Posting record growth, India seems poised to become a major player in the world economy. Although progress has been spectacular, reforms and the opening up process have remained far from complete and the country will still have to meet many challenges to hold the new course. The Country @rating of Indian-companies has been stable at A4 since 2000, reflecting not only consistent economic performance but also the slow pace of reforms and structural change as well as the relative frequency of late payments.

India's economic growth in 2003-04 will probably be about 7%, after disappointing 4.3% GDP growth in 2002-03. With that dynamism (enviable for many European economies) offset by population growth of almost 2% a year, however, GDP per capita has only been increasing by 2% to 3% a year since 2000.

With the farm sector employing nearly 65% of the labour force, fluctuations in rural household incomes have weighed heavily on the economy. The monsoon rainy period extending from May to September has played a crucial role. While that period was poor in 2002-03 – which largely explains the disappointing performance that year — it was excellent in 2003-04 thus contributing to India's current remarkable performance.

Recent trends nonetheless appear to reflect the growing importance of other economic sectors. The services sector is becoming one of the country's strengths and shaping up as the economy's engine. Growing at a 7% annual rate, it now represents half of GDP. Located in large urban areas, IT services and call centres have been attracting skilled labour that constitutes a growing pool of discerning consumers. The Indian consumer's profile has thus been evolving imperceptibly: an urban population with more comfortable incomes is becoming the main driver of consumption growth. That phenomenon of an increasingly urbanized consumer has resulted in an explosion of mobile telephone and mortgage loan sales.

At this juncture, however, farm-production uncertainties still weigh heavily on growth and constitute a handicap in combating poverty and emerging from underdevelopment. Living standards have remained significantly lower in India than in other emerging countries with per capita income of $548 against $963 for China and $822 for Sri Lanka. Moreover, although growth may be high, income distribution has remained very inegalitarian. While the country's southern and western regions have been benefiting from the good times, the rest of the country has, in many respects, continued to stagnate.

>> INDIA HAS BEEN OPENING UP SLOWLY BUT SURELY

Marked by the development strategy formulated by Ghandi based on self-sufficiency (the famous 'swadeshi' policy), India has only been opening up progressively and pursuing an export strategy of specialisation in high technology services. Indian companies have been exploiting the country's two distinctive comparative advantages: a highly qualified labour force (combining solid IT or high technology training with English fluency) and very low-cost labour.

The country has consequently been benefiting from a growing movement toward delocalisation by IT service and engineering companies, primarily from the United States. The installation of Microsoft, IBM, and virtually every other major American IT company has spurred the creation of many local subcontractors. With India thus reportedly garnering 80% of the offshore IT industry, software and IT service exports have been growing 30% a year, increasing from 4% of total exports in 1997-98 to 20% in 2002-03. Although the sector's GDP contribution is still modest (its sales abroad represent only 2% of GDP), it has been growing at a dizzying pace.

Sales of IT services and high technology reached $9.5 billion, a 200% increase compared to 94-95. Such growth will be unsustainable in the medium-term. The delocalisation process will certainly continue but at a slower pace. That spectacular development has nonetheless begun to produce a bandwagon effect on other sectors where extremely skilled, low-cost labour is available.

The country has been benefiting, for example, from the ongoing delocalisation of call centres of English-language companies like British Telecom or the Aviva and Prudential insurance companies. Another example is the pharmaceuticals sector where many specialists work in research and development at costs far below those encountered in Western countries.

The 'cruising' speed of foreign direct investment inflows seems to be increasing again and they should reach $4 billion 2003-04, up a billion from the previous year. That level of investment nonetheless remains low compared to more open Asian economies. Singapore, for example, with only 0.004% of India's population, attracts $9 billion a year. Moreover, all comparisons show the extent to which the process of opening the Indian economy has to be put into perspective with its foreign trade representing only 1% of world trade, a performance hardly worthy of that demographic giant. Moreover, although the country may have progressively reduced customs duties, the total of its tariff and non-tariff barriers still represent 25% of imports against an average of 12.5% across Asia.

>> RISKS THAT COULD STALL PROGRESS

The regional political situation and the historically stormy relations with Pakistan pivot on the Kashmir question, a majority Muslim Indian state. Pakistan views Kashmir's connection to India as despoliation. India, meanwhile, considers that territory its rightful property. That fundamental divergence on the nature of the dispute has been impeding attempts to settle the conflict. Nonetheless, since the peace initiative launched by the Indian Prime Minister, Atal Behari Vajpayee, relations have tended to improve with the two countries agreeing to begin peace negotiations in 2004 including the thorny Kashmir question.

The other source of concern involves India's financial situation with the government struggling to reduce colossal public sector debt that has represented over 9% of GDP for several years. The causes are mainly structural with revenues collected representing 9% of GDP against 14% in most large Asian countries. Moreover, the financial situation of Indian states has deteriorated. Their deficit has doubled in ten years due to a very decentralised tax system, conducive to laxity. The accumulation of deficits has led to a bloating of public sector debt that now represents nearly 85% of GDP. Regarding external debt ratios, India's situation has been satisfactory, due notably to the growth of exports and the level reached by foreign exchange reserves (over $100 billion this year), which attests to a comfortable currency liquidity situation.

In the domestic political arena, although the prospect of legislative elections in 2004 does not augur well for rapid improvement in India's public sector finances, it is clear that to hold its current course the country will not be able to postpone fiscal discipline much longer. Nonetheless, the evolution of relations with Pakistan (will there be confirmation of the rapprochement or not?) will have a decisive effect of India's room for manoeuvre in continuing its prudent integration into the world economy.

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