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MANILA — India is a paradox. The successes of a select group of sectors — from information technology to industr and services — are creating an urban elite showcased as the builders of a modern and vibrant country on the cusp of joining the major economic powers of the world.

Yet, just outside their corporate campuses and air-conditioned shopping malls, 840 million Indians continue to survive on less than $2 a day. An increasing gulf between these groups poses a major social, political and economic dilemma.

The challenge is threefold: India must create rapid growth in the number and size of its islands of excellence; it must strengthen the development of bypassed regions and peoples; and it must expand the ability of the poor to improve their economic position. India’s future will depend on how well and how quickly it meets these challenges.

Per capita income is less than a tenth of that of the United States, leaving plenty of room to grow while remaining competitive. In the coming years a demographic dividend will significantly increase the growth rate of the working-age population. The consequent decline in the dependency ratio could lead to an increase in savings and investment rates. These three factors together could make annual growth rates of 8 to 9 percent achievable over the next two decades, up from average growth of about 6 percent in the past decade.

If these growth rates are realized, India is projected to rise to third, after China and the U.S., in terms of its share of world GDP with purchasing power at parity by 2025. This prospect has greatly heightened interest in India’s future.

In the medium term, India will need to introduce aggressive reforms to address a number of central challenges. Macroeconomic imbalances, particularly budget deficits running at close to 10 percent of GDP, must be corrected. This problem is aggravated by deficit financing of subsidies for power, fertilizer and loss-making state-owned enterprises. Linked to the budget deficits, underinvestment in social and physical infrastructure must be reversed. Highly distorted land and labor markets must give way to greater competition and flexibility with security. Institutional strengthening for improved governance is required to improve the business and investment climate. These reforms are preconditions for productivity improvements.

There are political obstacles to change in each of these areas as reform will produce winners and losers. This makes it imperative that the government expand the constituency for reform.

In this regard, early success of the present government’s Common Minimum Program, which focuses on improving the well-being of farmers and low-income citizens, takes on heightened importance. The program focuses on increasing infrastructure in rural areas, providing universal access to basic education and health, and guaranteeing 100 days of minimum-wage employment for one person in each poor household. Public investment, carefully targeted public expenditure programs, and strengthened governance are critical for success.

Inclusive growth will require smart government spending. First, revenue generation, both in quantity and quality, must improve. Rapid and sustained GDP growth is necessary for increased budget revenue. It is important to keep in mind that the government can serve as a catalyst only by ensuring the provision of adequate public goods and services. Economic growth is the driver of improvements in living standards in India, especially for those in abject poverty. It is the private sector that will be the engine of growth and the creator of new jobs.

Greater integration with the world economy is an area of great promise, but India lacks a political consensus for open markets. India currently accounts for only about 0.8 percent of world trade. The share of trade in GDP is 22 percent. Greater trade openness will promote learning, impart market discipline and increase productivity by exposing Indian firms to intense competition and encouraging technology improvements.

In responding to the trade liberalization of the 1990s, India has demonstrated it has world-class companies with an increasing share of profits coming from foreign sales. These companies have demonstrated their competitiveness by exploiting India’s software capabilities, domain knowledge and a large pool of educated technocrats. These capabilities also have led to an expansion of research and development and the advancement of technology in key sectors.

But globalization and competition pose a dilemma. To benefit from the opportunities offered by globalization, India’s institutions, infrastructure and incentive regimes must be harmonized with its competitors. Otherwise Indian firms will face major constraints to becoming, and remaining, competitive. Reforms, in turn, could result in significant short- and medium-term adjustment costs. Benefits would take longer to realize, but once realized, they would increase exponentially. The politico-economic ramifications of short- to medium-term pain vs. long-term gain will determine the pace and nature of reform.

Two more factors will be critical to growth: India’s ability to strengthen interdependence with industrial countries, and energy security. Manufactured exports growth could trigger industrialization that has barely begun and could provide a major source of jobs. Manufacturing requires energy; thus energy costs will be an increasingly important aspect of competitiveness. High prices could constrain participation in global trade.

India must learn to use its large coal supplies in an environmentally friendly way. Its neighbors have both hydropower and hydrocarbon energy sources, but tapping them would require a dramatic shift in the political and security mind-set.

India must balance a challenging combination of competition, cooperation and coordination as it strengthens its interdependence with industrial countries, deepens integration with its neighbors and broadens inclusiveness within the country. Bold and sustained reforms designed to make economic efficiency and social justice mutually reinforcing are needed to realize its vast potential.

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