Saturday, March 13, 2010
Some lessons from the India puzzle
It is amazing that India with little FDI inflows, poor infrastructure and a smaller diaspora of professionals and semi-skilled personnel can grow at a lightning pace of eight to nine per cent.
In this context, it may seem that India has little to offer as it has not contributed to the global imbalances in the first place, unlike China and other East Asian export-dependent economies, which have been relentlessly garnering current account surpluses in their balance of payments.
India's growth is anything but export-led, as it had relied primarily on the prowess of its domestic market, with the services sector leading the way accounting for 55 per cent of gross domestic product (GDP) against manufacturing's 15 per cent share.
Still, the Indian model is of relevance to other Asian economies which are in search of a new model that would shift the source of growth from exports to domestic demand and from manufactures to services, the key ingredients behind India's success story. For the fragility of export dependence has been exposed by the crisis that has spread everywhere through the trade channel.
It is India -- not China -- that is truly amazing. China's emergence as the second largest economy in the world, fuelled by double-digit growth, is hardly surprising. That China could grow so fast is understandable, given the massive inflow of foreign direct investment (FDI), heavy investment in infrastructure, and a large commercial diaspora that brings in not only capital but also business experiences from abroad.
India pales in all these counts with very little FDI inflows, poor infrastructure, and a smaller diaspora of professionals and semi-skilled personnel. What's more, it is not easy for India to introduce radical reforms, as it has a noisy democracy and a coalition government composed of members with distinctly different agendas.
It is indeed remarkable that India could grow at a blazing pace of eight to nine per cent, in spite of the odds. Curiously, India's outward investment is far more impressive and sophisticated than China's, the single most important recipient of FDI flows.
Thus, India remains a puzzle that is hard to decipher. While there are lessons to learn from the Indian experience, India can hardly be a role model for others in the region, partly because its experience is unique, which does not allow it to be replicated elsewhere, and partly because it is riddled with serious internal imbalances of sorts that others would not want to emulate.
In any case, it is important to stress that the Indian model does not guarantee economic stability, as India itself was affected by the global economic crisis, with its GDP growing at a slower pace (five to six per cent) in the wake of the crisis due mainly to export contraction. It is not difficult to explain why big economies were able to weather the storm better than smaller ones, given the size of the domestic market, as was indeed the case with India, China and Indonesia.
The Indian story with respect to crisis management is quite similar to that of other affected countries in the region, especially in terms of monetary easing and fiscal stimulus.
India, which has been running budget deficits for decades, upped the ante by raising it to 10.2 per cent of GDP in response to the crisis. India's public debt has been surprisingly small relative to the size of the budget deficits year after year, currently hovering at around 76 per cent of GDP. This suggests that much of the deficit is financed by inflationary means. No wonder that high inflation, sometimes double-digit, has become a regular feature of India's economic expansion. Surely India needs to rein in fiscal imbalances and contain inflationary pressures.
Arguably, liberalisation and bold institutional reforms represent the main key that unlocked India's huge economic potentials that translated into impressive growth in recent times. The modern history of Indian economic reforms began in 1991 in the aftermath of the fall of the Soviet Empire, which necessitated the repositioning of India as a regional and global player. India then opted to work with market forces more closely by instituting liberal policies. India's vibrant corporate sector today owes its prowess to the liberal policies without which it could not flourish.
While East Asian economies may have lessons to draw from the Indian experience by questioning their export-led growth strategy, which had led to lopsided current account surpluses and excess savings, India needs to revisit its own strategy of banking on domestic demand and keeping a low international profile as exporter.
Purely from an economic standpoint, the question of growth being led by external demand or by internal demand is a non-issue, so long as there is no policy bias one way or the other. If countries can adopt neutral policies without bias in favour of exports or domestic consumption, markets will determine the share of exports in GDP which would be larger for smaller countries and smaller for larger ones.
The imbalance problem is associated with market distortions compelled by policy bias that has caused resources to flow from the non-traded into the traded sector in some countries or the other way around in others. Such biases are manifested usually in factor prices being distorted either to favour or to penalise certain activities. The under-pricing of land, labour, credit and energy is a case in point.
Specifically, subsidies and levies have contributed much to the misallocation of resources among competing end-uses.
NOW that the global economic crisis appears to be receding with nascent recovery reported in several key economies including the United States, the epicentre of the crisis, the focus of attention is shifting to post-crisis global rebalancing.
India needs to export more and import more by removing its own market distortions caused by policy prejudices, just as China and other East Asian economies need to rely less on exports and more on domestic demand by eliminating their pro-export policy stance.
The prescription is pretty much the same for all, namely policy neutrality toward external versus internal demand that would ensure efficient resource allocation. India would grow even faster if it could exploit its export potentials.
India can be an important stabilising force, playing an active role in the global and regional arena. Recent Indian bilateral trade pacts are a good beginning, but they fall short of great expectations judging by the long exemption lists for tariff cuts. Even so, there is a need for East Asia to embrace India wholeheartedly, as this would help revitalise India's reform process.
By MOHAMED ARIFF distinguished fellow at the Malaysian Institute of Economic Research