A report on

“The Indian economy vs. the Chinese economy”

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TABLE OF CONTENTS

Acknowledgement …………………………………………………………. 01

Executive summary…………………………………………………………. 02

Overview ………………………………………………………………………… 03

Globalization ……………………………………………………………….. 10

Growth Trends: China’s Fast Track vs. India’s Gradualism Model…………………………………………………………………………… 11

Consumption - Macro: China Spends Twice As Much as India 12

Consumption - Micro: Markets for Most Products in India Are a Third to a Tenth of China’s………………………………………………….. 17

Investments: China’s Total Capex is more than Four Times India’s ………………………………………………………………………………… 19

External Trade: China’s Share in Global Exports Is Six Times India’s…………………………………………………………………………………. 20

Summary of Key Reforms in India and China……………………… 23

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ACKNOWLEDGEMENT

I would like to express my gratitude to all those who gave me the possibility to complete this project. I want to thank xyz, which gave me a scope to make this project.

I have furthermore to thank especially abc, who gave me an opportunity to do this project and encouraged me to go ahead with my project.

Executive Summary

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The Asia-Pacific region is experiencing tremendous demographic changes andUnprecedented levels of urbanization.

The region’s average food and drinks market growth between 2003 and 2007 was 25.0%, the largest of any other region. Over the same time, growth in per capita Spend on food and drinks averaged 18.5%.

The region suffers from a consistently low per capita spend, as well as low scores for commercial infrastructure and social structures. However, it boasts very large populations and high levels of market growth.

China has been ranked first overall, having received a score far above any other country. The score is a result of high marks for market size, growth, and intensity, as well as population – all pointing to the potential for high levels of reward.

However, China ranks lower for per capita spend and social structures, reflecting the widespread poverty in the country and some regulatory issues.

Of the four Chinese food and drinks categories examined, the one exhibiting the most growth is the soft drinks market.

India has been ranked third overall, having received high scores in market size, growth and intensity, as well as for its large population.

Like China, India ranks low for per capita spends – again a reflection of widespread poverty – and for commercial infrastructure, a result of the country’s highly fragmented retail market.

Of the four Indian food and drinks categories examined, the bakery and cereals market has exhibited the highest level of growth, followed by the soft drinks market.

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THE INDIAN ECONOMY VERSUS THE CHINESE ECONOMY: A COMPARATIVE STUDY

A LOOK INTO THE ECONOMIES OF BOTH THE COUNTRIES

INDIA-A GROWTH STORY:

INDIA is one of the oldest civilizations in the world with a kaleidoscopic variety and rich cultural heritage. It has achieved all-round socio-economic progress during the last 60 years of its Independence. To study the economic history, we divide the economic history into the Pre-colonial period, the colonial period and the post-independence period.

The PRE-COLONIAL ERA can be said as the age of the Mughal and the different dynasties that flourished during that era. A brief look into the economic happenings:

1525AD – 1550AD- India was the second largest economy in the world. The gross domestic product of India in 1550 was estimated at about 40 per cent that of China.

1550AD – 1575AD- During this period also India still was the second largest economy in the world. The gross domestic product of India in 1575 was estimated at about 50 per cent that of China.

1575AD – 1600AD- During this period, the annual revenue of Emperor Akbar's treasury in 1600 at £17.5 million. The gross domestic product of India in 1600 was about 60 per cent that of China.

1600AD – 1625AD- India was still the second largest economy. The gross domestic product of India in 1625 was estimated at about 70 per cent that of China.

1625AD – 1650AD- The gross domestic product of India in 1650 was estimated at about 80 per cent that of China.

1650AD – 1675AD- The gross domestic product of India in 1675 was estimated at about 90 per cent that of China.

1675AD – 1700AD- Annual revenue by the Emperor Aurangzeb's exceeded £100 million in 1700 (twice that of Europe then). Thus, India emerged as the world's largest economy followed by China and France.

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1700AD – 1725AD- During this period however China was the world's largest economy followed by India and France. Collapse of the Mughal Empire and the resultant chaos triggered India's long but slow decline on the world stage. The gross domestic product of India in 1725 was estimated at about 90 per cent that of China.

1725AD – 1750AD-During this period, Mughals were replaced by the Nawabs in north India, the Marathas in central India and the Nizams in south India. China was the world's largest economy followed by India and France. The gross domestic product of India in 1750 was estimated at about 80 per cent that of China.

1750AD – 1775AD- China was the world's largest economy followed by India and France. The gross domestic product of India in 1775 was estimated at about 70 per cent that of China.

COLONIAL PERIOD

The Colonial rule brought along a enormous change in the economic structure of the country. The whole process of taxation was revised, which affected farmers a lot, a single currency system with fixed exchange rates, `standardized` weights and measures, free trade was encouraged and a kind of capitalist structure in the economy introduced. The raw materials and man power were exported back to their home country which gradually caused a setback among the millions of Indian population.The finished goods were then brought back to India and sold at high rates among the well to-do people. Other developments were in transport and communication like introduction of railways, telegraph and so on was made which in a way affected the economy.Towards the end of the colonial rule it was seen that development in the Indian economy was hampered and it was reduced down from its glorious strong economic background.

1775AD- 1800AD- During this period, the East India Company began tax administration reforms in a fast expanding empire spread over 250 million acres (or 35 per cent of Indian domain). China was the world's largest economy followed by India and France. The gross domestic product of India in 1800 was estimated at about 60 per cent that of China.

1800AD – 1825AD- China was the world's largest economy followed by India and France. The gross domestic product of India in 1825 was estimated at about 50 per cent that of China.

1825AD – 1850AD- China was the world's largest economy followed by the UK and India. The gross domestic product of India in 1850 was estimated at about 40 per cent that of China.

1850AD – 1875AD- China was the world's largest economy followed by the USA, UK and India. The gross domestic product of India in 1875 was estimated at about 30 per cent that of China.

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1875AD – 1900AD- USA was the world's largest economy followed by China, UK, Germany and India.

1900AD – 1925AD- USA was the world's largest economy followed by the UK, China, France, Germany, India and the USSR. The gross domestic product of India in 1925 was estimated at about 10 per cent that of the USA. During this period, India became a net importer from net exporter of food grains.

1925AD – 1950AD- USA was the world's largest economy followed by the USSR, UK, China, France, Germany and India. The gross domestic product of India in 1950 was estimated at about 7 per cent that of the USA. About one-sixth of the national populations were urban by 1950.

1950 – 1975- Socialist Reforms were introduced.USA was the world's largest economy followed by the USSR, Japan, Germany and China. The gross domestic product of India in 1975 was estimated at about 5 per cent that of the USA. Current GDP per capita grew 33% in the Sixties reaching a peak growth of 142% in the Seventies, decelerating sharply back to 41% in the Eighties and 20% in the Nineties. From FY 1951 to FY 1979, the economy grew at an average rate of about 3.1 percent a year in constant prices, or at an annual rate of 1.0 percent per capita. During this period, industry grew at an average rate of 4.5 percent a year, compared with an annual average of 3.0 percent for agriculture. Many factors contributed to the slowdown of the economy after the mid-1960s, the main one was the socialist policies pursued by Nehru and his cabinet.

The following shows the GDP of India at market price.

Year Gross Domestic Product US Dollar Exchange in Rs.1950 99,340 4.791955 108,730 4.791960 171,670 4.771965 276,680 4.781970 456,770 7.561975 832,690 8.39

*source: Ministry of Statistics and Programme Implementation

1975 - 2000

Privatization Reforms were introduced.USA was the world's largest economy followed by Japan, Germany and China. The gross domestic product of India in 2000 was estimated at about 4 per cent that of the USA. India started having balance of payments problems since 1985, and by the end of 1990, it was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to the point that India

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could barely finance three weeks’ worth of imports. The government introduced reforms such as the liberalization.The following shows the GDP of India at market price.

Year Gross Domestic Product

Exports Imports US Dollar Exchange in Rs

Inflation Index (2000=100)

1980 1,380,334 90,290 135,960 7.86 181985 2,729,350 149,510 217,540 12.36 281990 5,542,706 406,350 486,980 17.50 421995 11,571,882 1,307,330 1,449,530 32.42 692000 20,791,898 2,781,260 2,975,230 44.94 100

* Source: Ministry of Statistics and Programme Implementation

2000 – THE PRESENT SCENARIO

There was the rise of Oligarchy. The gross domestic product of India in 2007 was estimated at about 8 per cent that of the USA. Currently, the economic activity in India has taken on a dynamic character which is at once, curtailed by creaky infrastructure, cumbersome justice system, dilapidated roads, severe shortages of power and electricity yet at the same time accelerated by the sheer enthusiasm and ambition of the industrialists and the populace.

The following shows the GDP of India at market price.

Year Gross Domestic Product

Exports Imports US Dollar exchange in Rs

Inflation Index (2000=100)

2000 20,791,898 2,781,260 2,975,230 44.94 1002005 34,195,278 44.09 121

* Source: Ministry of Statistics and Programme Implementation.

THE CHINESE ECONOMY – A HISTORICAL PERSPECTIVE

The history of the china can be studied by dividing into the Qing dynasty (1625AD-1911AD), the nationalist republic economy (1911-1950), and the People’s Republic (1950 onwards).

THE QING DYNASTY

1625 – 1650- China was the world's largest economy followed by India and France.

1650 – 1675- China was the world's largest economy followed by India and France. From this time to about the 1800s, the seclusion of China on a world-scale grew to its peak during the Ming Dynasty after the Yung-lo emperor's reign in the 1400s.

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1675 – 1700- India was the world's largest economy followed by China and France.

1700 – 1725- China was the world's largest economy followed by India and France. Collapse of the central authority of the Mughal Empire and the resultant chaos triggered India's long but slow decline on the world stage.

1725 – 1825- China was the world's largest economy followed by India and France.

1825 – 1850- China was the world's largest economy followed by the UK and India. Industrial Revolution in the UK catapulted the nation to the top league of Europe for the first time ever.

1850 – 1875- China was the world's largest economy followed by the UK, USA and India.

1875 – 1911- USA was the world's largest economy followed by China, UK, Germany and India. Collapse of the central authority of the Qing Dynasty and the resultant chaos triggered China's short but rapid decline on the world stage.

NATIONALIST REPUBLIC

1911 – 1925- USA was the world's largest economy followed by the UK, China, France, Germany, India and the USSR. The gross domestic product of China in 1925 was estimated at about 20 per cent that of the USA.

1925 – 1950- USA was the world's largest economy followed by the USSR, UK, China, France, Germany, India and Japan. The gross domestic product of China in 1950 was estimated at about 10 per cent that of the USA.

PEOPLE'S REPUBLIC

1950 – 1975- USA was the world's largest economy followed by the USSR, Japan, Germany and China. The gross domestic product of China in 1975 was estimated at about 10 percent that of the USA.

1975 – 2000-USA was the world's largest economy followed by Japan, Germany and China. The gross domestic product of China in 2000 was estimated at about 10 per cent that of the USA.

2000 – Present -The size of China's economy has been rapidly increasing, though some now question whether the cost has been too great, and whether the economy has 'overheated', with side effects such as pollution and a substantial gap between rich and poor worrying many Chinese. In 2008, China's GDP was about 25% that of the USA, and its manufacturing sector was 80% that of the USA.

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The table below shows the year wise GDP of China:

Year Gross domestic product Percentage change

1980 7.911981 4.738 -40.10 %1982 9.1 92.06 %1983 10.9 19.78 %1984 15.2 39.45 %1985 13.5 -11.18 %1986 8.8 -34.81 %1987 11.6 31.82 %1988 11.3 -2.59 %1989 4.1 -63.72 %1990 3.8 -7.32 %1991 9.2 142.11 %1992 14.2 54.35 %1993 14 -1.41 %1994 13.1 -6.43 %1995 10.9 -16.79 %1996 10 -8.26 %1997 9.3 -7.00 %1998 7.8 -16.13 %1999 7.6 -2.56 %2000 8.4 10.53 %2001 8.3 -1.19 %2002 9.1 9.64 %2003 10 9.89 %2004 10.1 1.00 %2005 10.4 2.97 %2006 11.1 6.73 %2007 11.4 2.70 %2008 9.272 -18.67 %

Now that we have seen the historical economic importance of both the economies, we now need to see the current trends and the happenings of both the economies in the present scenario.

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The China-India comparison is central to the Asia debate. It is also of great importance to the rest of the world. In the end, it may not be an either/or consideration. While the Chinese economy has outperformed India by a wide margin over the past 15 years, there are no guarantees that past performance is indicative of what lies ahead. Each of these dynamic economies is now at a critical juncture in its development challenge – facing the choice of whether to stay the course or alter the strategy. The outcome of these choices has profound implications – not just for the 40% of the world’s population residing in China and India but also for the future of Asia and the broader global economy. As recently as 1991, China and India stood at similar levels of economic development. Today, the Chinese standard of living is over twice that of India’s, with China’s GDP per capita hitting US$1,700 in 2005 versus a little over US$700 in India. The two nations have approached the development challenge in very different ways. China has pursued a manufacturing-led growth strategy whereas India has chosen a more services-based development model. While each approach has its advantages and disadvantages, China’s outstanding performance in the development sweepstakes over the past 15 years makes it a very tempting model for the rest of Asia to emulate.

The contrast between the two approaches is dramatic. The industry share of China’s GDP has risen from 42% to 47% over the past 15 years, maintaining a huge gap over India’s generally stagnant 28% manufacturing portion over the same period. By contrast, the services share of India’s GDP increased from 41% in 1990 to 54% in 2005 –well in excess of the lagging performance in China’s services, where the GDP share went from 31% in 1990 to 40% in 2005.China’s macro character fits its manufacturing-led growth dynamic to a tee. Benefiting from a high domestic saving rate, huge inflows of foreign direct investment (FDI), and major efforts on the infrastructure front, China’s economic growth has been increasingly fueled by exports and fixed investment. Collectively, these two sectors now account for over 75% of China’s GDP – and are still growing at close to a 30% rate today. India’s macro story is the mirror image of China’s in many key respects. Constrained by a lower saving rate, limited inflows of FDI and a sorely neglected infrastructure, India has turned to a fragmented services sector as the sustenance of economic growth. The labor-intensive character of services has provided support to India’s newly emerging middle class – a key building block for India’s consumption-led recovery. As a result, private consumption currently accounts for 61% of India’s GDP, far outstripping the 40% share in China. The growth contribution of India’s export and investment sectors pales in comparison to that in China.

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Retaining the Fruits of GlobalizationAnnual GDP growth has averaged 10% in China in the past three years and 8% in India. During the same period, the global economy has enjoyed the biggest boom in decades, averaging 4.5% growth a year. The unprecedented economic expansion is due to rising productivity growth from globalization and information technology. China and India have been at the center of increasing global integration and have done well in keeping the fruits of globalization at hometo fuel their economies.The two economies have used different approaches to retain some of the globalization benefits. China has pursued the typical East Asian model of recycling export revenue into fixed investment. As capacity expands in line with rapid export growth, the domestic economy does

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not suffer from high inflation, merely floating upward with the global economy. Indeed, inflation in China is less than 2% despite 33% annual growth in exports for the past three years. This reflects the excessive savings and investment bias of the political system. In addition to the traditional East Asian investment/export approach, China has taken advantage of its strong government and the country’s size to achieve unprecedented economies of scale for productivity gains. In infrastructure, for example, the economies of scale have cut capital costs in transportation, telecommunications, and electricity to below those of any other economy. In the production and distribution of consumer goods, the economies of scale that China has achieved are unmatched elsewhere in the global economy. The increase in scale economies has also contributed to low inflation. India has also achieved a breakthrough in trade. Exports grew 25% a year in 2002-05 compared with 10.5% in the ten-year period prior to this. However, India’s export base at 19.5% of GDP in 2005 is much lower than that for China (38%) and so its export success is not sufficient to drive the economy’s strong growth. India has taken advantage of its flexible financial markets to attract foreign capital to fund its growth. Consumer credit, funded substantially by foreign capital inflows into its capital markets, has given the Indian economy a strong consumption anchor in this boom. India’s credit rose by 25% a year over 2002-05 versus 19% growth in fixed investment. In contrast, China’s credit increased by 17% and fixed investment by 27% in the same period; even though the share of China’s fixed investment in GDP is one third higher than India’s. India’s growth model bears more resemblance to the Anglo- Saxon than the East Asian model. Its external accounts haveevolved in a similar fashion. Its current account balance deteriorated to a deficit equivalent to 1.7% of GDP in 2005 from 1.5% of GDP in surplus in 2003. In contrast, China’s current account surplus improved to 7.2% of GDP in 2005 from 2.8% in 2003. While China and India have different growth models, they have both captured the opportunities from the current wave ofglobalization. Productivity gains have benefited from a low-base effect. As the production chain becomes fully integrated across the world in the coming years, the low-base effect will disappear and the tailwinds from globalization for China and India will weaken. How to sustain fast productivity growth beyond the current boom is a major challenge for both economies.

At present, the two countries appear to favor a muddling-through approach, i.e., deal with an issue only if it appears to be an imminent threat to growth. Failure to heed long-term implications in crafting macro policy is a global phenomenon, however. The best example is the lack of consideration for balance sheet problems by all major central banks even though economic history teaches us that the great economic crises have all been due to overstretching the balance sheet.In that regard, China and India are just joining the crowd.… IN INDIA:The threat to India’s growth over the next two years is its poor infrastructure. To address the problem, India needs to mobilize capital more effectively and streamline the process for the implementation of infrastructure development, objectives that require strong government. Coalition politics, as now prevailing in India, tend not to produce strong governments. Since India has been able to achieve high growth in the past three years even with a poor infrastructure, the hope is for continuation of the same for the next two years. Another challenge to India’s growth is the potential bursting of its asset bubble. India has experienced

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enormous growth in its stock and property markets, mainly through price appreciation in response to low real interest rates. In this low interest rate environment, the most important factors are an increase in foreign capital inflow and a rise in import competition, which have contributed to low inflation. However, both factors have limited life-spans.First, the foreign capital inflow is a component of the financial globalization that has kept risk appetite high and rising. The increase in globalization has resulted in low inflation and strong liquidity – the backdrop for the current euphoria surrounding high-risk assets. As globalization matures, global liquidity conditions will normalize, and money can no longer be expected to rush to India in the same quantities under the same terms.Second, increasing import competition forces local producers to accept lower prices. Low inflation in India, as in the rest of the world, is due to globalization benefits from a low base. Asproduction responds to new prices, imports no longer are as effective in keeping inflation low.Buoyant asset markets have had a massive wealth effect on consumption while the low cost of capital has encouraged more capital investment. This is probably the reason for India’s growth rate surpassing its historical trend. The appropriate policy would be to raise interest rates aggressively to contain the cost when the bubble bursts. However, as politics favor ‘keeping the party going for as long as possible’, preemptive measures are not being taken. Increasing scale economies is also a source of productivity growth for India and should offset any waning in foreign capital inflows to sustain economic expansion. The modernization of India’s consumer sector, in particular, could accelerate productivity growth. To achieve this, India needs to build a transportation system that supports modern logistics and retool the regulatory infrastructure to support large-scale production.We can take these three steps India can take to accelerate growth beyond the current cyclical boom:1) Introduce legislation that allows the implementation process for infrastructure projects to cut through the current maze of regulations and to acquire land quickly.2) Set up several special economic zones along the coast in areas without land title disputes. These SEZs could be cities with their own streamlined regulatory and bureaucratic infrastructure. (The current SEZs are project-based tax breaks for export production, which will probably not lead to the formation of new cities – a must for India to accelerate urbanization.)3) Sell state-owned assets to jump-start a 100 billion-dollar infrastructure program as the core of India’s modernization.

… AND CHINA:The challenges to China in sustaining its high growth are quite different. The fundamental weakness of the economy is low consumption. Household consumption at 40% of GDP is exceptionally low by any standard. The excessive dependence on investment and exports makes China vulnerable to the global economic cycle. The dominant role of the government in the economy, its bureaucratic bias towards investment, and lack of organized forces in society to check government excesses have led to macro vulnerabilities. Excessive liquidity due to low consumption and foreign speculation on a possible renminbi revaluation has resulted in rapid growth in the property market in terms of both production and price. The rise in property prices has become another deterrent to consumption, as Chinese households hunker down to shelter from escalating living costs. This further sustains the liquidity boom that feeds the property

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sector. This sort of dynamic increases the imbalance in the economy. China’s cyclical risk and structural imbalance are one and the same. Unless China is able to rebalance its economy, it could suffer from mounting appreciation pressure on its currency and deflationary conditions at the same time. The required reforms in China would not be hard to implement.China just needs to find ways to give money to households. To rebalance the economy, China has to address the wealth, income, and security issues that have caused the household sector to shrink relative to the overall economy.1) On wealth, the government owns land, natural resources, and state monopolies. As these assets are not on the household balance sheet, consumption remains below what national wealth can support. Government wealth has to be shifted to the household sector to balance the economy.2) On income, the labor surplus has kept the rise in wages below that in labor productivity. This causes labor income to contract relative to the economy and contributes to insufficient consumption, excessive liquidity, and speculative mania.

Growth Trends: China’s Fast Track vs. India’s Gradualism Model

Acceleration in growth in the post-reform period: China’s economic growth has averaged 9.4% a year since 1978. Taking advantage of a sharp rise in the working population ratio in the early 1970s, the government initiated major structural reforms in 1978, which allowed the virtuous interplay of labor and capital. India’s economic growth underwent a structural shift at the start of the 1980s. Over the decade, the government made an attitude shift in favor of the private sector. Economic growth averaged 5.7% a year in the 1980s versus 3.5% in the prior three decades. Since 1991 the government has initiated major liberalization measures, adopting the open-economy model. India has achieved average growth of 6% a year since 1991 and in the past five years, growth has averaged a higher rate of 6.7%.

The emphasis for China remains manufacturing and for India, services: In terms of segment growth mix, China has followed a model similar to that of other Asian countries, relying on manufactured exports as a key anchor for sustainable acceleration in growth and integration with the global market place. As a result, China’s manufacturing sector has recorded real growth of 11.5% a year since 1978. Growth in services and agriculture averaged 10.6% and 4.6%, respectively, over the period. India’s growth mix, however, has been significantly different from that of China. Over the past 15 years (since the start of India’s reforms), India’s services sector growth has averaged 7.9% a year compared with 6.0% for manufacturing and 2.5% for agriculture. In comparison, China’s manufacturing growth has been about 12.6% a year over this period versus 10.1% for services and 3.8% for agriculture.

Differing focus on exports and fixed investments as growth drivers: China has been over-reliant on exports for stimulating growth compared with India. Its export (goods plus services) to GDP ratio has increased to 38% from 7% in 1980. India’s exports to GDP

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ratio has risen to 19% from 6% in 1980. Similarly, China’s investment-to-GDP ratio has increased to 49% from 20% in 1980 compared with a rise in India’s investment share of GDP to 30% from 21% in 1980.

Accounting for growth differences: A simplistic way to account for growth in a country would be to consider the contributions from the three basic drivers: (1) labor force inputs, (2) capital inputs and (3) total factor productivity.

Total factor productivity (TFP) is that part of non-factor inputs that enables higher growth with less application of factor inputs. It encompasses the contribution of technology and managerial aspects to the growth of real output. The two major areas where India’s growth suffers compared with that of China are capital accumulation and lower productivity growth. In the past 10 years, on average, more than 4.5 percentage points of China’s GDP growth was accounted for by capital accumulation, which was supported by its high national savings rate. In comparison, capital accumulation in India, contributed only about 2.1 percentage points of GDP growth. For India, a large proportion of its growth is accounted for by total factor productivity although it was lower than that for China on average in the past ten years.

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Consumption - Macro: China Spends Twice As Much As India

India’s consumption-to-GDP ratio is higher than China’s: Although in nominal US dollar terms India’s GDP is 35% of China’s size, India’s consumption spending is about 45% of China’s. India’s overall consumption-to-GDP ratio was 72% in 2004 compared with 54% for China. Not all the difference in consumption-to-GDP ratio is explained by the demographic position (as defined by the age-dependency ratio) of the two countries. Indeed, China’s consumption ratio was lower than India’s even while its demographic position was similar to India’s in 1975. India’s active consumerism culture, populist attitude of the government and the larger share of household income in GDP are the key reasons for consumption’s relatively higher share of GDP.

China’s consumption growth rate is higher than India’s: Although China’s share of consumption in GDP is lower than India’s, its absolute spending on consumption was US$1,074 billion in 2004 compared with India’s US$498 billion. China’s consumption growth has also been higher at 7.6% over the past 10 years (compared with India’s 5.8%), driven by its higher per capita income.

Both India and China are witnessing a shift in the consumption mix: In India and China, rising per capita income, changing demographics (rising young population), rapidly emerging modern retail format and increased access to financing are bringing about a change in the consumption basket. The share of organized sector products is increasing while that of primary products is declining. The Indian consumption basket is still relatively primitive currently and biased towards such products as food, beverages and tobacco. An average Indian spends about 49% of his/her expenditure on products other than food, beverages and tobacco compared with the average for China of 67%

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Reforming the retail distribution network: China has already built a modern retail distribution system to a large extent while India has just initiated such a network. The new retail format is beginning to drive a change on the supply side in India. This is a reverse of the process in China where the supply chain was relatively modernized for exports before the shift was initiated in retail distribution. We believe this change in the retail sector could lead to a significant transformation in India’s small & medium manufacturing as well as farming segments. This, in turn, could provide India with the opportunity to participate in the global export market for low-ticket manufactured goods.

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Consumption - Micro: Markets for Most Products in India Are a Third to a Tenth of China’s

Consumer product penetration rates higher in China: Penetration rates and per capita consumption are higher in China than in India for most broad-based manufactured consumption items because China’s per capita income is 2.4 times that of India. In fact, real per capita private consumption expenditure in China has increased by an average of 7.3% a year over the past 10 years compared with 5.3% in India.

China’s consumer product market is significantly larger than India’s: Not only is China well ahead of India in terms of exports, its domestic market for consumer products is also much bigger. For consumer non-durables as well as durables China’s market (annual sales) is about three to ten times that of India. Among durables, annual sales in China for products like cell phones are about double those in India whereas at the other extreme are items such as televisions where annual sales in China are about seven times those in India For non-durables, India’s market is of similar size to China’s in basic products like soaps but lags in products such as detergents, skin care products and bottled water.

India lags China in per capita consumption of key items by a range of 4 to 11 years, depending on the product: Even if it manages a big shift in growth rates and follows China’s trend, India is likely to remain 4 to 11 years behind China across different products. To approximate the amount of time the market size for the various consumer products in India will take to reach China’s current market size, we performed a regression analysis with China’s and India’s per capita consumption of various products being dependent on their respective per capita income levels. Based on this regression analysis, we arrived at India’s and China’s respective per capita consumption to income slope levels, which explain the penetration trend to per capita trend relationship, as shown in. These slopes help explain the relationship between past growth in per capita consumption and the increase in per capita income levels. We have projected per capita

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consumption and, in turn, the market size in India based on two scenarios: 1) India will continue to follow its own past slope i.e., it follows its past penetration to per capita income trend; we call this Type I; and 2) India will shift to China’s slope i.e., it follows China’s penetration to per capita income trend; we call this Type II. We have also provided alternative calculations, assuming two real GDP growth scenarios, 7% and 8% a year. We have forecast the number of years India will take to reach China’s market size

Under these growth scenarios and under the two slope functions – one using India’s past trend and the other using a shift to China’s past trend. Our nominal GDP growth forecasts for India assume constant real GDP growth of 7-8% a year. For per capita calculations, we have used the population growth projections of the United Nations.

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Investments: China’s Total Capex is more than Four Times India’s

China’s investment-to-GDP ratio is 1.6 times that of India: In 2005, China’s investment was 49% of GDP (US$1,082 billion) while India’s was an estimated 30% of GDP (US$240 billion). The key driver for China’s high investment rate is a higher domestic savings rate. FDI accounts for about 5.5% of total investment in China versus 2.7% for India. Indeed, China’s capex to GDP is now 2.7 times that of the US and it accounts for about 11% of global investment.

Rising share in global capex: While the world investment to GDP ratio has been constant over the past 10 years, the ratios for India and China have increased; hence, the combined share for the two in global investment rose significantly to 13.4% in 2005 from 7.2% in 2000 and 3.0% in 1990.

China’s huge infrastructure bias: One of the major areas of difference in the capex of the two countries is in investment for infrastructure. In 2005, China infrastructure investments were an estimated US$201 billion (9.0% of GDP) compared with US$28 billion (3.6%) for India. Another key variation is in investment in property. In 2005, China’s investment in housing construction was US$224 billion (10.1% of GDP) versus an estimated US$33 billion (4.1%) in India.

Manufacturing, services and agriculture mix: Not surprisingly, while China’s investments are biased towards manufacturing, India’s investments are evenly spread between manufacturing and services. Both countries have cut the share of agriculture in

total investment.

India’s poor penetration in fixed investment-dependent products: Steel and cement demand reflects the differences in spending on capex. China’s steel and cement demand is about 10.5 and 7.5 times that for India, respectively. However, the growth in demand for these products in India should accelerate as its investment-to-GDP ratio rises further, reflecting an improvement in savings to GDP.

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External Trade: China’s Share in Global Exports Is Six Times India’s

India lags China substantially despite an improvement in the trend over the past few years: While India had a 2.2% share of global goods exports in 1948, this position has been steadily eroded, reaching a low of 0.4% in 1981 and around 0.9% currently. Even if we consider services, India’s combined share in goods and services was 1.1% in 2005 versus 0.4% in 1990 and 1980. In contrast, China’s combined share in goods and services rose sharply to 6.6% in 2005 from 1.6% in 1990 and 0.9% in 1980.

India takes the lead in high-end commercial services: On an aggregate basis, China’s share in world commercial services exports is 3.3% versus India’s 2.3%. However, this includes tourism and transport revenues. China’s total services exports are about US$81 billion compared with US$57 billion for India. The mix, however, is very different. India has a bias toward scaleable IT software services and IT-enabled business process services (IT and ITES). IT and ITES currently account for 37% of India’s total services exports. We expect IT and ITES exports to rise to US$60 billion by 2010 from US$21 billion in 2005. Due to strong growth in IT and ITES, India’s commercial services exports have grown 29% a year in the past five years compared with 21% for China. We believe that India’s aggregate share in the global commercial services trade will start to outpace China’s share in the next five to six years.

Relatively less supportive business environment constrains India’s manufacturing: China’s success in manufacturing is well demonstrated by its 7.3% share of global goods exports compared with 0.9% for India in 2005. China’s goods exports recorded a CAGR of 18% from 1990 to 2005 versus India’s 11%. We believe that India needs a further overhaul of its manufacturing business environment to follow China’s lead in manufacturing. The key factors constraining manufacturing so far are lack of world-class infrastructure, rigid labor laws, inefficient tax laws and government interference.

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With gradual implementation of reforms and a rise in its savings rate, India is beginning to make inroads into manufactured exports. India’s top ten exports are currently biased towards products that are high in labor intensity and natural resources. However, incrementally, India’s exports will move towards high capital/infrastructure intensity sectors. India is already beginning to compete well in complex manufacturing such as chemicals, engineering goods and machinery, automobiles and auto components.

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SUMMARY OF KEY REFORMS IN INDIA AND CHINA

India China How did the reform process begin?

The reform process in India was triggered by a major macroeconomic crisis in early 1991. This was caused by a large fiscal and current account deficit, high inflation, increasing internal and external debt, three changes of government in a span of two years and socio-political upheaval. In June 1991,the new government (led by Mr. PV Narsimha Rao from theCongress Party, with Dr. Manmohan Singh as the Finance Minister) immediately made a commitment to structural reform. The rupee was devalued by 19% against the US dollar in two quick moves in July 1991.Various external as well as internal reform measures have beenimplemented subsequently. The government cut tariffs on imports, reduced quantitative restrictions on trade, liberalized the foreign investment policy and encouraged exports through tax exemptions. On the internal front, licensing requirements were removed for most major sectors, undue control on trade & business was reduced, banking reforms were initiated and the process of fiscal consolidation was initiated.

The Third Plenum (of the 11th Party Congress Central Committee) held in 1978 is widely regarded as the starting point of China's reform process. The government initiated market oriented reforms with the gradual experimentation approach inthe rural sector and later followed it up in the industrial sector. On the rural front, China initiated a massive de-collectivization program whereby the land was distributed or contracted out to households. This program was accompanied by a sharp increase in agricultural procurement prices and a decrease in agricultural input prices.The government later initiated a “big bang” industrialization plan with gradual liberalization of product pricing, the setting up of new systems that rewarded local government for promoting development, allowing greater autonomy of management toSOEs, encouraging external trade through deregulation, implementing labor reforms, setting up special economic zones, attracting FDI, establishing township & village enterprises and transferring commercial banking operations from just one bank (People's Bank of China) to four banks.

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External Sector ReformsTrade reformsExchange Rate The macro economic reforms

commenced with the devaluationof the rupee by 19% to Rs26:US$1 from Rs21 in July 1991. The rupee was subsequently floated on the current account. Over the years, the Reserve Bank of India has allowed market oriented movements in the currency. Its interventions have usually been with the aim of checking volatility rather than setting the direction.

China implemented current account convertibility of the renminbi (RMB) in 1996 but it followed a fixed exchange rate regime until recently. On July 21, 2005, China decided to change its currency regime. The renminbi was revalued by 2.1% against the US dollar and from that day fluctuations of 0.3% have been allowed on either side of the central rate, announced by the central bank on the previous day (i.e., the currency is able to crawl by 0.3% a day against the US dollar at a maximum although, in practice, the government still does not allow a 0.3% movement in a day).

Tariffs India lowered its weighted average import tariff rate from 87% in F1991 to 47% in F1994 to around 15-17% currently. The peak rate on non-agricultural products was reduced from 355% in F1992 to 35% in F2001 and 12.5% in F2006.

China has lowered import tariffs dramatically. Weighted average import tariffs were well over 50% in the early 1980s, but have been reduced to just 9.9% currently – close to honoring the WTO commitment to reduce tariffs to 9.8% by 2010.

Capital account reformsFDI In 1979, the Chinese government

granted legal status to foreign investment. The establishment of SEZs in 1980 also improved the climate for FDI flows. In 1986, new provisions were passed, which included reducing fees for labor and land use; establishing a limited foreign currency market for joint ventures; and extending the maximum duration of a joint-venture agreement beyond 50 years. The FDI climate further improved in 1990, when a number of provisions were adopted to make China an attractive destination for FDI (e.g., protection from nationalization). Hong Kong played an instrumental

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role in the takeoff in FDI in the mid-1980s to early 1990s amid the migration of the manufacturing base and the subsequent expansion. Overseas Chinese and Hong Kong enterprises had already established robust track records in China before WTO accession in 2002, which has further helped increase FDI Inflows into the country.

Portfolio investments

In September 1992, the government allowed FIIs to invest in Indian capital markets. A single FII is allowed to invest up to 10% in a company. Initially, the government limited the investment by FIIs to a ceiling of 24% of paid-up capital; however, this has since been liberalized and FIIs are now allowed to invest in Indian companies with no limits (subject to certain sector caps). In 2003, domestic mutual funds/resident individuals were allowed to invest in companies abroad that have a reciprocal 10% holding in a listed Indian company (subject to specified conditions). The reciprocity condition for domestic mutual funds was relaxed in 2006.

The Shanghai and Shenzhen stock exchanges were established in 1990. China allowed FIIs to invest in B shares. Subsequently, China allowed Qualified FIIs (QFIIs) to invest in the A share market. The investment limit for any stock is 10% of the total share capital for each QFII, with a 20% maximum for all QFIIs combined. Restrictions on outbound portfolio investment are gradually being relaxed. Formal announcement was made in mid-April 2006 for the QDII (qualified domestic institutional investor) scheme. Under this scheme, Chinese institutional investors are allowed to invest abroad. Domestic banks, insurers and fund management companies will be the first institutions to do so.

Internal Sector ReformsAgricultural reforms

After independence India initiated some land reforms by dividing land among the tenants and introduced the green revolution, which increased agricultural output in the 1960s. There have not been any major reforms in agriculture since the broader macro reform process began in 1991. The government’s spending on infrastructure for agriculture has been very low. Total public spending on agriculture dropped to 0.4% of GDP in F2004

The first sets of reforms in China were in the agriculture sector. China collectivized agriculture in the 1950s, with the establishment of the commune system. However, in the late 1970s a household responsibility system was developed, under which the communes’ land was divided among households. This gave a big impetus to the rural economy, with incomes increasing by up to 50% over 1978-84. Recently, the government has decided to increase its rural

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from 0.6% in F1991. Only about 40% of the land is irrigated, leaving farmers exposed to the vagaries of monsoons. Over the past few years, the government has launched some initiatives to accelerate agriculture growth, including allowing exchange-trading of commodities; encouraging states to reform laws to liberalize marketing of agricultural produce; and encouraging banks to increase lending to the agriculture sector.

spending plan. In March 2006, Premier Wen Jiabao announced that the government would make a concerted effort to build “a new socialist countryside” over the next five years. The government announced a 14% increase in its 2006 rural budget to Rmb340 billion (US$42 billion, 1.7% of GDP). It also abolished the tax on agricultural income and plans to invest US$148 billion on rural roads over the next five years.

Industrial reforms

Key industrial reforms implemented in India are:Removal of licensing regime: The government abolished licensing requirements for setting up all but 18 industries in 1991. In 1998-99, further de-licensing took place and now licenses are required only in industries such as alcohol, tobacco products and those pertaining to defense equipment. Removal of undue control of trade and business: In 1991, the government abolished the Monopolies and Restrictive Trade Practices Act, which constrained corporate acquisitions and over-regulated business practices. Deregulation of product prices: The prices of various goods, such as steel, cement, paper and pulp, have been deregulated since the reform process began. Now most manufactured product prices are determined by market forces except for a select few products like oil & coal.Reduction of protection to SME sector: The government has over the years been reducing reservations for small-scale

Key industrial reforms implemented in China are:Reforming SOEs: In 1979 the government allowed state-owned enterprises to retain profits. Gradually, the government is trying to build professional management within SOEs. It has also adopted SOE labor reforms, such as the contracting of labor, retrenchment and performance-linked pay. The reform process picked up in 1995 when the central government adopted the idea of ‘grasping the large and letting go the small’, wherein it intended to keep about 1,000 enterprises as state-owned and privatize the rest.Deregulation of product prices: Initially, China adopted a dual trackapproach to price liberalization wherein price determination was through both planned and market forces. By the mid-1990s, prices of most products in China were liberalized. SME reforms: Since 1978, the importance of Township and Village Enterprises (TVEs) in China has increased manifold. The TVEs are hybrid institutions – alliances between TVE entrepreneurs and local

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industries (SSI). The number of items reserved was reduced from a peak of 873 in 1984 to 506 in 2005.Privatization of SOEs: In India, the disinvestment process initially focused on the transfer of minority rights to public and financial institutions. However, no controlling right was sold to the private sector. In 2003-04, the government privatized a few public sector enterprises, where it passed the controlling interest to strategic investors. However, the sale of controlling stakes is unlikely to take place in India in the near term, with a clear change in government policy in this area. The public sector accounts for about 20% of industrial output.Labor reforms: India still lags on labor reforms. Current regulations require enterprises employing more than 100 people to undergo a complex approval process before retrenching employees.

government officials (acting in the capacity of ‘owners’). TVEs have emerged as one of the key growth drivers of industrial output in China.Encouraging private and joint sectors: The government has allowed non-state-owned enterprises to operate in China and they have proven to be a primary driver of economic growth since the 1980s. Non-state-owned enterprises accounted for 61% of total value-added industrial output in 2005, up from 43% in 1998. Privatization of SOEs: China has pursued a limited form of privatization by way of the sale of stakes in state-owned companies to public and foreign institutional shareholders. The government has used this as an opportunity to strengthen state-owned enterprises. The amount collected in China from the sale of stakes in SOEs is many times that in India.Labor reforms: China has been successful in introducing a flexible labor system. China has over the years shifted to a more flexible policy on labor in terms of both hiring and firing. Geographical mobility of labor is still limited, nevertheless. Unfavorable conditions for migrant workers in urban areas have limited the pace of migration; hence, the apparent labor shortage in recent years in the coastal cities.

Fiscal Reforms Tax Structure: India initiated major tax reforms in the early 1990s. It has reduced the marginal rate of personal tax from 56% in F1992 to 30% currently, lowered the corporate tax rate from 50% in F1992 to 30%, and cut the peak

Tax Structure: China has implemented major changes in its tax structure over the past 20 years. It has already cut its import tariff such that the total import tariff as a proportion of the value of imports is less than 2.5%, compared with 10% in India. China adopted the

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excise and non-agriculture import tariff from over 100% and 150% in F1992 to 24% and 12.5%, respectively. Since the mid-1990s, the government has expanded the tax net by levying taxes on services. In 2005-06, the government replaced the multiple-rate sales tax (ST) system, which was independently managed by various states, with a synchronized single-rate system. The new system leaves the central tax collection system independent. The government has since announced its intentions to shift to a country-wide common goods and services tax (GST) by 2010-11. Fiscal Prudence: India pursued some public finance reforms from the early 1990s to the mid-1990s by reining in expenditure and augmenting revenues. This helped reduce the consolidated fiscal deficit to 6.4% of GDP in F1997 from 9.4% in F1991. However, the emergence of coalition government at the center resulted in major slippage in government finances and pushed the fiscal deficit to a new high of 9.9% of GDP in F2002. Although the headline fiscal deficit has since dropped to 7.8% of GDP in F2006, the off-budget oil and electricity subsidy burden remains high at 1.9%. We believe the government needs to initiate major expenditure reforms and move effectively to outcome-based expenditure management from the current outlay-based system to cut non-interest revenue expenditure.

value-added tax system in the mid-1990s, which further improved the efficiency of the tax system. Tax incentives have been widely used to attract foreign capital, but the upcoming reform on unifying tax rates on local vs. foreign enterprises will be a landmark change towards a more level playing-field in China.Fiscal Prudence: China has initiated several measures for better management of government finances. Previously, all government revenue and expenditure had to go through the central government. However, in the 1980s, the process was decentralized, with the local government transferring a negotiated amount to the central government and keeping the rest. This gave increased incentives to the local governments to improve revenue collection and tax efficiency. Government accounts in China are relatively well placed. The aggregatefiscal deficit in China has remained under 3% of GDP over the past 10 years.

Banking sectorreforms

India has steadily strengthened its banking system, improving the

Although China has initiated reforms for the banking sector, its progress

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regulatory framework, imposing strict prudential norms and encouraging greater competition. The government has allowed private sector entry since the mid-1990s. Private players have already built a 27% share of loan assets in the banking system. The prudential norms in terms of capital adequacy requirements have gradually tightened, and currently banks are required to maintain a CAR of 9%. Most banks already comply with the norm of 9% CAR and will move to meeting Basel II requirements by March 2007. In 2002, the government enacted the Foreclosure Act, which gave lenders powers to forfeit assets of defaulting borrowers, enabling quick recovery of NPAs. One area where the Indian banking system lags is in the relatively restricted access to foreign capital, which is capped at 20% for the SOE banks and 74% for private banks.

pales when compared with India. Until 1980, there was hardly any competition. The government then created four large banks. Subsequently, joint stock banks were formed and foreign banks were also allowed to open branches. By 2007, foreign banks will receive national treatment in China under the WTO agreement. Of a total of around 115 banks in China, 53 do not yet comply with the Basel I requirement of capitaladequacy ratio of 8%. However, over the past few years the government has taken steps to reduce NPLs and has recapitalized the weaker banks. China has also announced that certain banks with a large number of overseas branches will adopt Basel II norms from 2010 to 2012. On balance, China lags India in banking sector reforms.

InfrastructureReforms

Except for telecoms, overall progress in infrastructure has historically been slow in India. However, over the past two years, infrastructure has gained the attention of policymakers.Roads: Investments in this long-gestation sector have been low, averaging just US$ 2.5-3 billion over the past 10 years. The government has now initiated a US$38 billion seven-phase national highway development, covering 65,000 kms of national highways to increase road spending.Seaports: Over the past few years, the government has introduced several measures to augment

While the overall regulatory system in China is still fairly weak, the government has undertaken major initiatives to encourage adequate investments in infrastructure.Roads: China has largely relied on government investments in this area. Investments have averaged US$34 billion p.a. over the past 10 years. Indeed, in 2005 China spent US$67 billion on road development. The government plans a major push on building rural roads over the next the few years.Seaports: China has built world-class port infrastructure. A large part of this is owned and developed by the government. Hong Kong enterprises

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private investment in the sector. The average turnaround time at Indian ports improved to about 3.4 days in F2005 from 8.5 days in F1996. Although a good beginning has been made, progress is still slow, leaving the overall cost-efficiency at Indian ports relatively low compared with world averages.Telecom: The government opened up services like cellular, radio paging, and data services to the private sector in F1993 and followed it up with the opening up of basic telephony to private participation and foreign equity (up to 49%) in F1995. It also fixed a 49% foreign investment limit for cellular telephony, which has recently been increased to 74%. The favorable policy environment has encouraged the private sector to participate aggressively, and private investment has contributed significantly to growth in the sector. Significant technological change has resulted in a 90% decline in the cost of accessing telecom services over the past seven years. Overall progress in this sector is commendable with the subscriber base having risen to 130 million as of 2005 from 12 million over the past 10 years.Airports: After neglecting airport infrastructure for years, over the past three years, the government has initiated a number of policy measures to attract the private sector and improve efficiency. Some of the major initiatives taken by the government in this context are an open-skies policy for passenger traffic, restructuring and privatization of Mumbai and Delhi

have played a big role in the development of China’s ports, but they have also done so in partnership with local governments.Telecoms: Prior to 1994, the Ministry of Post and Telecommunications (MPT) was the regulator as well as thebiggest player in the Chinese market through its arm, China Telecom. Subsequently, the entity was split into two parts: the Ministry of Information Industry (MII), the operational arm, and China Telecom. Later China Telecom was further divided on the basis of geography and business. In recent years, China's telecom sector has become more open to foreign investment. The government has encouraged foreign companies to establish telecom companies by acquiring domestic companies and has also allowed established joint ventures to apply to operate telecom services. Over the last ten years, China’s telecom subscriber base has increased 17-fold to 744 million from 44 million.Airports: Over the past 15 years, China has spent approximately US$14.8 billion on upgrading its airport infrastructure. Recently, the Civil Aviation Administration of China (CAAC) announced plans to invest a further US$17.4 billion over the next five years on airport infrastructure.Electricity: The Electricity Law was promulgated in 1995 and was the first comprehensive legislation for the electricity sector. In 1997, the State Power Corporation (SPC) was formed. In 2002-2003, the government split the SPC into 11 separate companies, which included two grid corporations, five power generating groups and five

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airports, announcing construction of Greenfield airports in select cities and undertaking the modernization of other domestic airports. Electricity: The electricity sector is one area in need of serious and immediate overhaul. The most important investment deterrent in the power sector is the poor financial condition of the state electricity boards (which own more than 90% of the distribution in the country). The electricity operations of the public sector incur annual losses of US$4-5 billion due to the large burden of subsidies and theft in electricity distribution. While the government has initiated several measures over the past few years, the effective implementation of reforms in this area is far slower than required. This constrains investments in the sector with peak electricity shortages at 12%. SEZs: The government initiated the first major change in April 2000 for the establishment of Special Economic Zones. However, the response from investors has been poor. In May 2005, the government approved a new SEZ legislation which is more comprehensive and provides for a larger tax incentive package. Since the new legislation was passed, various private investors have announced their intentions to set-up SEZs. However, the response from the private sector is largely for investing in small SEZs where tax benefits are a key attraction.

other companies. The government also established the State Electricity Regulatory Commission (SERC) to be responsible for supervising and regulating market competition in the electricity industry. However, the SERC shares power with regards to pricing and electricity sector investments and as a result the government continues to control the sector. Despite this, the operations are far more efficient than those in India. The government has taken the lead in boosting investments in the sector. China has increased its electricity generation capacity to 508 GW currently from 217 GW in 1995.SEZs: In 1980 China created four Special Economic Zones, which enjoyed special policy benefits like lower tax rates in addition to good infrastructure facilities. The success of these SEZs led to the creation of more such zones, and this has been a cornerstone of China’s reform success.

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CONCLUSION

China and India represent the future of Asia – and quite possibly the future for the global economy. Yet both economies now need to fine-tune their development strategies by expanding their economic power bases. If these mid-course corrections are well executed – and there is good reason to believe that will be the case – China and India should play an increasingly powerful role in driving the global growth dynamic for years to come. With that role, however, come equally important consequences. IT-enabled globalization has introduced an unexpected complication into the process – a time compression of economic development that has caught the rich industrial world by surprise. The resulting heightened sense of economic insecurity that has stoked an increasingly dangerous protectionist backlash could well pose yet another major challenge to China and India – learning how to live with the consequences of their successes. The Indian government has recently signaled its intention to lift the economy to a higher growth path, whereby GDP would expand at an annual rate of 10 per cent. High growth, according to the government, provides the best antidote to poverty.29 The economic expansion that started in 2003/04 provides evidence that India’s growth rates in favorable circumstances are comparable to Asia’s powerhouse, China. Whereas high domestic demand has increased inflationary pressures in the Indian economy and dragged the current account into deficit, China’s economy has experienced deflationary tendencies that seem to reflect excess supply in the economy. In this regard, investment in infrastructure is imperative to increase the supply-side potential of the Indian economy. It is equally critical to push forward with the economic reforms that have progressed slowly of late, especially in terms of privatization and labor laws. The recent growth in industry is a positive sign of the economic expansion reaching beyond the services sector – a necessary evolution for employment growth and further progress in poverty reduction. An increase in fiscal revenues would provide resources for spending in education, health and infrastructure, without further worsening the delicate state of fiscal balances. A gradual phasing-out of budget subsidies, replaced by direct cash transfers, could also form an important part of fiscal reform.

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