India: Trying to find its position and ascertain its role in the new global order.

India is an emerging market and its economy and society are currently undergoing a transition
from near autarky to a free market economy. The process of reform was triggered by a balance of
payment crisis in 1991. Subsequently, Indian government established a dual exchange rate system
to allow partial convertibility of the Indian rupee that exists still today. Officially, the Indian
rupee has a market determined exchange rate. However, the central bank trades actively in the
USD/INR. Hence, the currency regime can be at best described as a de facto crawling peg to
USD. In 1999 India reduced capital controls allowing Foreign Institutional Investors full account
convertibility (subject to certain quantitative restrictions prescribed by the Central Bank) and
liberalized norms for external commercial borrowing by the private sector but households are still
not allowed to diversify their savings (earned inside India). However, owing to an enormous
expansion of the current account and the capital account, India is increasingly moving towards
full convertibility. India probably has a more transparent and open framework for supporting
financial and exchange policies than China, but it has to address first its fiscal deficits concerns
before it can seriously think to attain full account convertibility.
India's domestic saving rate has been rising, driven mostly by higher corporate savings
and improved fiscal position of governments, but household, the largest surplus sector, savings
rate has remained stagnant and rather it has shown a relative preference towards physical asset, a
likely result of higher inflation. The central government has voluntarily agreed to phase out the
automatic monetization and steadily increased its reliance on domestic market borrowing from
21.3% in 1990-91 to 99.3% in 2008-09. This transformation might be a driving factor for
government to reign inflation and bring its fiscal deficit to a more sustainable level.
The cost of capital in India, especially for private corporate sector, is quite high. Firstly,
Indian financial system has a huge government monopoly over financial intermediaries whose
investment mandate is quite restricted and the private financial intermediation is in its nascent
stage. Secondly the capital account controls has prevented foreign investors especially from
investing in small caps whose accessibility to external commercial borrowing and private
placement are limited. A loose fiscal policy and higher level of inflation has also kept the nominal
interest rate quite high which does not boost confidence in the economy.
India belongs to the BRIC group of emerging markets but unlike its counterparts that
have relied heavily on export for their growth, Indian economy has relied heavily on its domestic
consumption and its current account deficit has been widening. There are three significant
features to this recent solid growth. First, the structure of India’s economy proved resilient to the
crisis, because of low leverage and low reliance on external trade. Second India reduced its
taxation rates and introduced successfully indirect taxation that improved the fiscal position of the
government. And third the current ruling government had changed the course of government
expenditure by starting an enormous Keynesian style fiscal expansion. Although India’s
sovereign external market borrowing is negligible but private borrowing in the foreign capital
market have increased tremendously, hence any downturn in the external economy may not affect
the sovereign directly but it will surely impede the access to foreign capital for the private sector.
Absorption of capital into the Indian economy is limited by the bottlenecks present in
Indian frail infrastructure. A high capital influx in 2007 had resulted in overheating of economy
and inefficient allocation can lead to bubbles. Although India has avoided significant asset
bubbles, but it does not reflect the efficiency of the regulatory framework in place, which has
allowed several scandals, rather it reflects the control on lending that can be effectuated by the
huge nationalized banks that dominate more than 70% of Indian banking assets.
Indian manufacturing sector has never quite developed for export oriented purpose. The
most obvious reason lies in the high taxation (30-40%) and tariff structure, that although have
been reduced substantially are still not yet enough to be internationally competitive. But a more
onerous task that lies at hand is the deregulation of land and formal labor sector. The land and
labor reforms are highly politically divisive topic that lies within the legislative purview of state
governments, who neither have the political will power nor the motivation to pursue these
reforms. As long as the prospect of these reform appear bleak, Indian competitiveness will always
raise concerns in the mind of its investors.
India like China has a huge competitive advantage that relies heavily on its huge supply
of labor resource. A huge portion (~60-80%) of this labor force lies in the so called informal
sector that relies on various forms of subsistence living (agriculture, retail etc) for its survival.
But having missed the global manufacturing wave in 80’s and 90’s to its East Asian neighbors,
India experimented with an rather indigenous initiative –The Software and Technology Parks of
India- that was modeled along the lines of Special Economic Zones but instead focussed
exclusively on services. This initiative was hugely successful and continues to be the engine of
growth and employment, although the benefits of this initiative have been largely limited to the
formal sector of the labor force.
The Indian demographics hold both promises and challenges for the economy. India has a
high fertility rate and its working population (15-65yrs) is slated to grow for another 30-40 years
before the graying of population sets in. A growing population has a positive impact on economy
through increase in savings and given the limited scope of social benefits currently available in
India the fiscal consequences on the sovereign appears limited. But, at the same time, it puts into
question the availability of resources and the quality of the population that can be sustained
within this limited means. India also has the world’s second largest arable lands, but the small
size of land holding and delay in land reform have not helped India to realize its potentials.
Corruption in India is prevalent and so is the government. Corruption has been the result
of inefficiency ensuing from an extensive government involvement that it is incapable to regulate
and unwilling to get away from. The Indian economy is described as a mixed economy with both
state planning and a vibrant market economy. Since reform many market-oriented changes have
prevailed but still the corrupt bureaucracy and the lethargic pace of judiciary process have been
its biggest detractors. The constitution of India bestows wide fiscal and constitutional powers to
the central government and the balance of power has always been skewed in its favor. But the
size of Indian democracy generally does not allow any single party to dominate the Indian
national politics so the national parties nowadays depend on a huge coalition, that ranges between
5-15, of regional parties to form stable governments-a source of constant political passivity and
limits the mandate of government actions. This renewal of regional power politics is concurrently
having an adverse effect on national integration and affecting the social harmony that exists
among castes, religions and regions.
India lies at one of the most geo politically volatile regions of the world where terrorism
and internal threat of secession have plagued it since independence. Indian foreign policy has
been usually described as a reactionary rather than an affirmative statement in diplomacy. India
has inherited from its colonial masters their legal, educational and bureaucratic framework but the
most important of all -their language English- the most formidable connection that exists between
India and the Anglo Saxon world. India is a developing country and has led the group of
developing countries to resist the Doha round of WTO talks in the past. But the current Indian
government has shown a remarkable shift in policy by changing its prior stance and renewing its
engagement with WTO and has since been negotiating aggressively Free Trade Agreements with
EU, Japan and ASEAN countries. India has significantly improved its relations with the US. Over
the years the Indian Diaspora in US has been instrumental in fostering the goodwill between the
two countries that has only been recently appreciated after the Indo-US relations have improved.
From an economic and foreign policy perspective for India any disturbance in Middle East will
become its Achilles heel, partly because of India’s high reliance on their oil and partly from the
large Indian community employed there whose remittance forms a substantial portion of India’s
capital account. China is India’s biggest neighbor and competitor. Although currently this
relationship is in cold but as both these nations develop this will be one of the key relations that
will define the New World order to come. India, since reforms first started, has remarkably
integrated itself with the rest of the world through both capital and labor movement and the way
forward lies further in its capacity to adapt and evolve in the new global order.

INDIA IN 2009

Nominal GDP: 1,384.7 Billion USD

GDP Real Growth Rate: 8.5 %
Change in Domestic Demand: 11.5%
Fiscal Deficit: 129.36 Billion USD / 9.3 % of GDP
Current Account Deficit: 38.41 Billion USD/ 2.7% of GDP
Trade Deficit: 117.32 Billion USD
Services Surplus: 78.9 Billion USD
Capital Account Surplus: 51.85 Billion USD
FDI: 17.95 Billion USD
Excess Official Reserve Created: 13.44 Billion USD
Total Public Liabilities: 1,002.12 Billion USD / 72% of GDP
Internal Public Liabilities: 971 Billion USD
External Public Liabilities: 30.6 Billion USD
Total External Liabilities: 261.72 Billion USD
Official Reserve: 283 Billion USD
WPI Inflation: 8.5 %
REER (1993-94 = 100): 94.12
Total Banking Asset: 1,164 Billion USD/ 84% of GDP
Bank Reserve % of total Asset: 6.01 %
Deposit as % of Total Asset: 78%
Advances/loans as % of Total asset: 57%
Real Estate Loans: 150-175 Billion USD
Reserves to Total Risk Adjusted Asset: 13.4%
Tax Revenue as % of GDP: 17.5%
Major Trading Partners EU, Middle East, US
Major Goods Exports Textile, Generic Drugs, Agricultural Pdts
Major Imports Oil, Capital Goods, Organic Chemicals
Population ~1.2 Billion
Population Growth Rate 1.58%
Working Population ~ 400 million (57.8%)
Literacy Rate ~70% (2008)
Gini Index 0.39
Source: http://dbie.rbi.org.in/ Data has been calculated at current exchange rate

Author: Debashis Senapati