by Rakesh Mohan
Prospects and Challenges
Assume that India’s economy grows at just 6 per cent a year on average over the next two-and-a-half decades, while the rest of the world grows at 3 per cent. Then India’s share of world GDP, at purchasing power-parity, would rise from around 7 per cent today (according to the International Monetary Fund) to 15 per cent, not far short of where China is currently. It would then be a big power by any standards, even if still a relatively poor country. It is easy to imagine that India could do relatively better than this. Moreover, if India’s trade rose at least in line with GDP, then its share in world commerce might also more than double. Again, the rise could be far bigger than that. Such outperformance, relative to the rest of the world, is not merely likely, but also highly desirable. This is the only way India could hope to eliminate the mass destitution that, despite recent successes, still plagues the country.
It follows that the overriding interest of the country is to pursue policies that allow it to exploit the opportunities for greater trade, capital inflows and access to know-how that the world economy affords. No less must India pursue policies aimed at expanding those opportunities. As a huge country, it is not just an importer of the world order, but inevitably a creator of that order as well. Particularly at a time when the advanced countries of the West are increasingly doubtful of their historic role in the global economy, the rising giants of Asia—China first and foremost, but also increasingly India—will have to play an increasingly systemic role. The old days of resistance to demands made on India will no longer be sufficient. India will have to accept an increasingly hegemonic role, even if alongside other big powers.
1. Role in World Trade
As India’s trade grows, it is likely to shift the global terms of trade against itself, at least to some extent. That is not an argument against trade. It is merely a recognition that size matters: as the country grows, the marginal returns on trade are likely to fall. But that also means India needs to do what it can to open world markets, while, again as desirable, it opens its own. Indeed, the growing relative size of India’s market is going to give it growing clout in international trade negotiations.
An important strategic question for India is whether it should seek to strengthen the western-created liberal trading order or to create something different. I would argue strongly for the former option. Indeed, if anything, India should seek to strengthen the multilateral system of the WTO against the growing tendency towards regional arrangements. This is not to preclude participation in the latter, particularly if that affords the opportunity for behind-the-border integration that could benefit a country with an expanding role in the global creation of intellectual property and the development of new multinational companies. Nevertheless, India must look towards the world as a whole for three mutually reinforcing reasons: first, its immediate region is not big enough to provide substantial opportunities; second, any region that might afford huge opportunities (Asia, Europe or the Americas) contains at least one, if not more, economic power sure to remain bigger than it would itself be for the next quarter of a century or so; and, finally, its trading interests are, because of its sheer size, bound to be global. If a country must operate globally and must, even if it operates regionally, deal with powers greater than itself, then the global approach should be the cornerstone of its trade policies. The global approach is the broadest and the one that gives the closest thing to an international rule of law in trade matters. At the global level, India should also always be able to find allies, even though it may also find negotiating partners as obstructive as it can sometimes be itself.
The implication of this is that India should, if at all possible, play a constructive role in the WTO, including in further global negotiations. In truth, the obstacles to successful completion of mega-regional negotiations are not much smaller than those to global ones. But, as a matter of realism, it also makes sense to seek participation in regional negotiations that are likely to set the terms of international rules in important areas. Should the TPP be ratified, now very unlikely, India should seek to join. Yet, India does not need to wait for further global negotiations to liberalize. In many areas, it is still in India’s interests to liberalize its own barriers to trade, along with relevant domestic obstacles to the exploitation of opportunities to trade. In particular, as China’s comparative advantage in labor-intensive manufacturing diminishes, an opportunity has re-opened for India. It should try hard to seize it.
In short, India should pursue trading opportunities through a judicious combination of unilateral and reciprocal liberalization, with the latter being pursued by both multilateral and plurilateral means. Throughout, India must also recognize its interest in maintaining and indeed strengthening the liberal trading order and its potential role in achieving this outcome. It must understand, too, that its interests are now increasingly broad, as its role as an exporter of complex services, as a developer and user of intellectual property, and as the home of important multinational companies grows. Particularly important for India is the freedom of movement of Indian people, which is needed to support its dynamic exports of services. Indeed, India has a particularly strong interest in liberalizing trade in services, more broadly. But to achieve this, it will also need to increase access to its own market for services.
2. Role in Global Capital Flows
As with trade, India is almost certain to become a more important recipient and source of capital over the next quarter of a century. It will also, for the same reason, become a more important player in creating and implementing the rules governing the global monetary and financial systems. And again, just as with trade, India needs to find a way to balance its own interests with reform of the global systems.
So far as India’s own liberalization is concerned, further progress on current lines should be the aim. Flows of FDI and equity capital should be free, in both directions, subject to natural concerns about national security, domestic competition and areas of high political sensitivity. Investment in retail has been such a sensitive area. In truth, both domestic and foreign investment in large-scale retail outlets creates the same issues for the competitiveness of India’s small retailers.
Yet, despite a general orientation towards liberalizing capital flows and the domestic financial system, policymakers must also be aware of risks. It is essential, for example, to ensure the soundness of the domestic financial system. One way to do so is to pursue the idea of ring-fencing retail from investment banking, as proposed by the Independent Commission on Banking in the UK.34 More broadly, India should adopt and possibly go beyond the Basel agenda for stability. Areas of particular attention should be capital and liquidity requirements, which should be raised above global minima.35 The soundness of Indian finance will also become significant for the world, since it is almost inevitable that at least a few Indian financial institutions will become global players. Similarly, foreign financial players will seek a sizeable presence in India’s growing markets. This will give India substantial influence on global rules. It should prepare itself now on how to use it.
Equally important, policymakers must pay attention to risks of destabilizing capital flows. As they already know, the main risks are created by short-term debt, particularly if denominated in foreign currency and intermediated via the banking system. These issues will not go away. Yet, as time passes, the Indian economy is likely to begin to have the weight needed for the rupee to become a reserve currency. This would change the nature of the risks to domestic financial stability, but not their salience.
If India does want the rupee to become a significant reserve currency, it would also have to consider eliminating all exchange controls. On balance, this choice should be avoided for as long as possible: the gains would be small against the risks. John Maynard Keynes famously wrote ‘let finance be primarily national’ in 1933, at the depth of the Great Depression.36 India should not go that far. But it should be consistently aware of the persistence
of the dangers against which Keynes then warned the world—those of irresponsible and short-sighted international finance. The events of the last decade have not diminished the relevance of these concerns: on the contrary, they have reminded us brutally of their continued importance. It is now widely recognized that emerging and developing countries could do better with continued exchange controls—notwithstanding the difficulties they create—than with hasty and incautious liberalization.
3. Role in the Global Monetary System
Financial reform and liberalization are closely related to the operation of the global financial system. Imbalances in current and capital accounts, large-scale currency intervention, irresponsible financial deregulation and desperate monetary-policy experiments have combined to create enormous risks of financial instability. Part of the answer is strengthening the global financial system. But the other part is strengthening the international monetary system.
Ideally, two things need to be achieved. The first is more powerful disciplines over countries that run chronic current-account surpluses. These are deflationary for the rest of the world economy. That, in turn, tends to lead to destabilizing monetary policies and financial crises in net-capital-importing countries. This then causes huge financial crises, as we saw across much of the western world in 2007–08 and then, more narrowly, within the Eurozone in 2009–12. Ideally, penalties should be imposed on chronic surplus countries, particularly on those that intervene massively in currency markets to keep their exchange rates down. As a deficit country, it would be in India’s interests to promote such a discussion, even though a successful outcome is depressingly unlikely, given the long history of unproductive debates on this topic. These go back to the interwar period and the Bretton Woods conference of 1944 that led to the creation of the International Monetary Fund.37
The second concern is international liquidity. At present, the main source of emergency liquidity for emerging and developing countries is their own foreign-currency reserves. But building such reserves creates important difficulties: it gives emerging countries a strong incentive to accumulate reserves by intervening heavily in foreign-currency markets and running current-account surpluses; it provides countries that issue reserve currencies with seigniorage and, more important, an incentive to run irresponsible fiscal, monetary and financial policies; and it may still provide crisis-hit countries with inadequate liquidity in a crisis. Instead of self-insurance, it would be far better if there were more collective insurance. The IMF’s own resources are at present far too small to play such a role, particularly in a world of largely liberalized capital accounts. The Fund’s total resources amounted to roughly $1.3 trillion in October 2016.38 Meanwhile, total global foreign-currency reserves amounted to $11 trillion in July of the same year. Moreover, nearly all of the Fund’s resources involve conditionality, which imposes delay, quite apart from perceived humiliation. Another important source of temporary liquidity has been swap lines among significant central banks. But these swaps come at the discretion of those central banks and also are unavailable to most emerging economies. The best solution would be to allow the IMF to create large increases in so-called Special Drawing Rights (SDRs) in emergencies.39 India should argue for an amendment of the Fund’s articles to make this possible. As its role in this and other organizations increases, it could be a powerful voice for such reform.
The other issue with the systems of international reserves is the continued dependence on national currencies. China’s determination to make the renminbi a reserve currency suggests that this will continue, but possibly even exacerbate instability. Certainly, a multiple-reserve currency could be even more unstable than one with a single dominant currency. The ideal answer would be to allow the IMF to create more reserves via the SDR. At present only about 4 per cent of total global reserves consist of SDRs. India, as a powerful and rising non-reserve-currency country could be an important voice for such a reform. To achieve this, it would need to change the current voting weights and super-majority voting requirements in the Fund.40 This is a worthwhile objective. But experience with recent attempt to change voting weights—particularly the huge difficulties in getting this ratified in Congress—shows that this is likely to be a an uphill fight.41
4. Role in Labour Flows
Remittances have become an important part of India’s balance of payments, growing from a mere $2.1 billion in 1990 to $66 billion in 2013.42 But, beyond this, India’s diaspora is a potent source of economic connections, know-how and international influence. This gives India a considerable interest in the immigration policies of western countries and those in the Persian Gulf. At the same time, India’s own economic development could be accelerated by the skills of foreigners. It should be extremely open to immigration of highly skilled foreigners. This would also make it easier to argue for such openness in foreign countries. Beyond this, there is a strong case for rules governing the treatment of migrants, both skilled and unskilled. As a source of both and a potentially important recipient, India should promote such a dialogue.
5. Other Challenges
These are far from the only global challenges confronting a rising India in the global economy. Perhaps the most important additional issue is climate change. That is far more than merely an economic issue. However, tackling climate change evidently involves both economic costs and consequences. As a poor country with relatively low emissions of greenhouse gases per head, India could reasonably feel it has no moral obligation to tackle a problem others have created. At the same time, Indians share the planet with everybody else. Moreover, as a large and rapidly growing country, India’s policy choices—not to mention the path of its emissions—will be of great importance. Finally, new energy technologies, notably solar power, provide important opportunities for India. For all these reasons, India will be compelled, willy-nilly, to play a big part in tackling the global challenge of climate change.
Conclusion
Some are born great; some achieve greatness and some have greatness thrust upon them. In the global economy, India is achieving greatness by virtue of its increased openness and relatively rapid growth and, as a result, has the demands of greatness thrust upon it. While far behind China, its weight in the world has substantially increased and will increase further. At the same time, its increased openness has created new opportunities and improved performance. The great gamble on openness and reform, from more than twenty-five years ago, has paid off. It has led to a new policy consensus and improved performance. Nevertheless, these are still very early days. India has a long way to go in further opening and, above all, domestic reform. It will also have a big and growing role to play in the global system as a whole.
India must decide its interests and priorities. It seems clear that as a dynamic, increasingly open, market-oriented democracy, its interest lies in promoting a peaceful world that possesses an equitable, rules-governed global order, based on liberal principles. If India gives its growing strength to this cause, it will be doing well by doing good. But first, it must accept that it will need to become a leader, not just a beneficiary of what is today an increasingly enfeebled global system. Can India rise to this challenge? The next quarter of a century will provide the answer.
6
Trade-policy Reform in India Since 1991
Harsha Vardhana Singh1
An important part of the Indian experience with trade-policy reform since 1991 is that these changes were managed without major disruptive consequences despite the fact that India’s average tariffs are close to the world’s lowest tariff economies.
Introduction
In his 1991 Budget speech introducing a vast range of Indian economic reforms, Dr Manmohan Singh said:
As we enter the last decade of the 20th century, India stands at the crossroads. The decisions we take and do not take, at this juncture, will determine the shape of things to come for quite some time … But India’s future development depends crucially on how well th
e planning process is adapted to the needs of a fast changing situation.
For trade policy, these words ring as true today as they did twenty-five years ago, even though India has covered a long distance in the direction set out in 1991. India is once again at a crossroads, with global market conditions changing rapidly in a world where even the notion of international trade and trade policy is not what it was a couple of decades ago. Thus, trade-policy reform must be based on an evolving framework, which needs to be renewed and focused upon in the context of the times, bearing in mind both the conventional and new areas of trade policy.
An important part of the Indian experience with trade-policy reform since 1991 is that these changes were managed without major disruptive consequences. The economy has been on a strong growth trend, though from time to time, there are concerns about its weaknesses, with even a revision of the direction of trade policy in certain sectors, such as electronics.