What India needs to escape the low-middle income trap

NEW DELHI - The Modi Government's reform agenda has not generated enough jobs to absorb India's excess labour, the French banking group, Natixis, says in a research note on India's upcoming election. Natixis assesses Modi's pledges on three key factors of production: labour, capital and productivity.

"Whether it is demonetisation, GST or FDI liberalisation, most progress (has been) made on capital, while (progress) remains very limited on labour reform or a general increase in total factor productivity," the note says.

It asks what India needs to escape the low middle income trap (GDP per capita of US$2,015 versus China's US$8,827).

"A number of issues seem crucial," the note says.

"First, India needs more inward FDI into the manufacturing sector, as well as a higher savings rate. We use China in the early 2000s as an example.

"India currently attracts only 0.6% of GDP to manufacturing FDI versus China's 2.5% of its own GDP in the early 2000s.

"In other words, manufacturing FDI was 9.5% of fixed asset investment (FAI) for China versus India's 2% of FAI. This is particularly surprising, since China's overall FAI is larger than that of India as a percentage of GDP.

"In addition to needing about 2% more of GDP in FDI, India needs to increase its savings rate to be able to fund much-needed infrastructure development -- as well as to increase FAI more generally."

Natixis says the Modi Government has fallen "very short" of the bold reforms needed to take India beyond the low-middle income trap.

"This is especially true for labour-related reforms and more generally those enhancing total factor productivity.

"Should India attract 2% of manufacturing FDI, then it will be able to close its financing gap (with a current account deficit of 2.4% of GDP in 2018). This would make India much less vulnerable to volatility of capital flows."

Natixis says that while India, in the last few years, has experienced the fastest growth among major Asian countries, job creation has been underwhelming.

"India's absorptive capacity for the country's growing supply of labour remains weak and so does its ability to build the necessary infrastructure.

"This remains a key problem, as its working population is expected to expand rapidly, so much so that India needs to create at least 11 million jobs per year in the next decade.

"As it is, India has a low labour participation rate - only 54% versus China's 68%, according to ILO estimates.

"Worse still, within the Indian employment population, 82% of jobs are in informal sectors, meaning most have vulnerable employment with economic low output, versus China's less than 60%.

"Moreover, India's investment in infrastructure has stagnated in less than 10% of GDP." www.natixis.com(ATI).