers in the formal sector to this vast pool of new customers.
Though volumes are potentially large, individual transactions will be small and geographically
scattered, which can play havoc with costs. Organizational structures, whether within the
existing providers or independent, have to be developed to accommodate these specific
market conditions. From a regulatory perspective, the massive expansion of services brings
with it risks and these have to be identified and provided for.
I will now turn to the issue of the corporate bond market. To provide a backdrop, Chart 16
shows the estimated financial requirements for infrastructure over the 12th Plan period,
2012-17. Over the next five years, over Rs. 40 lakh crores or $1 trillion are desired to be
invested. As I indicated earlier, infrastructure supply is a serious bottleneck and large,
efficiently implemented and well managed projects across sectors are imperative. Even as
these are getting under way, there is an obvious lack of financial channels for them to
mobilize resources. So far, the responsibility for financing new investments has fallen
predominantly on banks. For reasons relating to asset-liability management and sector
exposure limits, the capacity of banks to continue to finance this sector is limited. Therefore,
alternative channels have to be quickly put into place. The corporate bond market is perhaps
the most important of these.
For several years, one committee after another has been making recommendations for
actions to develop this market. These cut across regulatory domains and this is perhaps one
reason why, despite the several steps taken, a critical threshold that would make the market
viable was not reached. However, in recent months this is on high priority with both the
regulators and the government addressing the remaining binding constraints. The 2011-12
Union Budget took a crucial step in exempting bonds issued by Infrastructure Development
Funds from withholding tax. It would be reasonable to extend this facility to bonds issued
directly by infrastructure companies. Another issue that has been flagged, inter-state
differentials in stamp duties, is being addressed by attempting a harmonization of rates
across states. To make a large number of bonds attractive to a potentially large domestic
investor base in the form of insurance and pension funds, credit enhancement mechanisms
which will allow bonds to meet minimum rating requirements for a price are being explored.
The more efficiently and reliably this service is delivered, the larger will be the potential pool
of investment for these huge institutions.
Of course, aspirations notwithstanding, the question is whether bond markets can realistically
emerge as an alternative channel of financing, for infrastructure certainly, but also for
investment in other sectors. Chart 17 provides a cross-country comparison. It would appear
that even in the context of emerging economies, Indian bond markets do have some
headroom available.
VI. Concluding remarks
I have addressed four sets of factors, which I believe hold the key to sustainable growth and
tried to articulate my thoughts on what the policy imperatives are. As I have pointed out, in
many areas, reform measures have been taken or are in the pipeline. However, there are
also many in which either action needs to be taken on the basis of credible supporting
evidence or, new approaches and solutions need to be visualized. I also want to
reemphasize my caveat that this was not meant to be an exhaustive list of actions for
sustainable growth.
I will not attempt to summarize my thoughts on actions and solutions for each set of factors.
But, I would like to end by emphasizing three key principles that have provided, explicitly or
implicitly, a common thread running through my presentation.
First, policies and strategies for growth have to be welfare-oriented. Placing the well-being or
quality of life of the key stakeholders - individuals or households here - at the centre of
strategic thinking is the key to sustainability.
Second, any policy or strategy must give due consideration to the risks involved.
High-riskhigh-return may be a valid approach to portfolio management by individuals, but is not so in a
policy setting, where it is difficult to justify the large losses to some stakeholders in terms of
large gains to others. "The greatest good for the greatest number" is certainly a valid premise
for policymakers, but it needs to be complemented with "the least risk for the greatest
number". In situations in which heightened risks are unavoidable for some stakeholders,
reliable safety nets need to be an integral part of the strategy.
Third, a pragmatic, "whatever works" approach is important. There are multiple
environments, multiple economic, social and political contexts in which policies are made and
implemented, even within a single country. No single solution can be expected to work in all
of them. Bottom-up thinking, which draws on local knowledge and understanding to design
appropriate solutions is necessary. At the same time, a top-down element, which articulates
common goals and policy principles, increases efficiency in resource mobilization and
allocation and facilitates learning across jurisdictions, also plays a critical part. An optimal
mix of the two needs to be found.
Let me end by once again thanking the MCCI for inviting me to speak on this special
occasion. I do hope that my presentation met your expectations.
BIS central bankers' speeches

BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches
BIS central bankers' speeches