U.S.-India Economic Relations Need a Reality Check

After a decade of rapid economic growth and Goldman Sachs predicting in 2003 that India would become the world’s third largest economy by 2035, India is now one of the most vulnerable emerging economies. Its current account deficit has increased to 4.9 percent of GDP in the first quarter of the fiscal year after experiencing a current account surplus eight years ago. The falling rupee will likely help exports remain competitive. But exports will not return India’s growth to where it once was. For that to work, India would need to have a strong manufacturing sector, instead of seeing it contract. The goal should be to significantly lower India’s current account deficit, but to narrow the gap it will need to attract $250 billion in foreign investment in the next year.

Policymakers cannot seem to improve the ease of doing business in India, and have not articulated to voters why it is so important to focus on this particular issue. The World Bank’s Doing Business report ranks the country 132nd out of 185 for ease of doing business, behind Yemen, Kosovo, and the Russian Federation. Specifically, it has the second worst ranking for enforcing contracts, is fourth from the bottom for dealing with construction permits, and is almost as close to the bottom for starting a business. Disappointingly, India’s 2013 rankings have slipped in almost every category since 2012. India can do better.

The problem with India’s economic slowdown is not that its growth rate has fallen to half of what it was, but that investors are less willing to overlook the problems that were always there. India is a difficult place to do business, but a difficult economy with 10 percent growth is far more appealing than a difficult economy with 4 percent growth, when problems come into sharper focus. It becomes harder to ignore things like poor infrastructure, power outages, corruption, and bureaucratic red tape.

The government’s response has compounded problems, deterring investment rather than attracting it. Efforts like tightening capital controls and making rules that preference domestic production (though this has since been put on hold) have increased foreign investors’ concerns. Recent overtures to attract FDI focus too much on short term (and external factors) and not on the fundamental domestic factors that deter investment, a fact that was underscored in a recent report by the Asian Development Bank. The problem isn’t just the rules—it’s their inconsistent enforcement and the rate at which those rules change. This exacerbates other difficulties such as acquiring land, inflexible labor laws, inconsistent energy supplies, and an insufficient supply of semi-skilled workers.

Recently, American investors loudly expressed their anxiety over India’s economic policies. In June, an unprecedented number of congressmen sent a bipartisan letter to the White House conveying Congress’s concern about India’s trade policies. For many Washington-based observers, this was an uncomfortable departure from past bilateral trade policy disagreements. Secretary of State John Kerry and Vice President Joe Biden both visited India this past summer and Prime Minister Manmohan Singh visited President Obama in Washington at the end of September, but many investors see little being done to address their frustration and remain unconvinced.

The Obama-Singh meeting was productive on defense and strategic matters, with progress on the U.S.-India civilian nuclear deal and a Joint Declaration on Defense Cooperation, but less so on economic ones. A serious discussion on commercial and economic disagreements—real and perceived—was left off the table. Given that Prime Minister Singh is nearing the end of his term and that President Obama has a full agenda, it might not be surprising that the most contentious issues got less attention. Even then, the fact that the two leaders could not give their respective trade agencies some direction is a missed opportunity.

The most logical way to do this would be to reconvene the Trade Policy Forum (which has not met since 2010), which would then organize the two trade bureaucracies for action. The TPF is the formal channel for these disputes to be discussed, negotiated and (ultimately) settled. Without this forum, or another formal platform through which to channel the discussion, there is little optimism for much progress. While reinvigorating the TPF would not solve any of the outstanding issues on its own, it would at least provide the reassurance that the leaders recognize the need for compromise and solutions.

India’s growth was strong over the past decade because of cheap money, strong internal consumer spending, high commodity prices, and an emphasis on a highly-skilled service sector. Now the money supply will likely tighten up, commodity prices are dropping, the labor market is running out of skilled workers, and India lacks a large semi-skilled workforce to boost domestic manufacturing. India’s recent economic slowdown has shown that its policymakers could very well miss their chance to make the economy more resilient and competitive. India and the United States have shown that they can cooperate and think strategically on energy and defense issues—that same strategic thinking should be brought to trade policy.

Scott Miller is a senior advisor and holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Karl F. Inderfurth is a senior advisor and holds the Wadhwani Chair in U.S.-India Policy Studies at CSIS.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2013 by the Center for Strategic and International Studies. All rights reserved.

Scott Miller
Senior Mentor (Non-resident), Executive Education

Karl F. Inderfurth