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Can India be a breakout nation?

By Ruchir Sharma | Dec 9, 2012, 08.05 PM IST

In my day job as an investor I wander the world, kicking the tires ofemerging economies to see how fast they cango, but I've been a writer for as long as I have been an investor because I see my job as more art than science. I findmany of the popular theories about why emerging nations grow amusingly academic and overconfident, for examplein their attempt to forecast decades into the future by looking decades into the past. I try and travel to at least oneemerging market every month not because I love planes but to get a first-hand grip on the unique mood and feel of acountry to understand where its economy is likely to head in the next five to ten years, the period that matters topractical people.

The glory that was India or China in the 18th Century can't tell you much about who the next leaders will be or whatthey will do for prosperity. Loosely speaking, in the last decade economists have tried to explain and forecast whichnations will succeed or fail by focusing on one key factor. The hottest one right nowbased on a US bestseller thatI didn't writefocuses on institutions, the basic idea being that countries with stable and open banks, courts,legislatures and other institutions create an environment in which entrepreneurs can build businesses and innovate,one of the keys to a competitive economy. Like all such grand theories, this one gets one clue right but starts to fallapart as soon as you try to apply to it every mystery, case by case. If open institutions are the magic key, how do youexplain the many success stories in Asia, especially China, where most institutions are intensely secretive yet alsoquite competent? And neither does China have very clear property rights - a favorite factor of many developmenteconomic theorists.

Another set of these ideas focuses on geography, arguing that nations fail because of remote or landlocked locations,off the beaten path ofglobal trade, or isolated in the deserts of equatorial Africa. Sounds plausible enough, but someof the most out-of-the-way nations ofCentral Asia were among the world's fastest growing economies in the lastdecade, including Kazakhstan andTajikistan. These theories miss a lot of facts on the ground, much like the movie"Borat", which was spoofing Kazakhstan as hilariously backward at a time when it was booming. The fastestgrowing province of China is now InnerMongolia, long a punch-line synonym for the back of beyond.

A close cousin of the geography theories is the idea that culture determines growth, but this one had for the mostpart fallen off the map until Mitt Romney revived it during the presidential campaign, when he suggested that"culture makes all the difference" in describing the very different fates ofIsrael andPalestine. The origins of thistheory go back to German philosopher, who suggested that the protestant work ethic explained the economic successofnorthern Europe, compared to Catholic nations of southern Europe or the Confucian and Buddhist nations ofAsia. Later, ignoring Weber, the culture theory was revived to explain the rise of Korea and China as a function ofthe superiority of the Confucian work ethic. But where was this much talked about work ethic in China underChairman Mao? The whole thing started to fall apart when Buddhists and Hindus began to prove that they, too, canwork up an economic boom. To apply it to Islamic cultures today ignores the strong growth in the most populousparts of the Islamic world, including Indonesia andTurkey, which will be the next two economies to join theexclusive club of a one-trillion dollar economies that so far has only 15 members.

A theory that is especially popular in India right now focuses on the "demographic dividend", and suggests that the

fastest growing economies will be found in the countries with the best demographics, meaning the youngest, fastestgrowing population and labor force. Indians came to love this idea because it transforms their booming populationwhich was feared only a decade ago as a "population time bomb"into a competitive advantage. Both the fear andthe euphoria are irrational, because the impact of population growth depends on how government handles it. Formany decades, until very recently, a booming population was a huge advantage to China, because the governmentfound work for all those youths in export factories. And for many decades, also until very recently, a boomingpopulation was a huge disadvantage for Africa, where the economies weren't generating jobs, and all those youthswere so many more mouths to feed.

These one-dimensional theories are often based on historical records going back decades and look forward for

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equally long periods. As a result, they tend to miss what is going to happen over the next few years. Global growthis slowing, and so is growth in emerging nations, with wider gaps between winners and losers. Spotting winners inthis new era will require looking at many factors, and traveling to see what is happening on the ground, not relyingon theory or numbers alone.

I like to get out and travel, to try to understand the individual storyline in each country, which is why I am as much awriter as an investor. As an investor I find it useful to work as a journalist, because writing for the public forces meto clarify the basic national plotlines in my own mind, and as a journalist I find it useful to work as an investor,because managing other people's money forces me to seek the true story, not only the provocative one. What I'd liketo offer you today are some of the rules I've learned over the years about how to spot a country that is preparing totake off, or crash land. There is a place for wonky data analysis in my other world, but here I'd like to focus onsimple rules any smart traveler or writer can understand and apply on the ground. Below I consider India's prospectsusing my rules for spotting breakout nationsthose that can grow faster than rivals in their income class, andexpectations for that class.

1. The growth-is-not-easy rule

The longer a boom lasts, the less likely it is to continue. In the last decade, emerging markets took off as a pack,creating the illusion that rapid growth is easy, and normal. Nothing could be farther from the facts. Rapid growth isextremely difficult, and rare. It is unusual for an emerging nation to post even one decade of fast growth, much less

to extend that boom into a second decade, and even less into a third, fourth or fifth decade. Only two countries sinceWorld War II have grown at an annual pace of more than five percent for five decades, South Korea and Taiwan.What this means is that, in the big picture, emerging nations are not, contrary to widespread belief, catching up torich nations. On the whole, the average income in emerging nations is just as low, relative to developed nations, as itwas in 1950.

So if a boom lasts as long as a decade, the probability that it will continue shrinks rapidly with each passing year.Typically, pundits and the public assume the oppositethat one good decade spells good times foreverso whenyou see that overconfidence, you know the end is near. This is what happened to India, which came to believe it wasdestined to be the next China before its run of 8 to 9 percent growth suddenly slowed last year. Now, India may becoming to understand the harsh reality, which is that the normal state of economic competition is chaos, with morelosers than winners, and that this is true not only for nations but for the states of India.

Chaos is the rule for competition between nations, and even for states within big emerging nations. A big exceptionis China, where the same southern coastal provinces where the boom began in 1980 have tended to dominate theranks of the fastest growing states. In recent years, growth in China has spreadsteadily into the interiorlikely dueto the consistent control of a heavily centralized national government. The states of India, in contrast, tend to riseand fall quite dramatically, depending in part on who the state leader is. If you divide up the last quarter century intofive year periods, only one Indian state, Maharashtra, has remained among the top five fastest growing states foreven three consecutive periods, while in China five different provinces have achieved this kind of run. One hope forIndia is the growing evidence that its structure is evolving from one single economy into a federation of stateeconomies, with many of the poorer states like Biharnow leading the country in terms of the pace of economicgrowth. But the lesson of the chaos rule is simple: India just put up a decade of very strong growth, which reducesthe likelihood of strong growth going forward.

2. The regime rule

The political system doesn't matter, but leaders do. The success of command-and-control capitalism in China has setoff a vigorous debate over which political system is most likely to produce growth, which I think misses the point.It's not the type of system that matters, it is the stability of the system and, even more important, whether the leadersrunning it understand the basics of economic reform, and have the street credibility to push tough reform. Whetherthose leaders work in a democratic or authoritarian system makes no difference. If you look at each of the last threedecades, only a few dozen nations grew at an average annual rate of 5 percent or more for the full decade, and abouthalf of these were democracies, and half authoritarian states, including monarchies and military regimes In India it ispopular to argue that China has been able to grow faster because its authoritarian system can push tough reformsmore easily. However, a closer look at countries that have posted high economic growth over the past three decades

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shows that 52 per cent were democracies. What matters most is not the system, but whether the political leadersunderstand economic reform. This signal is mixed for India, because faltering leadership at the national level isbalanced by the rise of dynamic state leaders.

3. The leadership cycle rule

The longer a regime lasts the less likely it is to take smart steps to promote economic growth. Over time leaders getsettled and self-satisfied, they shift focus from the national interest to protecting vested interests, or they simply runout of progressive ideas. As Ralph Waldo Emerson said, at last every hero becomes a bore. In an establisheddemocracy, such heroes will be eased out by their own party, even if they were seen as dynamic forces of reform.Britain has done this twice in recent decades, to Margaret Thatcheron the right andTony Blairon the left. The worstcase of stale heads of state is in the former Soviet republics, from Belarus to Turkmenistan and Kazakhstan toRussia itself, where Vladimir Putin seems to have anointed himself leader-for-life, changing his titles but not hisdominant role. George W Bush tells a great story about how Putin changed in office: the first time they met, Putinwas focused laser like on bringing down Russia's debt, but the second time they met, eight years later, Putin was fallof bravado, trying to figure out ways to but American debt, and cracking jokes about how his dog was bigger, better,faster than Bush's terrier, Barney.

Power goes to the head. In recent years, the general success of emerging markets helped convince many leaders thatthey are personally responsible for their nation's success. From Cameroon and Nigeria to Bolivia andVenezuela,

incompetent or corrupt leaders have fought successfully for the right to extend the deadline on their terms in power.A relateddodge is stepping down in favor of your spouse. This is how Nestor andCristina Kirchner extended theirhold on Argentina, which has been so badly run it was demoted from the list of nations Wall Street tracks as"emerging markets" and into the lower class of "frontier markets."

Roughly speaking, leaders seem to go stale as an economic force after roughly seven or eight years in power, whichis what we are seeing in India. From the first term of Prime Minister Singh and the Congress party coalition to thesecond, economic growth has slowed, inflation has risen significantly, and so has the deficit. But in an increasinglyfederal India, the longevity of the central government is balanced by the rise of new state leaders, for whom strongstate economic growth has become a necessary condition for reelection in virtually every state ballot since 2007. Sothis rule sends another mixed signal for the country.

4. The tough reform rule

Watch for complacency. The economies that grow rapidly for many years or decades have a sense of urgency aboutcatching up with the developed world, and to do that they generate steady momentum behind economic and politicalreform, even in good times. Among the star reformers today are Polandand the Czech Republic, still driven to catchup with the West after so many decades of forced stagnation under Soviet rule. But those are the best-caseexceptions. Most nations reform only when they are in crisis; so the more useful question is, when a country's backis to the wall, does it push the kind of tough reform and austerity measures that will promote long term growthlikeSouth Korea after the Asian crisis of 1998or does it simply spend money to cushion its population against feelingany painlike Japan after its property bubble popped in 1990? India is a classic case of the reluctant and erraticreformer, but at least when crisis hits, it tends to adopt or at least accept real competitive reform that open its doorsto outsiders, and allows it to grow when the global economy gains speed.

There is, in fact, a steady ten year cycle of crisis and reform in India. What happens is India falls into some kind of

financial crisis, usually because it can't scrape up the dollars to pay its foreign bills, and has to scramble its way out.In the early 1980s and early 1990s, this meant running hat in hand for a loan from the IMF, which forced India to cutback at home and open up to trade abroad. In the early 2000s, however, following the dotcom meltdown, growthslowed sharply and India took presented a couple of reformist budgets that, among other things, freed up trade infarm goods, rationalized the interest rate structure and also increased the focus on key sectors such as roads andtelecom. . This helped set the stage for India to participate in the global boom that was to come. Now, as growthslows in the wake of the global debt crisis and capital flows are scarcer, India has once again begun to roll outreformincluding opening its doors to foreign retailers and mending its subsidy payout system. So, for the momentat least, India is headed in the right direction on reform.

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5. Reaction to inequality rule

Watch for angry populist protests against inequality, because it is a signal of imbalance in the economy that can alsostop reform in its tracks. These days, inequality is a hot button issue from Seoul to Santiago, and you can hearcitizens just about everywhere complain that the global economy is profiting the plutocrats, expanding the ranks ofthe poor and squeezing the middle class. While in countries like Mexico, popular resentment has long driven thesuperrich to seek a low profile; in others such as India, the superrich were recently feted as a symbol of growingeconomic prowess, but now they face tough questions about what they contributes to that success.

Development economic theory holds that inequality will at first increase due to market forces being at play but willthen decrease after a certain level of income is achieved. Our research shows that the tipping point is around $5,000- that's when inequality should start to decrease. Of course, even before that inequality should not run well ahead ofper capita income levels or that too can lead to a backlash against the reforms. Longer growth spells are robustlyassociated with more equality in income distribution. Korea - the country I call the goldmedalist of growth becauseof the way it achieved sustained economic success in an almost unparalleled way - was one of the least unequaldeveloping countries during its period of high growth and there was not much explicit use of welfare policy toreduce inequality. Research shows that land reform carried out in the late 1940s and the total destruction ofindustrial assets during the Korean War made Korea an unusually equal country at the very beginning of its growthprocess in terms of income and wealth. It then forestalled the rise of inequality primarily by creating one of thestrongest systems of universal education, for rich and poor, in the world. On the other hand, poorly designed

incentives could grossly distort incentives and thereby undermine growth, hurting even the poor.

Watch then for how governments address inequality. Right now, many emerging nations are addressing the problemby ramping up welfare states that they cannot afford, providing subsidies that support the poor, but don't help themjoin the middle class. When I warn, for example, that Brazil's government is now spending as much, relative to thesize of its economy, as the richest welfare states of Europe, I've been attacked as a typical Wall Street type whocould care less about the poor. That attack quite misses the point, which is that to sustain growth nations have tomaintain a kind of Zen balance in the economy appropriate to its stage of development and trying to carry a fatwelfare burden at an early stage won't get the job done. To this day South Korea spends very little on social welfare,for a nation in its income class, and I would in fact argue that Korea needs to spend more on welfare in areas such aschild care so that more of its women can get to work. Korean women are well educated but their participation in thelabor force is relatively low because the support system for child care is weak forcing more women to stay at hometo look after the children.

Among those nations that are overspending right now: Brazil, Russia, Thailandand India. At nearly 30 percent ofGDP, total government spending in India is very high for a country at its income level, which is way out of balanceand a bad sign.

6. The billionaire balance rule

Read the list of top billionaires. It can provide a quick bellwether for the balance of growth, across income classesand industries. If a country is generating too many billionaires and outsized fortunes, it's out of balance. If the sametycoons dominate the list for years, it's a sign of stagnation. Healthy economies should produce billionaires, but theywant good billionaires who face real competition and make money in productive industries like technologytheindustry that produced the most billionaire wealth worldwide in the 1990s. As Warren Buffet put it in a 2006 letterto shareholders: "If you want to get a reputation as a good businessman be sure to get into good business".

Unfortunately the 2000s saw the global rise of the bad billionaires, who rely on government connections to cornermonopolies in industries like oil, which now dominates the billionaire lists.

Russia, the world capital of the bad billionaires, scores badly by ever measure, with the same oil tycoons dominatingthe top of the list year in and year out, piling up outsized fortunes. Russian billionaires are now so powerful they aresqueezing out both the middle class and the millionaire class: Russia a rank second in the world for billionaire, sixthfor people worth more than $100 million, and doesn't even make the top 15 for millionaires.

India is not in Russia's league, but until recently its billionaire lists made for gloomy reading, too. There has beenlittle turnover among the top ten billionaires, and when changes come they tend to replace the 1990s generation of

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tech entrepreneurs with provincial tycoons who cut political deals to corner unproductive industries like mining orreal estate. Along with Russia, India is one of the few nations where the average wealth of the top 10 billionaires isin excess of $10 billion. With no wealth or inheritance taxes, India has long been top heavy with billionaires, but thisclass now controls assets equal to 12 percent of GDP, compared to 3 percent in China.

The billionaire lists are likely to grow more useful as the sample for emerging markets, many of which had fewtycoons even 15 years ago, increases. It's clear what to look for: Billionaires should face competition that limits theircontrol of the economy, that promotes turnover at the top, and that generates wealth in industries that are productive,not politically connected. On the upside, the 2012 top 10 list for India include two who weren't there five years ago,with at least from a dynamic and productive industry: pharmaceutical magnate Dilip Shanghavi. What matters for acountry's future is not how good or bad the current situation is, but whether the direction of change is for the betteror worseso even these marginal changes in the billionaire list could be a good sign for India.

7. The corruption matters rule

In absolute terms, India scores not that badly on corruption perception indexes, at least compared to countries ofsimilar per capita income like Vietnam or Nigeria. There is a clear link between wealth and corruption. Simply put,the richer a country is the less corrupt it tends to be. But like the chicken and egg story it is still not clear whichcomes first: do countries tend to be less corrupt because they are rich or does corruption hold back a country'sgrowth prospects.

The answer probably again lies in the balance. Corruption is normal at low income levels but if there is too muchcorruption relative to a country's per capita income or if perceptions about corruption begin to worsen dramaticallyover a short span of time than that can retard growth. In 2010, I was struck by how quickly India was falling in theperception rankings, and by how loudly Indian businessmen were complaining that they could not do business athome, because of all the graft. For this reason, I wrote a cover story forNewsweekin September 2010 on hocorruption could end up being India's fatal flaw and it ended being one of the better-timed stories I had written. Idon't see a lot of improvement in the mood. While at 94 out of the 174 countries tracked by TransparencyInternational, India's ranking is not that low given its relatively low per capita income of $1,500 with other countrieswith a similar per capita income such as Nigeria and Vietnam ranking even lower, what's troubling is how sharplyIndia's corruption ranking has fallen over the past decade. It ranked 70th in 2001 and normally as a country movesup the per capita income curve its ranking should increase not fall. Therefore, this is a bad sign.

8. Factories first rule

Look for the factories, because economic miracles begin in and are typically driven by manufacturing. As economistDani Rodrik has shown, virtually all of the most successful economies of the postwar era were exceptionally good atmoving workers from the farm to more productive jobs in urban factories. The trick is finding a niche in globalmanufacturing, because once a country gets in the game, productivity and growth take off even in countries withmeddling government, incompetent institutions, and remote locations. One reason, Rodrik writes, is that it isrelatively easy to copy factory assembly lines from a cutting edge country like Sweden, but it can take years if notcenturies to copy Swedish institutions.

India ranks poorly by this rule, because it has gone at the development path backwards. Most long-term economicsuccesses began developing with a focus on low-end manufacturing, which put rural workers into more productivefactory jobs, improving their skills and creating a pool of capital to deploy when the manufacturing boom ends, and

the economy began to shift to services. India went the opposite way, starting by moving workers into IT serviceindustries like software and call centers, which require fewer workers and are not that much more productive thanthe farms those workers came from, Rodrik argues. In India the manufacturing share ofGDP has stagnated over thelast 10 years and slipped a bit in the past five, to just 14 percent, which is a good five to 10 points lower than itshould be at this stage of development. And it could be increasingly difficult for India to get in the manufacturinggame: because modern factories employ fewer and fewer people, it will be difficult for upcoming emerging marketsto move great masses of labor from farms to factories, the way China did. This is a tough obstacle for India.

9. The currency rule

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Economists have all kinds of fancy ways to measure the competitive strength of a currency, but when a country ispricing itself out of the competition; you can feel it on the ground. Until very recently, the rapid increase in the priceof oil and other raw materials was driving up the value of currencies in countries that rely on exports ofcommodities, from oil to iron ore and coffee. The rising value of these currencies, including the Brazilian real, theRussian ruble, and the South African rand, was inflating the price foreigners pay for every other kind of good thesecommodity-driven nations try to sell, from cars to consulting services to hotel rooms. In early 2011 the major Riopaper, O Globo, ran a story on prices showing that croissants were more expensive than in Paris, haircuts cost morethan in London, bike rentals more expensive than in Amsterdam, and movie tickets sold for higher prices than inMadrid. I developed an index comparing the price of rooms in business hotels in the major emerging marketcapitals, which showed that Moscow and Sao Paulo were more expensive than even most developed world capitals.India, however, ranked rather well by this measure. Its room prices were 14 percent below the average for majoremerging market capitals in late 2011 and have fallen by 37 percent since then, as the rupiah weakened. This is agood sign. If the local prices in an emerging-market country feel expensive even to a visitor from a rich nation,outsiders aren't going to stay long, and they aren't going to invest much in factories or farms either.

10. The locals know best rule

Watch the locals, they know the economic scene best, they get the news first, and they will be bringing money hometo a nation on the rise and fleeing one in decline. In a financial crisis, the first to flee are the large local investors,who in many emerging markets must move money through underground channels because of rules limiting capital

flows. The use of back channels means that this flight of money will not show up in the standard national accountingcategories, but often produces a marked rise in the catchall category called "errors and omissions." In normal times,the largest movements of money are captured as net capital flows, which will be deep in the red if locals are votingwith their feet and moving money out of the country. Right now, this indicator is flashing red in Russia, wherecapital has been flowing out at a stunningly high rate for several years, and this year will reach about $74[e2] billionor 4 percent of GDP this year. South Africa is also in the red zone, with net capital outflows equal to 2 percent ofGDP. India looks pretty good by this measure: capital is flowing into the country, equal to about 4 percent of GDP.And there is no sign locals are sneaking money out of the countrythe usual warning sign of a balance-of-paymentscrisis A good sign.

11. The going global rule

The sight of local companies "going global" is often celebrated in headlines as a national success, but the accurate

read on this signal depends on the circumstances. Going global can be a sign of corporate strength or of nationalweakness. If more than 50 percent of a nation's corporate earnings are coming from abroad, it could be reason forconcern. In Singapore, where businesses can't make all that much money at home because the population is so small,it is not alarming that more than 50 percent of earnings are made overseas. In nations with sizable domestic marketslike Mexico and Russia, it can be read as a vote of no confidence in the local economy. South Africa is perhaps theleading example of this negative -phenomenon, but India is not far behind.

Driven abroad in part by the rising cost of meeting payoff demands from corrupt officials, Indian businesses havebeen cutting investment at home, from 17 percent of GDP in 2008 to 12 percent, while the overseas share of Indiancorporate profits has risen fivefold in just five years. Given the potential of the domestic marketplace, Indiancompanies should not need to chase growth abroad. But just over half the earnings of India's top-fifty companies arenow "outward facing" or dependent on exports, global commodity prices, and international -acquisitions.

When emerging nations start spending too little on investment at home, the big risk is a spike in inflation. Asinvestment dries up, the nation is not putting enough money into the new factories and new roads that are required tomake and deliver the goods desired by an increasingly prosperous middle class. Supply falls behind growingdemand, and prices start to shoot up. That's why graft is inflationary: it channels money away from productiveinvestment. In 2010 and the first part of 2011, inflation in India was running at more than 9 percent, up from 5percent during the 2003-2007 boom.

12. The helicopter rule

One measure of success in an emerging nation is how fast you can drive across town in the national capital at rush

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hour. This really matters. The larger the traffic jams, the less the country has been spending on new roads, bridges,and other basic hardware of a modern economy. The low investment rate doesn't just lead to annoying delays. It alsomeans the economy can overheat at a very low rate of growth, like a weak engine. If a nation's supply chain is builton aging factories and potholed roads, supply cannot keep up with demand, and prices will rise. A big reason Chinacould grow at a double digit pace for so long without much inflation was that it was investing about 10 percent of itsGDP each year on new infrastructure. In contrast, a nation like Brazil overheats at a much slower rate of growth inlarge part because it invests just 2 percent of GDP on new infrastructure.

I call this the helicopter rule because one clear sign of underinvestment is when private citizens and businesses startcoming up with artful ways to dodge around or fly over the weak public networks of roads, power lines orcommunication facilities. In Paulo, CEOs exasperated with the clogged roadways have developed an alternativetransport system: a network of landing pads on the rooftops of office skyscrapers, so that top executives canhopscotch from one corporate headquarters to another by helicopter. In African markets including Nigeria, it iscommon for businesses to install elaborate backup generators with fuel storage tanks, to keep the power runningduring frequent blackouts.

By this rule India doesn't rate very high. It investments about 7.5 percent of GDP on new infrastructure, which ismore impressive than the results, in part because an increasingly large share of that money is spent not by privatecompanies but by the government, which is not doing a great job of building the roads, bridges and airports thatIndia needs. In all this is another mixed signal for India.

13. The inflation rule

This is one is especially critical for India because so many top officials are getting it backward. They explain India'shigh inflation by saying that rising prices are normal for a prospering economy, as demand grows for fancier cars,better food, and pricier homes. Now, these are smart people with prestigious academic credentials, but they simplyhave the facts wrong. The rule is that low inflation is a hallmark of long economic booms, because stronginvestment creates the extra capacity that allows the economy to meet rising demand without higher prices. Andwhen prices do begin to rise, it's a sign that the boom is over. The Growth Commission Report sponsored by theWorld Bankdetails 13 economic success stories of countries that were able to sustain an average growth rate of 7percent or more over at least a 25-year period. During their respective boom periods, inflation in these countries waslower than their emerging market average 70 percent of the time. Further, Brazil skews the average. In othercountries, inflation decelerated steadily through the high growth periods and was, in fact, lower at the end of the

boom than at the start.

14. The market mirror rule

The stock market may seem like a casino to many people, but it is also the best real time reflection of the economicscene. Just a glance can tell you more than you might think. If the market lists few companies and has a total valuerepresenting only a small fraction of the economy, this is a country with a lot of room to grow rapidly. If the markethas hundreds of listings representing a widely diverse array of industriesas is the case in South Korea or Indiaitis a sign of healthy balance in the economy. If the stock market does not list even one manufacturing company, as isin Moscow, it is a very bad sign. Stock market growth normally mirrors growth in the economy, and if it does not,that is a sign of serious distortions in the economy's structure.

In Mexico, for example, the stock market grows much faster than GDP because the economies are dominated by

monopolies, which are highly profitable (which is good for stock prices) but also highly unproductive (which is badfor growth). In China over the last 10 years, the stock market has actually been shrinking even as the economyboomeda symptom of investor distaste for unprofitable state companies. In India, the big and diverse and growingmarket mirrors economic growth not only in India but across the emerging markets, a very good sign as this alsohelps in a more efficient allocation o capital.

15. The second city rule

Check the size and growth of the second city, compared to the first city. In anybig country the second-largest cityusually has a population that is at least one-third to one-half the population of the largest city. This ratio reflects

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regional balance in the economy, and it holds true for many of the nations that were breakout stories in recentdecades: Sao Paulo andRio de Janeiro in Brazil, Seoul and Busan in Korea, Moscow andSt. Petersburg in Russia,as well as Taipei and Kaohsiung in Taiwan. It's a red flag if a country is stuck in violation of this rule, but it's a goodsign if a capital-centric nation is moving toward greater balance. It's even better if the country is producing newcities with populations of one million or more, which suggests that growth is lifting all regionsnot favoring theelite in the capital city. Much of the recent political trouble in Thailand stems from the simple fact that Bangkokisten times larger than the next most populous city, and its dominance of political and economic life has provoked therural revolts that have stymied growth in recent years. By contrast, Indonesia has both a strong second city inSurabaya, with a population roughly one-third that ofJakarta, and there is a growing number of cities of 1 million,increasingly the healthy geographic spread of growth.

India scores poorly on the second city rule: it appears to have a strong second cityDelhi is only slight lesspopulous than Mumbaibut in a nation this sprawling, it is probably more accurate to say that power isconcentrating in a string of megacities, and that its first cities now dwarf its second cities and its small cities. InIndia 16 percent of the population lives in cities of more than 10 million people, compared to 5 percent for China.China has far more strength in mid-size cities and particularly in small cities. Between 1950 and 2010, 23 cities inChina saw population grow tenfold to 1 million or more, compared to just six in India: Dhanbad, Aurangabad,Bhilainagar, Ranchi, Guwahati and Chandigarh. So this rule exposes one vulnerability of India.

16. The cluster rule

Take note of how locals get along with the neighbors. It's only natural for nations to trade most heavily with theirneighbors, and it's also important for any nation that wants strong growth. One of the striking characteristics of therare postwar economic success is that they tend to appear in geographic clusters: the oil nations of the Gulf, thenations on the southern periphery of Europe after World War II, the nations of East Asia in the same period. Formost of East Asia, trade within the region has been growing faster than trade with the rest of the world. Indeed thesuccess of East Asia has been driven in no small measure by the willingness of China, Japan, Taiwan, and SouthKorea to leave old wars in the past, at least when they are cutting business deals. In contrast there is no region in theworld with weaker trade among immediate neighbors than South Asiaincluding India, Pakistan, Bangladesh, andSri Lanka. Isolation, lawlessness, and old grudges have made it difficult to move across borders, and trade withinSouth Asia has stagnated at 5 percent of total trade with the world. Indeed South Asia could learn a lesson fromAfrica, where there are at least five separate efforts underway to create regional common markets modeled on theearly stages of the European Union. For now, however, bitterness among the South Asian neighbors is preventing

the rise of regional economic power. Not a good sign.

So, what do these rules tell us about the direction of India? We have seven negative signals, four positive signals andfive mixed signals. I don't try to weight these signals for importance or assign some spuriously precise score to theresults, but the general picture suggests that India has about a 50/50 chance of being one of the few winners inglobal economic competition over the next five to ten years. Those of you familiar with Breakout Nations will knowIndia is one of very few countries that I place in this gray area. That brings to mind a phrase that Prime MinisterSingh is said to be very fond of, which is that whatever you say about India, the reverse is also true. There'ssomething to that.

I define winners as those nations which grow faster than rivals in the same per capita income classso that Indiacompete against nations like Indonesia andPhilippines with incomes lower than $5,000and also the growthexpectations for the country and the class. Expectations surprises some people, but lots of research shows that

satisfaction is derived less from how rich you are, than how rich you are relative to your neighbors, and to what youhad hoped for. So while India's growth has slowed sharply, but so has growth for all other emerging nations, and sohave India's expectations. In a national economy that seems to be breaking up into its component states withoutfalling apart, those expectations now vary widely between fast growth states like Gujarat and slow growth states likeWest Bengal. But no one talks about India being the next China anymore, which should make it easier for the nationto reach its goals. There's not a lot of fear or euphoria. If there is one big theory in the rules, it is that balance isgood, and India's hopes are in balance right now.

Ruchir Sharma is managing director and head of the Emerging Markets Equity team atMorgan StanleyInvestment

Management, and author of 'Breakout Nations: In Pursuit of the Next Economic Miracles'

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