Wednesday, February 23, 2011

Shun the negativity. Rejoice that India will soon be the #1 economy in the world!

Forget what the newspapers prefer to put on their front pages (Bhanot’s and Verma’s arrests and all kinds of sensational subjects).....focus instead on Citigroup’s report on India’s surging economy (tucked away somewhere deep inside the papers). Focus also on the government’s aim to double exports to $450 billion in the next 4 years (inside pages again). Begin your day with confidence; and enjoy the sunshine!

Let me give some initial numbers so that the context of this post becomes clear. India is today about a $1.3 trillion economy. This figure is obtained by dividing our GDP measured in INR by the exchange rate (say Rs 45 per $). This is the most commonly used method for measuring the relative sizes of economies worldwide. On this basis, India is presently ranked somewhere around the 10th position. China’s economy is about $5.3 trillion and has just gone past Japan which is around $5 trillion. The US is the #1 economy at $15 trillion; Germany is around $3 trillion; France and the UK around $2.5 trillion and Spain, Italy, Russia and Brazil somewhere around us.

However, there is a major flaw in measuring the economy in this manner. The flaw is in the exchange rate used. The exchange rate is ok for trading purposes, but is dependent on several factors that can skew its value. Consider what happened in India 2-3 years back when the exchange rate shot up to Rs 40 to a $. This happened not because India became a stronger economy per se....but because suddenly there was a surfeit of dollars flowing into India. As a result, the dollar’s value fell. There were so many dollars available; they could be bought cheap. But why did the dollar inflow increase? Because foreigners were investing larger sums of monies into India. This would give an impression that the Indian economy had already become much bigger (than it really was); in reality.....this high dollar inflow only meant that the investments in the Indian economy had become much bigger; growth would hopefully follow a few years down the line. As a result of this change in exchange rate, the Indian GDP as measured in exchange rate $ terms suddenly entered into the trillion dollar club. Because the $ can vary so much, economists prefer to use a different measure to gauge the real size of an economy and its growth.

The measure economists prefer is the PPP. PPP stands for Purchasing Power Parity. Basically, rather than focusing on the exchange rate, this measure focus on purchasing power that the people in a country enjoy. After all, living standards of people are all about what they can afford to consume and save. A McDonald’s burger costs $2.5 in the US; but it costs just Rs 45 in India. A burger feeds both people equally. So really speaking, the exchange rate should be something like Rs 20 to a $. Likewise, a bottle of coke costs $1 in the US, but only Rs 12 in India. For this product therefore, the real exchange rate should be around Rs 12 to a $. When such an exercise is carried out over many many products and services, the real exchange rate for the entire economy is derived. For India, as a whole, the real exchange rate is somewhere around Rs 12-15 to a $. If we were to measure the Indian GDP in PPP terms, it would be $3.9 trillion in 2009. The PPP measure improves the rankings of developing countries while keeping the developed world at nearly the same place. So the US is a $15 trillion economy and Japan a $5  trillion economy by either of the two measures.

At $3.9 trillion, India is already the 4th largest economy in the world. What Citibank’s report says is that in PPP terms, India will become the world’s 3rd largest economy (go past Japan) by 2015 and then the 2nd largest in 2040 (go past the US) and finally become the #1 economy in the world by 2050 (go past China). The question in many people’s mind would be that all this is fine....but when will we start seeing signs of prosperity all around us just like we do when we go to the developed world?

It’s a good question. When we talk of “prosperity”, we normally talk about the way our cities look (roads, buildings, infrastructure, transport systems, cleanliness, pollution etc).....this is what hits us first when we go to a developed country. The next thing to hit us is how well off even the poorest of the poor are.....well tracked by a measure called the Per Capita Income.....simply the GDP (in PPP terms) divided by the population (There is also the Gini coefficient which measures economic disparity, but we can leave it aside for now). My bet is that in the next 10 years, the first parameter will be satisfied to a large extent. Our cities will start looking like how cities in Malaysia or Thailand look today. In terms of per capita income, I think, we will remain behind the developed world for a much longer time. By 2050, even when we become #1, our per-capita will still remain about one-fourth of the US’s at that time.

What we should aim for is to become #1 in per capita terms. To do that, our economy will have to become 4 times the that’s going to take a much longer time! Our real goal should be to become #1 in per capita terms. Becoming #1 in GDP terms is only an interim milestone.

The real truth is that this is well within our grasp. As long as we stay motivated and focused on our goals. As long as we don’t let a few small hiccups affect our resolve. As long as the regular processes of democracy allow for us to vent our feelings and an Egypt-like situation never develops. As long as our media stays alert.....but does not become a cribbing, demoralizing, sensationalizing and harmful force. And most importantly, as long as we remain believers in our inherent strengths. Its a day I hope to see in my lifetime!

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