Sleeping giant awakes as India’s infrastructure builds

One of the key elements in India’s long-term story is the development of its ‘informal sector’. Every emerging economy and most developed economies have workers without formal employment or social security – those employed outside the regulatory and tax net.

Is the possible long-term gain worth the short-term pain for investors? Perhaps. The potential productivity growth in India’s rural hinterland is enormous, similar in scale to the growth exhibited by China in the past two decades.

The question is how to unlock it.

Although roughly 70 per cent of India’s population lives in rural areas, the informal sector is evident in towns and cities as well. It is massive and growing. Even excluding agriculture, the informal sector still accounts for more than 80 per cent of employment.

That figure is roughly 60 per cent in Brazil, 55 per cent in Mexico and 45 per cent in China. Including agriculture, some 92 per cent of the Indian workforce could have been classified as informal in 1983.

The informal sector is generally characterised as being unorganised, sub-scale and with low levels of skill. The (non-agriculture) informal sector contributed about 40 per cent of India’s GDP (2005).

Progress has been made with improvements in rural roads, electrification and telecoms infrastructure, which should have led to productivity gains. Notable examples include:

• The rural roads programme has built more than 300,000km of new roads in rural areas. This has resulted in a roughly 50-100 per cent increase in household income for those affected. More recently, a plan was announced to build 24 cities along the Delhi-Mumbai Industrial Corridor by 2040, with phase one scheduled for completion by 2019.

• Only 52 per cent of rural households have electricity, the rest remaining off-grid. The rural electrification programme has reached nearly 100,000 un-electrified villages. Households are able to save 3-5 per cent of total expenditure when they replace kerosene with a light bulb. This may not sound much, but to a family living on $1 a day, there is no discretionary spending, so 3 per cent is a huge amount.

However, the situation is still bleak: local corruption, murky statistics, and spotty implementation are rife, culminating in poor quality roads when they are built and power lines, when erected, often carrying no electricity.

A number of measures are essential to increase the informal sector’s access to proper infrastructure, technology, credit, and skills to improve their productivity and incomes.

The increase in disposable income resulting from the replacement of a kerosene lamp with an electric bulb, or a bullock-cart track with a paved road – though small individually – is enormous in aggregate, and represents a major opportunity for those companies well positioned to capture it.

These opportunities should arise primarily in consumption, banking and home-building as the increase in productivity results in rising levels of income, which in turn drives the huge latent demand.

At a far earlier stage of development and with a population soon to surpass that of China, but with a less autocratic government, India deserves attention from long-term investors.

Gary Greenberg is head of emerging markets at Hermes

INDIA: CHALLENGES AND SOLUTIONS

Challenge 1: Power

The lack of reliable power is a key impediment to the development of the informal sector in which only 27 per cent of rural and 52 per cent of urban manufacturing enterprises use electricity for production purposes.

Solutions

Power sector reforms – the government of India has embarked on power reforms such as fast-tracking 23,000MW of power projects and 1,600km of transmission lines.

Challenge 2: Availability of capital

Limited access to funds acts as a major constraint to development for entrepreneurs in the informal sector.

Solutions

Banking reforms and a better micro-finance (MFI) initiative – MFI legislation has just been introduced by parliament which, if passed, should help provide stability for the sector. Further, new banking licences set to be issued could help the growth of MFI lending as it will give access to deposits.

Driving exports – India’s chronic current account deficit results in periodic interest rate spikes and a higher than average cost of capital. Developing industries that generate foreign exchange could stabilise the rupee and lower interest rates, making capital cheaper.

Challenge 3: Skills gap

Only about 11% of the youth in India have received or are receiving any training, whether formal or informal. Lack of skills has a direct impact on overall productivity and income levels.

Solutions

Educational reforms – the Indian government is allocating US$20bn to vocational training and modernising classroom learning in an effort to create a skilled workforce of 500 million by 2022.

Source: Hermes