India Transformed

by Rakesh Mohan

  1.   Trade

  By 2014, India’s share in world merchandise exports had risen to 1.7 per cent of the global total, just over four times its share in the 1970s and nearly as high as in 1948.7 India’s share in world exports of commercial services was higher than its share in world merchandise exports, at 3.2 per cent. This marked a decisive turnaround. Yet, the global significance of India as a trading power must be kept in context. Including internal trade within the EU, India ranked only nineteenth in world exports of manufactures in 2014. Excluding EU-internal trade, it ranked thirteenth. India had become substantially more significant in global exports of commercial services, however, at eight overall and fifth after excluding intra-EU trade. Noteworthy components of these exports of services have been information technology and business-process outsourcing; net exports in these sectors rose from negligible levels in 1990 to 25 per cent of India’s total exports in 2012.8

  To put this performance in context, China’s share in world merchandise exports reached 12.3 per cent in 2014. By then, the East Asian giant was the world’s largest merchandise exporter, whether or not internal EU trade was excluded. China was a more significant exporter of commercial services than India, ranking fifth if intra-EU trade were included and third if it were excluded. Evidently, India’s impact on world trade has remained far smaller than that of China.

  The opening of the Indian economy, measured in terms of the ratios of trade to output, is, however, noteworthy. In 1990, the ratio of exports to GDP was 7 per cent. By 2014, it had reached 25 per cent, before falling to 21 per cent in 2015. Meanwhile, China’s exports reached an astonishingly high level of 36 per cent of GDP in 2006. But this had fallen back to 22 per cent in 2015, much the same ratio as India’s (see Chart 1). Big countries tend to have less trade relative to GDP than smaller ones. But India and China both have more trade relative to GDP than would be expected, given the two countries’ sizes.9

  Chart 1: Exports of Goods and Services over Gross Domestic Product (Per Cent)

  While India’s exports now account for much the same share of world exports as at the time of Independence, the ratio of its exports to GDP is now much higher than ever before. This is largely the product of the global opening to trade since the late-1940s. Ratios of trade to GDP have risen almost universally, as a result of the post-war trade liberalization of the high-income countries and the subsequent liberalization of most of the world’s economies in ‘the era of globalization’, from the late-1970s. In 1950, India’s ratio of exports of goods and services to GDP was only 8.4 per cent, little higher than in 1990.10 Between 1950 and 1990, therefore, India’s exports grew roughly in line with GDP. Since then, however, exports have grown far faster than GDP, which was itself growing substantially faster than world GDP, though not as much so as China’s. The fact that the cumulative growth of the Chinese economy was far faster than that of India explains why China’s role in world trade is far bigger than India’s, even though the Indian economy is now roughly as open to trade as China’s.

  2.   Capital and the Balance of Payments

  The opening of trade is not the only transformation. Also important has been the increase in foreign direct investment (FDI) and portfolio equity, in both directions. In some ways, this indicates a more profound change in attitude than the opening of trade, given the hold of ‘East India Company syndrome’—the tendency to view all inward investors as Trojan horses—upon the minds of politicians and policymakers.11 Yet, while these anxieties have not altogether disappeared, they have diminished, partly no doubt because of India’s own outward investments, such as Tata’s acquisitions of Corus and Jaguar Land Rover in the UK.12 As India spawns its own multinational companies, it becomes increasingly difficult, both intellectually and politically, to spurn inward investors.

  India’s stock of inward FDI jumped from a mere 1.5 per cent of GDP in 1995 to 14 per cent of GDP in 2015. The stock of outward investment rose from negligible levels to 7 per cent of GDP over the same period. Relative to GDP, India’s inward and outward stocks of FDI in India are now as large as those of China (see Chart 2). Yet, once again, the difference in the growth of the two economies means that China’s FDI is far more significant globally, in both directions (see Chart 3). In 2015, for example, India’s outward FDI was just 0.6 per cent of the global stock, while China’s had reached 4.0 per cent of the total. Similarly, India accounted for just 1.1 per cent of the global inward stock, while China already accounted for 4.9 per cent. Both countries are substantially more important as destinations for greenfield investment than they are as recipients of FDI overall: India even received a slightly larger share of global announced inward greenfield investment in 2015 than China, though it was far less important than China as a source (see Chart 4). Meanwhile, though India became a far more important source and recipient of FDI, it has become almost entirely independent of the foreign aid that had mattered so much during the 1960s and 1970s.

  Chart 2: Stock of Foreign Direct Investment (as a Per Cent of GDP)

  Source: World Investment Report.

  Chart 3: Stock of Foreign Direct Investment (as a Per Cent of world FDI)

  Source: World Investment Report.

  Chart 4: Value of Announced Greenfield Projects

  (as Share of World Greenfield Investment)

  Source: World Investment Report.

  India has run a current-account deficit almost consistently (see Chart 5). Thus, unlike mercantilist China, India has been a net importer of capital in recent decades. This is modestly helpful for macroeconomic balance in the world economy: fast-growing emerging economies should be net importers of capital from slower-growing high-income ones. India has also been able to accumulate foreign-exchange reserves—even though it has a floating exchange rate—through modest amounts of currency intervention. Its reserves reached $367 billion in August 2016, nearly an order of magnitude smaller than China’s, but a source of security, all the same.13 Thus, the old days of carefully rationed foreign exchange and tight controls on imports have been replaced by a current account that operates largely in accordance with market principles. A brief period of turmoil in 2013 was managed easily enough: the days of currency crises finally seem to be over.14

  3.   Labour

  India is not a significant importer of labor. But it has become an important exporter. There have been substantial outflows of unskilled and semi-skilled temporary workers to Saudi Arabia, the United Arab Emirates and Oman. There have also been very large outflows of skilled labor, particularly to the US. ‘The Indian-born population in the U.S. grew from around 12,000 in 1960 to 51,000 in 1970. It then climbed to 206,000 in 1980, 450,000 in 1990, 1 million in 2000 and 3.2 million in 2010.’15

  Chart 5: Current-account Balance over GDP (Per Cent)

  4.   Conclusion

  India has a much bigger presence in the world economy than it did a quarter of a century ago. But it is not yet in the category of the great global economic powers. In 2016, India’s nominal GDP should be the world’s seventh largest, between those of France and Italy, though it should be third when measured at purchasing-power parity.16 In 2015, India’s merchandise exports totalled $267 billion, against China’s exports of $2275 billion, EU external exports of $1985 billion and US exports of $1505 billion. Even in commercial services, India’s exports were only $155 billion, against EU external exports of $915 billion, US exports of $690 billion and Chinese exports of $285 billion.17 Again, in 2015, the stock of India’s inward FDI was $282 billion, against China’s $1221 billion and the world’s $24,983 billion. The stock of India’s outward FDI in the same year was only $139 billion, against China’s $1010 billion. India is still a second-tier player in the world economy, but one with the potential to become far more than that over the next quarter of a century. It is rising, but has not yet risen.

  Evolution of Policy

  India, it is clear, has a far more open economy than it did about a quarter of a century ago. What policies did it a
dopt to bring about this outcome and how much room for further liberalization does India have?

  1.   Trade Policy

  India’s tariffs were nigh-on prohibitive before 1991. A wall of complex non-tariff barriers reinforced these barriers. As a result, imports were a mere 8 per cent of GDP in 1990. Arvind Subramaniam, chief economic adviser to the Indian government, summarizes the situation as follows: ‘Tariffs were stratospherically high – in absolute terms and relative to the rest of the world – prior to 1991 but have declined dramatically. They are close to 10 per cent today and have almost converged with tariffs in the rest of the world.’18 Yet, while non-tariff barriers have been liberalized, they remain extremely high. Mr Subramanian notes that ‘first, India’s overall barriers in services … are among the highest in the world (surpassed only by Zimbabwe)’ and are four to five times higher than in members of the Organization for Economic Co-operation and Development; and ‘second, they are also very high for India’s level of development’.19 Measurement of non-tariff barriers is always difficult. But the plausible conclusion is that India’s manufacturing is relatively lightly protected, while the services sector is highly protected. According to Mr Subramanian, this treatment of services results ‘in an overall trade regime that is quite protectionist’.20

  This picture for trade policy creates what Mr Subramanian describes as a ‘paradox’. While India’s trade regime is quite restrictive, particularly in services, ratios of imports and exports to GDP are both high for such a big country. This suggests that the barriers are not as restrictive as one might expect.

  Nevertheless, room for substantial further liberalization certainly exists. This is true even for tariffs. One opportunity, for example, is to lower bound tariffs towards those actually applied. According to the European Commission, ‘India has generally bound its tariffs at levels of 25 to 40 per cent’.21 This is a substantial multiple of the average applied tariff. That gives the Indian government the ability to raise tariffs substantially, without any need to compensate trading partners. But it also makes continuation of the low-tariff regime relatively uncertain. The explanation for this circumspection is traditionally Indian—the desire to maintain as much policy space as possible alongside residual suspicion of the outside world.

  Indeed, India has played a consistently defensive role in global trade negotiations. In the 1970s, it was one of chief protagonists of the principle of ‘special and differential treatment’ of developing countries with the General Agreement on Tariffs and Trade (GATT), the precursor of the World Trade Organization (WTO). ‘Again, after the WTO came into being in 1994, it played a major role in preventing a broadening of the trade agenda to cover “behind the border issues” such as government procurement, competition and investment.’22 India, finally, played a significant role in preventing agreement in the Doha round of multilateral trade negotiations.23

  India has been no less circumspect in pursuing regional and preferential trade agreements. These have sprouted in recent decades, partly because of the difficulty of completing global agreements. Indeed, the Bali accord of 2013, which merely covered trade facilitation, was the first to be reached within the WTO since the turn of the millennium.24 The number of regional trade agreements notified to the GATT and then WTO and in force jumped from seventy in 1990 to 423 in 2016, with many more currently under negotiation.25 As of October 2016, the Department of Commerce of the Government of India lists nineteen preferential and regional trade agreements in which the country is ‘engaged’.26 Meanwhile, India played no role in the Trans-Pacific Partnership (TPP), which included Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the US and Vietnam, but, notably, not Chin). It is, however, a part of the Regional Comprehensive Economic Partnership (RCEP), which includes the members of the Association of Southeast Asian Nations (ASEAN) plus Australia, China, India, Japan, South Korea and New Zealand. The TPP had been signed under Barack Obama, but not ratified, which made it simple for Donald Trump to repudiate it upon taking office.27 The RCEP is not yet agreed upon. So far, the preferential agreements India has made have amounted to very little. This is unlikely to change without a fundamental alteration in India’s attitude towards trade negotiations, which is to consider it almost a matter of honour to concede as little as possible, if not less than that.

  2.   Policy towards Capital and the Balance of Payments

  The Indian government has slowly opened the capital account, but far from completely. The FDI policy regime has shifted from a positive to a negative list: what is not forbidden is permitted. Foreign investors can in principle invest in most sectors, with minimal government interference. Portfolio equity investment by foreign investors was liberalized quite early in the reform programme. Investment in government and corporate bonds has also been deregulated gradually.28 As the activities of India’s own multinational corporations abroad have become more noteworthy, so has the domestic resistance to inward FDI diminished.

  After the crisis of 1991, India devalued the rupee substantially and adopted a managed floating exchange rate, with full convertibility on current account.29 The Reserve Bank of India is, nevertheless, prepared to intervene in the market to limit short-term instability. With the adoption of a more formal system of inflation targeting in 2016, India’s management of monetary policy and the exchange rate has increasingly converged on the current norm in the advanced economies—a floating exchange rate, inflation targeting; a monetary policy committee; and operational independence for the central bank.30

  Yet, quite rightly, India, just like China, has been cautious about full liberalization of the capital account. In particular, debt inflows, especially inflows of short-term debt, have remained tightly curbed. Several instruments are used: quantitative limits, price-based measures and administrative measures. The aim has been to reduce the vulnerability of the balance of payments to instability. This has been successfully achieved, through both the Asian financial crisis of 1997–98 and the global financial crisis of 2007–09. It has been done by avoiding the build-up of volatile foreign debt, and by curbing the build-up of debt denominated in foreign currencies and so constraining currency mismatches, particularly in the banking sector.31 Similarly, restrictions on capital outflows have been lifted only partially and slowly. Given the immense costs of international financial crises, these cautious policies are fully justified for India.32 To buttress the caution on the capital account, India has adopted the Basel III rules on capital adequacy and leverage of banks. It also requires foreign banks to enter only as subsidiaries. All this, too, is very sensible. The world has, after all, had a potent recent reminder of the dangers caused by unstable banks.

  3.   Conclusion

  India’s economy has not only become more open, it has also become increasingly liberalized. This is hardly surprising: liberalization and openness go together just like a horse and carriage. Yet, while converging on the liberal policy regimes of the advanced economies, India has not gone the whole way. Its barriers to trade are higher than those of advanced economies and even many emerging economies. It remains cautious about committing itself to low barriers to trade. The advanced economies might, given current protectionist pressures, revert to India’s current levels of trade protection. But that still seems unlikely. India has also moved towards a vastly more liberal foreign-exchange regime, with a floating exchange rate. But it retains controls on capital outflows and inflows of debt-creating capital, particularly short-term debt, for prudential reasons. This caution has been vindicated by the country’s success in avoiding much of the impact of global financial crises, though India is inevitably affected by global economic slowdowns and financial shocks.

  Impact of India’s Opening Up

  In his important book on India’s reforms, Oxford University’s Vijay Joshi stresses that India’s external opening has been associated with and surely—at least in part—caused the acceleration of Indian growth. Between 1960 and 1991, the trend growth
of Indian GDP per head (at purchasing-power parity) was 3.2 per cent. This rose to 5.3 per cent between 1991 and 2016. China’s GDP per head grew faster still, at more than 7 per cent a year over the latter period. By 2016, China’s GDP per head was at least double that of India, despite having been much the same in the late 1970s (see Chart 6).

  Chart 6: GDP Per Head (at 2015 Purchasing-power Parity $s)

  Source: Conference Board.

  Yet, India did not fall behind China because it liberalized too much, but rather because it liberalized too late and too little. In particular, India largely failed to exploit the opportunities for accelerated expansion of exports of labor-intensive manufactures that were such an important feature of China’s—and, before China, other east Asian economies’—accelerated growth of manufacturing, of low-skill employment and of GDP. This failure substantially reduced the ‘inclusivity’ of Indian growth. But, Mr Joshi notes:

  … the reason for this outcome can be traced to domestic policies. In practice, a host of domestic policy impediments—small-scale industry reservations, rigid labor laws, infrastructure deficiencies, lack of access to credit, weak human capital policies, and discouragement of FDI in labor-intensive industries—have suppressed the demand for low-skilled labor. (In contrast, the demand for skilled labor has risen, and with it the wage premium for skills, which is one reason why income inequality increased over this period.) … India’s inclusion deficit has domestic roots and cannot be blamed on globalisation.33

  The abiding resistance to letting market forces create mass industrial employment is an enormous error for which ordinary Indians have paid a similarly enormous price in worsened opportunities.

  At the same time, despite the failure to achieve Chinese levels of performance, India’s actual and expected impact on the world has grown substantially. This not only has economic implications, but also political ones. India’s relationships with other countries are increasingly affected by the expanded weight of the country’s economic ties and the growing perception abroad that this gigantic country—soon to be the most populous country in the world—is set to play an ever-increasing global economic and political role. This gives India leverage. It also imposes responsibilities upon it. India’s GDP per head (at PPP) is still only about one-eighth of that of the US. Nevertheless, its vast size and economic potential give it substantial and rising global influence. I have described India as being, like China, a ‘premature superpower’: it is on the way to possessing the dimensions of a superpower without the level of development that was previously associated with that status. Balancing its development needs with that status will be one of India’s greatest challenges.