This year marks 35 years since India adopted wide-ranging economic reforms. India had been moving toward economic liberalization since the 1980s, but the quantum leap occurred when the economy faced the prospect of a sovereign default and suffered the ignominy of having its gold shipped to London as collateral for an emergency loan. There have been periodic downturns in India’s economic journey since then. But the general trend was only up and forward. It seems that we are on the cusp of another such crisis at the moment. The terms of trade shock resulting from the war in West Asia combined with headwinds to pre-existing capital flows to pose a threat to the economy’s balance of payments. There’s no point in predicting how bad things will get. In theory, it can, and that’s the point: financial markets often find self-fulfilling doomsday prophecies very seductive.
Crisis management, on the economic front, is not ugly at all. It can involve rising prices, austerity, bids for foreign capital, entailing extraordinary profits, strategic gifts, and so on. Different sides of the political spectrum are expected to defend or criticize such measures. Most Indians are not old enough to remember the 1991 reforms, but they are old enough to remember the attacks launched by Narendra Modi and his party on the United Progressive Alliance government in early 2010 over things like the falling rupee and rising fuel prices. Its image appears in the mirror today with the BJP in power. Politicians will do what is expected of them. But it distracts us from the bigger question.
What is the origin of the current crisis? What can be done to avoid a similar situation in the future? This requires a reconsideration of the evolution of the structural levers of the Indian economy in the past three and a half decades.
The emerging Indian state adopted a conservative stance towards its economic fortunes. Among all the restrictions, foreign exchange restrictions were prioritized the most. Memories of colonial subjugation, the lack of a local industrial base, and even food self-sufficiency made foreign exchange an extremely scarce commodity that had to be spent very wisely. This philosophy, combined with what has been justifiably criticized as export pessimism, has translated into policies that have led to widespread restrictions on supply in the economy. From the industrialist who wanted to import foreign machinery to the research students who went abroad to study, there was never enough foreign exchange. It scarred a generation of Indians, especially those relatively privileged, who were not really worried about survival. These are the loudest voices advocating reforms today.
The 1991 reforms changed all this forever, albeit gradually. From Scotch whiskey to international credit cards to foreign machinery and components, everything is within easy reach in India today if you have the money (in local currency) to pay for it. And the accompanying dollars, one way or another, always show up on the other end. But there are no free lunches in the world, right? So how did we move from the pre-reform era, which suffered from scarcity of money, to the post-reform world, which was blessed with abundant pounds?
Has India become a trade surplus country and now exports more than it imports? Things have moved in the opposite direction, and the merchandise trade deficit has actually increased since the reforms. Two things helped. A large number of Indians have started earning dollars for services either through their companies or remittances they have sent home from their workplaces abroad. This filled part of the commodity trade gap. The rest was filled by capital flows: either foreign direct investment (FDI) or foreign portfolio investment (FPI) type. As long as the capital account exists to balance the current account deficit, you can spend as many dollars as you want without earning them.
Once the ongoing war and terms-of-trade shock subside, the merchandise trade deficit should begin to decline. As of now, it seems too late rather than sooner. Capital flow dynamics look less optimistic. A fascinating observation by Sajid Chinoy, chief economist at JP Morgan, is that unless India does more to make itself attractive to foreign capital (similar to countries like Vietnam), it is unlikely to see a rebound in capital flows in a world with rising interest rates (in the US), because capital is able to generate higher returns even in the core (domestic bases like the US) than when venturing abroad. The invisible success story (service revenues and remittances) in the current account faces an adverse technological shock for future generations of AI. Even if it is difficult to completely write it off, it is reasonable to say that the invisible peak of foreign exchange earnings growth is now behind us.
Logically, this leaves India with two options. Either reduce foreign exchange spending, creating a supply constraint situation before 1991, or earn more foreign exchange through merchandise exports. The philosophy inherent in both options is the same: Don’t spend what you don’t earn.
35 years is a long time in the economic history of any country. Of these 35 years, 22 have been spent under just two governments: 10 under the Congress-led United Progressive Alliance and 12 under the current BJP government. The broad economic trend vis-à-vis external constraints was the same with: increasing merchandise trade deficits; These rose to uncomfortable levels during terms of trade shocks, which were sustained by rising invisible surpluses and capital flows. Whenever this balance is disturbed, the crisis appears.
Aside from the accusations, the reality of three and a half decades of reforms is more realistic than satisfactory. Rationality requires that the Indian state and its democratically elected guardians accept this reality rather than opportunistic bluster. They should make appropriate demands on both labor and capital to achieve what is required. This will not be an easy requirement: first, politicians need votes, and second, political funding. Workers have become accustomed to prioritizing immediate needs, such as cash transfers, over future investments. Capital is interested in preventing creative destruction, not accelerating it, to make the economy more competitive.
This is a classic case of democracy being in tension rather than in harmony with the national interest. Bleeding-hearted liberals will find this narrative unpalatable, but even a basic knowledge of economic history tells us that utopian liberalism does not create national wealth.
