What Does India's Future Hold for the World Economy?

Includes: DBA, INP, PIN, USO
by: Balaji Viswanathan

In January, I visited a few villages in India partly to understand how global markets are affecting them. After spending a week in Europe and a few weeks Indian cities, the villages marked a refreshing contrast. As I walked in the fields, I saw that the villagers were happy, gave me free juicy sugarcane, and they were more upbeat about the economy than anybody else. As we will see, if India were to consume as much oil per-capita as a relatively poorer Eastern European nation like Slovenia, it alone needs 30 million barrels/day (mbpd) more (40% of world consumption), apart from another 35 mbpd from China. If they both want to consume as much as US, India needs about 60 million addition barrels apart from 70 mbpd for China (current world production is of the order of 85 mbpd).

These villages might never get to the economic level of an average American or European countryside, their per-capita income might never get closer to that of an average American, but the changes going on in these nameless places will have a profound impact on world’s commodity, tech and consumer markets. And this could change the wage-commodity price relationship substantially.

Changes at the ground level

Kovil Esanai, a small village in southern part of India and about 200 miles from the tech center of Bangalore, could have easily qualified for those UN ads on the world’s poor, with people earning less than $1/day. I spent my formative years and primary schooling in such villages where even the best village school is only slightly better than a glorified cowshed in terms of amenities and hygiene. Until about 2004, this village of Esanai didn’t have a telephone, most of the homes were constructed with mud and dried coconut leaves, people couldn’t even afford bicycles, the village school was a little more than concrete benches under big trees, and most energy usage was in the form of burning dried cow dung and wood.

However this village of 2009 is drastically different. Almost everybody has mobile phones, the village school has a brick building and every classroom has DVD players, projectors and PC, people drive new motorcycles built by Indian collaborations of Suzuki, Yamaha and Honda (NYSE:HMC), more houses are made of concrete with the “modern” amenities like refrigerators and gas stoves, and people have far more world awareness. The village is not some model village adopted by a world organization, nor is it near an outsourcing base or some major global factory. The nearest major town is 3 hours away and it takes more than half a day to reach a major city. The village is yet another part of developing world whose carbon footprint has dramatically grown and whose inhabitants have started to get a taste of the modern world. My back-of the envelope estimate shows that their average carbon consumption would have grown more than 5 times in as many years.

Image source: Market Research analyst

Implications for carbon consumption

Now, you are thinking so what? Almost everybody in the US has an automobile, concrete house, phones and good schools, why is this change relevant? Look at the graph below using the data from CIA factbook.

Data Source: CIA factbook

Compare India’s 2005 electricity usage with other countries – it is 30 times lower than the US and 60 times lower than Iceland. If India and China were to reach the economic level of Eastern Europe and consume the level of Slovenia, there will be a run on world oil markets. We would need additional 60 million barrels/day (75% world consumption) for India and China alone, let alone the growing demand for countries like Brazil and Saudi Arabia.

Wage differentials

While globalization has flattened a few wage rates for a few professions like software development, project management, portfolio management, etc, there is still a huge gap for non-globalized professions. For example, until 2004 a typical harvester or sower in agricultural fields earned $0.5/day (for about 10 hours of work) and this is 150 times less than a comparable wage in the developed world. Even a slightly more sophisticated job in McDonald's (NYSE:MCD) has a wage differential of more than 20 as the study below shows.

However, globalization train has left the station and more professions are coming closer to flattening the wage differentials across geography. With more education and labor development, the villagers in Kovil Esanai could be turned to produce goods that will substantially contract world prices and counteract the commodity inflation.

Data Source: Cross-country comparison of wage rates

New growth, New markets, New cash requirements

Unlike the west, India and China are still growing by over 5% of GDP and every year. You all must have heard the often hyped story of India and China, but the reality is their growth has real implications even if some of the hype is not true. The global recession is not going to change a lot of that. In the short term there might be a slowdown in growth, but the previous growth has set off real growth in India supported from domestic market. This would act as a cushion and be the base for the future growth. So, if you look past the next 2-4 years, the Indian market looks very attractive and for world markets as a whole, the following sectors look to be impacted the most.

  1. Commodities: As villages like Esanai step into modern amenities, their energy consumption will go through the roof. We need a lot more oil and electricity to satisfy the demand. India’s per-capita food grain consumption is one-fifth of US, and if it starts eating better then 2008 food grain shortage might get back. USO and DBA could get big.
  2. Capital: Right now countries like China and India have a surplus in capital because the majority of their citizens don’t have access to formal credit markets. As villages grow and people want to expand their economic signature, there might be a dramatic need for capital. Assuming that a per-capita capital requirement to expand, educate and establish is about $1000/year, India and China can suck up $3 trillion every year. It might not be far off from the point they could consume all their reserves (for China it is around $1500/per capita) and start requiring capital from world markets. That would be a good thing for millions of retirees looking for high yield savings.
  3. Technology: Indians and Chinese might be skipping the computer revolution and directly going to the mobile revolution. India is estimated to grow to 750 million mobile phones in next 2 years and already ranks as the highest in world mobile minutes usage. As they mature up into more powerful handsets it would be big for tech companies. Google (NASDAQ:GOOG) is already making use of the growth by various initiatvies like mobile search, Google bus, etc.

The Future

I see a future for the world economy where the relationship between commodities and human labor has completely reversed. The last few decades we moved in a fashion that made labor wages grow faster than commodity prices. In the developed world, workers with minimum wage ($7.25/your) could buy 8700 gallons of gasoline with a yearly salary and drive 261,000 miles in an average rated car. The price of food-grains to household income also reached among the lowest in human history, a couple of years ago. However, these will change and the events in 2008 summer was just a sampler. In the long term, the effect of entry of villages like Esanai to the global scene will put downward pressure on services and upward pressure on commodities, and commodity prices to wage rates will grow significantly more than the levels in summer 2008. This will cause a significant realignment in the current global economy where the developed world is moving mostly to services and the developing world into manufacturing. The pains of adjustment will be hard, but in the long term will help improve the strength of the global fabric.

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