For a Coherent Foreign Economic Policy

By Mansoor Dailami

Manager

Development Economics Group

The World Bank

Washington DC

Opinion Piece Special to The Economic Times

September 8, 2008

Greater integration into the world economy has served India’s interests well. Its soft power and role on the global stage are increasing. Now, as the balance of economic power shifts from the developed to the developing world, the country is well-placed to further engage with the world economy in a more strategic manner.

Two sets of transitions are now pivotal: a move towards more open macroeconomic management     in line with India’s growing integration into global trade, investment, and financial networks; and a reorientation of its foreign economic policy to capitalize on the new opportunities that are emerging as a result of globalization.

Transitions to a new economic paradigm are invariably complex and challenging. This is even more so in the current global environment of slowing growth, unsettled financial markets, soaring food and energy prices, and rising inflation. Dealing with these challenges will not be easy; it will require clear thinking and collective action by the international community at large.   For India, the challenge lies in maintaining its commitment to global integration, while taking cognizance of the changing international economic order.  

Almost a year into the global credit turmoil, the world economy is entering a phase of heightened uncertainty and difficult policy trade-offs. Clearly, much of the burden of adjustment rests with mature market economies, particularly the US. But emerging markets economies will not be insulated or decoupled from the fall-out of the global credit squeeze, nor from the consequences of policy and regulatory responses in the advanced economies. By infusing massive liquidity into the inter-bank markets, major central banks have avoided the perils of a systemic financial meltdown. But global credit turmoil has yet to run its full course, inflation has emerged as a growing concern, and global growth looks set to remain subpar in the next year or two. Monetary policy tightening by central banks in India and other emerging market economies is part of the solution. But this, by itself, is not enough. Inflation today is a global phenomenon linked to global commodity markets and monetary conditions. Therefore, the appropriate response would need to have an international dimension as well.

A world economic order geared to deliver long-term growth and price stability would be in India’s best interest. Inflation poses heavy socio- political costs. Moreover, India is critically dependent on imported energy, and with its growing population and rising living standards, its energy needs are bound to soar in the coming years. The country also needs massive foreign investment to build and upgrade its core infrastructure that is critical for growth to remain at the high plateau of recent years. And, as India’s exports move up the quality ladder, access to markets in advanced economies will be vital to the country’s long-term growth and modernization.

India’s economic reform and liberalization that was pursued at its own tempo has been a qualified success. Since liberalization in 1991, India’s economic and financial interactions with the outside world have multiplied several fold. India is now a hot new destination for global investors.   Foreign trade has grown almost 20 times in volume, and foreign direct investment has soared from $74 million in 1991 to $ 21 billion in 2007 - more than sufficient to finance India’s current account deficit. Foreign capital flows have allowed India to accumulate $295 billion in foreign exchange reserves as of end July 2008 - enough to cover over a year of imports. As part of this, Indian corporations and banks have established themselves as innovative borrowers on offshore credit markets. Some 85 Indian companies have their shares listed on stock exchanges in London, Luxembourg, and New York, and many of them are active players in the global mergers and acquisitions market. India made its currency convertible on current account in August 1994, ahead of the other BRIC countries, and capital account convertibility remains a stated policy goal. Progress to date has involved selective relaxation of controls on foreign investments in corporate securities, non-resident deposits in commercial banks, and direct investment in manufacturing - and increasingly services.

These developments have improved, probably fundamentally, India’s access to global private finance. India now has the flexibility to manage its balance of payments position to accommodate a high growth path, without having to rely on official donors and creditors. Such gains are worth protecting and building upon as India tackles the more challenging task of building the institutional and regulatory capacity to operate an increasingly open economy exposed to the vicissitudes of the international marketplace.

This highlights the need for India to deepen the development of local capital markets so that businesses can manage their foreign currency risks, the exchange rate can play a stabilizing role, and monetary policy can be geared to maintaining price stability.  Greater efforts are also needed to prevent excessive corporate foreign borrowing and debt accumulation that could spill over to the banking sector, raising systemic risk. With several Indian banks increasing their activity in international capital markets, high priority also needs to be accorded to strengthening the institutions responsible for the regulation and supervision of the banking system –both domestic and foreign.  

The second transition relates to the ways in which India communicates and delivers its foreign economic policy. This will require a greater degree of inter-agency coordination among the key line ministries of Commerce and Industry, Finance, Oil & Gas, and External Affairs. Each ministry must use its own unique strengths to work towards a common goal in core areas like energy security, access to private global finance, and the expansion and diversification of exports.

But a coherent foreign policy agenda does not simply consolidate across key areas; it seeks to capitalize on the opportunities presented by globalization by increasing mutually beneficial economic relations with key partners, while putting in place the necessary safeguards. This requires, in part, a delicate shift in the country’s world view to one that is more reflective of its own emerging power and aspirations, as well as the changes in the world economy.