The recent slowdown in the Indian economy and stalled reform initiatives have raised concerns about India's economic prospects. Kaushik Basu, chief economic adviser at India’s Ministry of Finance, gave his perspectives on India's recent economic achievements and how it is positioned to deal with future risks. Carnegie's Vikram Nehru moderated.
India’s Economic History
- Historically Closed Economy: Although India was an open polity and society beginning in 1947, it remained economically closed to foreign investment, with an intrusive government. Trade tariffs and duties rose through 1991 and investment licensing regulations discouraged private domestic and foreign investment.
- 1991 Crisis: The First Gulf War led India’s foreign exchange reserves to dry up, putting India on the edge of default. As a result, the Indian government instituted reforms, but Basu explained that they remained extremely limited, as they targeted liberalization of only foreign exchange transactions and licensing.
- Foreign Exchange Reserves: In 1990/91, India had about $5 billion in reserves; by 2005 it had grown to $300 billion.
Post-2003 Growth and Improving Ties with the United States
- Changing Perceptions: Indian professionals and the Indian higher education system gave Americans a more positive impression of India, which contributed to the increasingly close economic ties between the two nations.
- American Outsourcing: U.S. television attacks on outsourcing ironically advertised the viability of outsourcing and led to a sharp rise in demand for IT-related exports, which helped the Indian economy and led to closer ties with the US.
- Savings and Investment: Around 2003, India moved from low to high savings and investment, Basu asserted. Today about 35 percent of national income is invested, powering growth.
Slowdown in 2011: Three Explanations
2011 saw India’s GDP growth fall from 8.4 percent to a projected 6.9 percent, and inflation rose from 7 percent to 9-10 percent. Basu offered several explanations for these worrying trends:
- Slowdown in Decision-Making: Basu argued that corruption scandals and finger-pointing led to risk-averse behavior among bureaucrats. This fear slowed reforms, he explained. Furthermore, a coalition government requires more time to make decisions.
- Battle against Inflation: Rapid growth has been accompanied by rising inflation, and there is an ongoing debate over what is causing it.
- Global Slowdown: Globalization affects India more today than it did before, Basu said. Imported or exported goods and services have increased dramatically as a portion of GDP since 1995, making India more vulnerable to global shocks.
Implications of the European Debt Crisis
- Like a Ponzi Scheme: Basu suggested that the European debt crisis is a form of Ponzi scheme. The European Central Bank (ECB) rescued banks by giving $1.3 trillion in three-year bonds (LTROs – long term refinancing operations), essentially allowing the Ponzi scheme to run for one more round till 2014. However, much of the money banks raised from LTROs was then immediately lent to sovereigns at an even higher rate. The sovereigns lack economic strength, due to their own high fiscal deficits and high debt to GDP ratios. These banks needed to be rescued, but that does not change the fact that these (LTRO) bonds provide only a short term solution since underlying problems, such as competitiveness and fiscal stability, remain unresolved, warned Basu.
- Reforms Needed: Unless major reforms are undertaken, this will create problems and potentially increase inflation, Basu warned. One such reform would be a fiscal compact for the EZ countries. The EZ is a large economic entity and has formed a monetary union, but its member nations have a great deal of fiscal autonomy. Ultimately, the monetary union made borrowing easier, but the EZ lacked the fiscal restrictions and rules to ensure sovereign borrowing remained within acceptable risk limits.
- Limits of Fiscal Deficits: But even if fiscal restrictions and rules are instituted, countries are likely to abuse these rules by claiming ‘one-off expenditures,’ Basu said. Furthermore, there are also problems of how to deal with state-owned enterprises within such a system of EZ-wide rules and restrictions.
Implications for India
- EU Implications: India is expected to have a slow revival of growth through 2014, but EU problems could affect this recovery, Basu warned.
- Potential Threats of Arbitrage: If there is a global crisis in 2014, efforts by the RBI to pump money in to the system could lower interest rates, although preventing inflation would likely force India to raise rates again. Even with capital flow controls, this disparity could lead to problems of arbitrage.
- How to Respond: India must fiscally consolidate and have funds for another fiscal stimulus if necessary, Basu asserted.
- Ongoing Domestic Reforms: India has numerous areas where reforms remain outstanding, incomplete or stalled: allowing 51 percent foreign ownership in multi-brand retail, reduction of oil and food subsidies, creation of a social security system, introduction of a GST (goods and services tax), and infrastructure development.