India's Rising Star
Surging growth in its service economy offers opportunities for U.S. businesses. But the subcontinent lags far behind China in manufacturing.
By Andrew C. Schneider

Will India be the next China? The economic numbers make India look as if it is on track to be the next mover and shaker in global markets. The Indian economy -- which the government tracks by fiscal years ending March 31 instead of by calendar years -- posted an impressive 9.4% expansion in 2006-2007 and is on course for 8.2% growth this fiscal year.

China's top-dog status in emerging markets isn't really in danger, though. India's long-term average rate of economic growth is likely to be 7% to 8%, while China's will be on the order of 9% to 10%. That means China is going to retain its substantial lead over India in terms of the size of its economy in the near future. China's gross domestic product is close to topping $3 trillion, overtaking Germany as the third-largest national economy in the world. India's economy, by contrast, will be worth about $1 trillion this year.

India still has major growth bottlenecks to clear. The service sector is going gangbusters, but India's manufacturing sector is far from matching China's role as factory for the world. "Infrastructure has really been the Achilles' heel of trying to develop a more robust manufacturing sector in India," says Rick Rossow, director of operations for the US-India Business Council.

Electricity supply, highways, ports, airports and railroads all suffer from years of neglect, insufficient investment and political and bureaucratic constraints on development. All of these are factors that add time and expense to the manufacturing process. China's large direct investment in these spheres is a major reason why it, and not India, has emerged as a manufacturing and exporting giant.

Education is another very weak link. India's literacy rate is only 61%, compared with 91% in China. That limits not only the pool of skilled and professional workers, but also the pool of workers for lower-end services and semiskilled manufacturing jobs. In higher education, the Indian Institutes of Technology offer science, technology and business training comparable to anything available in the U.S. But they simply don't churn out enough graduates to fill India's needs.

Prime Minister Manmohan Singh is trying to smooth out the economy's rough spots. For example, in transportation, his government recently completed work on a diamond-shaped series of superhighways connecting the country's four largest cities: Delhi (which includes the capital district New Delhi), Mumbai (formerly Bombay), Kolkata (formerly Calcutta) and Chennai (formerly Madras). The Singh government also recently announced plans to pour $320 billion into infrastructure spending between this year and 2012, partly from public spending and partly raised by the private sector.

But there are limits to how fast Singh can transform India. China's nominally Communist dictatorship can enact vast infrastructure and other projects with scant regard to the objections or concerns of citizens. In India's federalist, parliamentary democracy, however, governments ignore the electorate and local business interests at their peril.

Singh's government is a case in point. It came to power dependent on the support of India's two Communist parties, which vote with the government but remain outside it. To keep their support, Singh has had to be very cautious about taking steps that could disrupt the lives of poor voters. While Beijing has regularly launched massive infrastructure or industrial development projects that force countless rural residents off their land, such an approach would be political suicide in India.

Likewise, Singh has had to move slowly in relaxing India's barriers to foreign direct investment, balancing the need to bring in capital and create jobs against the risk of a populist backlash. The same goes for relaxing affirmative action rules on hiring and admission in higher education in order to encourage the building of new universities.

That said, India is already turning into a lucrative prospect for U.S. companies, particularly for those in infrastructure-related industries: electric power, airport and ground-handling equipment, food processing, telecommunications, pollution control and water and wastewater treatment. Similarly, the shortfall in available university spots means that Indian students will continue to flock to the U.S. for graduate education, despite post-9/11 visa restrictions. India remains by far the largest supplier of foreign students to U.S. universities, according to the Institute of International Education.

Indian consumer spending is also taking off. With Indian firms scrambling to attract and keep qualified workers, wages for skilled labor are increasing at a rate of 12% to 14% per year. That will boost Indians' disposable income and help Indian sales of U.S.-made consumer goods, particularly fast-moving items such as processed foods and cosmetics.

Meanwhile, U.S. businesses are getting more creative about clearing India's existing hurdles. For example, foreign retailers are barred from operating big-box stores in India, but Wal-Mart found a backdoor entrance. It struck a deal with India's Bharti Enterprises to supply it with technology and expertise to develop the logistics and distribution network for Bharti's new big-box chain. Indian officials are doubtless pleased that Wal-Mart will set up a badly needed supply chain for refrigerated foods. The lack of cold storage units and refrigerated transport leaves the country's agricultural produce vulnerable to spoilage on the way to market.

Express mail and logistics companies UPS and FedEx are going to help Indian farmers get their produce to market and provide trade financing to help local suppliers export their goods. Citigroup and Blackstone Group have created partnerships with two Indian government entities to deploy $5 billion in financing for development of electric power infrastructure, roads, ports, airports and other commercial and industrial infrastructure projects.