US embassy cable - 04SINGAPORE3027

UNCLAS SECTION 01 OF 02 SINGAPORE 003027 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON, IN, SN 
SUBJECT: INDIAN ECONOMY: THE VIEW FROM SINGAPORE 
 
 
1. Summary.  On October 15, 2004 visiting Economic Officer 
Brian Briscombe  -- who was wrapping up a week-long trip to 
Delhi, Mumbai and Hyderabad -- and embassy officers held a 
series of meetings with private sector analysts to discuss 
the Indian economy.  While all expressed optimism about 
India,s future prospects, they also acknowledged serious 
problems, near-term resolution of which will be necessary if 
India is to continue to grow at its current pace.  The 
Singapore-based analysts identified the financial system, the 
government deficit, and the lack of political commitment to 
free market economics as key obstacles to India,s future 
economic growth.  Singapore's trade with India grew 54 
percent in the first half of this year -- faster than with 
any other partner -- and the Singapore government is taking 
an active approach to boosting trade and investment links. 
End summary. 
 
Liberalization 
-------------- 
 
2.  All of the analysts agreed that the GOI needs to further 
liberalize its trade and investment regimes in order to 
maintain the country,s current high rate of growth. 
According to Sailesh Jha of Credit Suisse-First Boston, India 
is "early cycle," i.e., it is currently experiencing the 
burst of growth common after the initial introduction of 
broad based liberalization (similar, he said, to the 
situation in Southeast Asia in the early to mid-1990s), but 
it will need to do much more to make high growth rates 
sustainable.  He noted that average tariff rates are still 
quite high, as is government involvement in the economy. 
While some technocrats recognize that further liberalization 
is necessary, politics make adoption and implementation of 
further reforms difficult. Dominique Dwor-Frecaut of 
Barclay,s Capital said that no one in India is actively 
advocating freer markets or more incentives to attract 
foreign direct investment, because of political 
sensitivities.  While liberalization will continue, it 
remains a very slow process, she said.  Arjuna Mahendran, 
Chief Economist and Strategist, Credit Suisse, echoed 
Dwor-Frecaut's sentiments when comparing China's and India's 
respective economic performance.  He noted that, if faced 
with a choice, Indians would prefer to maintain their current 
political institutions (and by extension their "more 
democratic way of life") than to "sacrifice" these in pursuit 
of more rapid and consistent economic growth (as in the case 
of China). 
 
3.  Dwor-Frecaut noted that the rapid rise in importance of 
India's services sector is not due only to the competitive 
advantage of its skilled workforce and English language 
ability, but also because the services sector developed too 
quickly for bureaucrats to stifle it through over-regulation, 
as they did with manufacturing.  She identified the country's 
labor laws in particular as a critical area for reform in 
order to attract FDI in a broader range of sectors.  Jha said 
that India will need to develop its manufacturing sector to 
create needed jobs, and argued that the idea that India can 
dominate services and leave manufacturing to China is wrong. 
China will become increasingly competitive with India on 
services, he said, as English language skills there continue 
to improve, and India can compete on manufacturing: it has 
many of the managerial and technical skills that are 
increasingly scarce in China. 
 
The Financial System 
-------------------- 
 
4.  All of our interlocutors agreed that the financial sector 
will constrain future growth.  State-owned commercial banks 
prefer to invest in government debt or government-owned 
corporations rather than lend to domestic businesses. 
Sailesh Jha argued that so far, this crowding out of domestic 
investment has not been a serious problem as domestic firms 
do have access to external capital sources, although this 
could change if global demand for emerging market debt dries 
up.  Dwor-Frecaut noted, however, that while larger firms 
have the option to seek external financing, smaller firms do 
not.  As a result of this lack of access to credit and 
stifling government regulations, small domestic investors are 
being forced into the large informal sector.  She argued that 
the GOI will not be able to make needed reforms and privatize 
the state-owned commercial banks until the government is less 
dependent on the banks to finance its deficit. 
 
5.  Van Anantha-Nageswaran of the Libran Fund was more 
upbeat.  He argued that while balance sheets are currently 
too "healthy" for the public sector banks to be shaken out of 
their complacency and encouraged to undertake risk-base 
lending to the private sector, private banks are starting to 
gain some market share and are doing some risk-based lending 
to domestic business themselves.  While he said the 
government could be doing more to promote the emergence of 
private banks, it is happening slowly on its own, injecting a 
bit more competition into the financial system.  This trend 
is still nascent, he said, but it could ultimately force 
public banks to rethink their way of operating. 
 
The Fiscal Deficit 
------------------ 
 
6.  None of the analysts were particularly alarmed about the 
budget deficit, although they do consider it a vulnerability 
for the Indian economy in the medium term.  Jha said that in 
the short term (12-18 months) it is "irrelevant," because it 
is not impinging on the liquidity of the financial system or 
pushing up interest rates.  Both Jha and Anantha-Nageswaran 
noted that because the mix of government debt is changing -- 
the GOI relies increasingly on domestically-issued debt and 
continues to be able to refinance at low interest rates -- 
there is little chance of an external crisis.  Jha and 
Anantha-Nageswaran also said that the government,s 
expectations of a shrinking deficit were somewhat 
unrealistic.  Jha said that Delhi,s hope of widening the tax 
base in the services sector would be difficult to implement, 
and Anantha-Nageswaran argued that there had been little 
improvement in the government,s political will to increase 
tax collection, with most gains in revenue coming from 
administrative efficiencies rather than policy changes. 
 
7.  Jha said that the deficit becomes more worrying over the 
medium term; if inflation continues to pick up and there is 
no monetary tightening by the government, the deficit could 
pose a risk to growth.  He argued, however, that the 
government can always spend its considerable reserves in a 
cash crunch.  Anantha-Nageswaran emphasized that the quality 
rather than the quantity of the deficit is worrisome; if the 
GOI was spending on infrastructure and education, the deficit 
would be less worrisome because it would contribute to growth 
and hopefully a virtuous cycle which would allow India to 
grow out of the deficit.  Instead, India,s infrastructure is 
famously poor, and the government is spending not on 
infrastructure and other capital investments, but on the 
administrative costs of maintaining a large bureaucracy. 
P.K. Basu, Managing Director, Robust Economic Analysis, 
similarly lamented the inadequate level of investment in 
infrastructure, noting that one of the Indian economy's 
brightest stars -- the software industry centered around 
Bangalore -- has been so successful in part because it has 
limited infrastructure investment needs beyond office space, 
electricity and optical fiber.  Other industries, he 
stressed, are not so lucky. 
 
Comment 
------- 
 
8.  Although they recognize the many challenges for India's 
economic development, all of the analysts we spoke to believe 
that India will continue to deliver a high growth story. 
Their enthusiasm is shared by the Singaporean business 
community and the government, who hope to capitalize on 
India's growth and expanding ties to East Asia.  India has 
become Singapore's fastest growing trading partner, with 
two-way trade increasing by 54 percent in the first half of 
the year.  In typical Singaporean fashion, the GOS is leaving 
little to chance, and is actively promoting economic links 
with India, in part to balance out its reliance on ties to 
the U.S. and China.  The GOS hopes to complete negotiations 
of the Singapore-India Comprehensive Economic Cooperation 
Agreement by next year, and Temasek, the GOS's investment 
holding company (run by Ho Ching, wife of Prime Minister Lee 
Hsien Loong), has become one of India's largest private 
equity investors, funneling close to $1 billion into the 
Indian economy in less than a year and opening its first 
office outside Singapore in Mumbai, according to recent press 
reports.  Not content to be a silent partner, Singapore also 
offers the GOI plenty of advice. Singapore's Trade and 
Industry Minister, for example,  who is in New Delhi this 
week to attend the India ASEAN Business Summit, made a speech 
on October 20 urging India to conclude FTAs with ASEAN 
countries to quicken its integration with Southeast Asia, and 
said that the GOI needs to remove non-tariff barriers, adopt 
mutual recognition of standards and investment guarantee 
pacts, and streamline new business registration procedures in 
order to encourage investment. 
 
 
LAVIN