Give up the ostrich act

Written by Rajiv Kumar | Updated: Jan 30 2008, 04:05am hrs
Back from the somewhat sombre and not the usual ebullient atmosphere at Davos, the finance minister will find that the general mood back home, though not as disturbed, is not as cheery as some of our delegates made it out to be to in their soundbytes at the Swiss ski resort. Most of them made out that the Indian economy will remain largely unaffected by the ongoing turmoil in global financial markets and a likely US recession. This was unnecessary. They could not have been serious, given the crazy rollercoaster ride that the Sensex had last week, largely in response to external factors. Moreover, Indias external sector transactions (total merchandise trade and invisibles) already account for more than 50% of GDP. There is sufficient empirical evidence to establish beyond reasonable doubt that Indias economic performance is (directly) related to global economic changes and (inversely) to differentials in the real cost of capital in global and domestic markets.

Then why assert that India will remain unaffected by its external environment If this party lineas it seemedwas adopted to sustain the India story and attract more foreign capital, it was no less unnecessary. Especially since we dont seem to be able to absorb even the current level of capital inflows, as reflected in the burgeoning reserves and continued upward pressure on the rupee.

I would instead have used the soundbytes to project the need for and Indias commitment to structural reforms that will increase the economys absorptive capacity, improve the investment climate for FDI by reducing uncertainties faced by foreign investors in dealing with procedures and labour market conditions, and improve the delivery of public goods and serviceswithout which inclusive growth will remain all but electoral rhetoric. The need of the hour is not to magnify the India hype, but to focus attention on measures to raise the economys potential growth rate. In this context, I wonder if it will be a good idea for India to skip the next Davos meet and instead spend the three days on a national convention on deepening reforms and improving the delivery of public goods and services.

I think the feeling of being unconnected and therefore remaining unaffected by goings-on in international markets arises largely because our financial institutions and markets still remain relatively isolated from global financial markets and flows. I believe this is seen as a strength in some quarters, as it reduces the probability of India suffering contagion effects. This was a widespread sentiment in the late 1990s, when India remained largely but not entirely unaffected by the Asian crisis that brought Asian tigers like Thailand, Indonesia, South Korea and Malaysia to grief. It is again being asserted that having withstood pressure to liberalise the financial sector has stood India in good stead, as the countrys financial sector remains overtly unaffected by the subprime crisis. This may well be true. But then, banks and the financial sector in general in other Asian economies (like China, Korea and Japan), which have liberalised financial regulations far more than we have, have also largely stayed unaffected. But unlike these other Asian economies, we have not had the benefits that come from a more open and better regulated financial sector that can mediate larger volumes of capital flows more efficiently, thereby both accelerating investment and ensuring its greater spread across various credit segments. There have always been trade-offs between development thrusts which, on one hand, have high growth with greater variance that lasts over short periods, and those, on the other, which result in low growth and virtually no variance.

The former is exemplified by South Korea and Taiwan, which have sped to OECD per capita income levels, while India is just at $900. China seems to be on the same track. Moreover, these sustained rapid growth rates, achieved by greater integration of the economy with global markets and trends, have also resulted in greater poverty reduction.

Therefore, instead of defending our relative lack of integration with the global economy, we would do far better to take substantive steps to move in that direction. The RBI should put up milestones towards the objectives set out in the roadmap it announced two years ago. At the present rate, the financial sector will remain largely unchanged by the end of March 2009, by which time the roadmap was supposed to have been implemented. This does not mean that indigenous banks will collapse, but it will imply that the RBI exercises its autonomy to press public sector banks to speed up the consolidation process and gain exposure to global market forces that should sharpen their skills and grant them larger opportunities.

The ostrich does not get affected by the storm as it burrows its nose beneath the sand and claims security. But it doesnt soar to greater heights either. The choice is ours.

The author is director & chief executive of Icrier, a Delhi-based thinktank, and member of Indias National Security Advisory Board