The Indian economy is the sixth largest in the world in market exchange rate terms and third measured in purchasing power parity. That makes the growth rate of over 7 percent over the last year all the more remarkable. India is the fastest growing major economy in the world.
With the world’s second largest population, and fast approaching China’s 1.4 billion, India is becoming more economically and politically important internationally. Yet it is by any measure still a developing country and still poor. Despite its population size, it ranks seventh in terms of nominal GDP, smaller than Germany or France. China’s economy is 2.5 times larger in purchasing power parity terms and almost five times larger measured at market exchanges.
Can India sustain its current rapid growth? Even if it’s decades before India catches up to China, the goal is to maintain falling poverty rates and improve living standards. Doing so will require good economic management, clear policy direction and improvement in institutions.
The immediate focus is on the next general election in April and May. Prime Minister Narendra Modi and the National Democratic Alliance, a coalition led by Modi’s Bharatiya Janata Party, are expected to secure a second term.
In this week’s lead essay Suman Bery argues that although India has played a more and more prominent role internationally, ‘domestic developments in banking and finance … have been the most significant issue in India over the past year’.
That’s despite the global uncertainties, some of which directly affected India. The tide turned on emerging markets as investors withdrew hot money, leaving countries like India and Indonesia trying to manage vast and sudden capital outflows. Bery reminds us that the Trump administration’s unilateral sanctions on Iran affected a major source of oil for India; and Delhi was faced with a new Pakistani government with close links to the military. Add to that the complicated economic and security relationship with China, and the Belt and Road that is being laid out around India, it was a year of major diplomatic challenges.
But the tussle over the domestic financial and banking system was the top issue, according to Bery.
A well functioning banking and financial system is vital to carrying capital to a growing economy. At the centre of India’s financial system is the Reserve Bank of India (RBI), India’s central bank.
Tensions between the Ministry of Finance and the RBI ‘had been brewing for at least a year’ and ‘burst into public view in October 2018 with an uncharacteristically public spat’ over the RBI’s policy independence. It culminated in the unexpected resignation of the governor of the RBI, Urjit Patel.
The tensions that spilled out into the public are all the more unexpected because, according to Bery, ‘in most respects, the RBI and the government are aligned on key policy goals’. Inflation is low and the RBI’s supervisory framework is consistent with best practice internationally.
The RBI has emerged weaker even though it is achieving its mandate and main goals.
The tensions between RBI and Finance are not unexpected given that the commercial banking sector in India is largely state-owned. India is not usually associated with the dominance of state-owned banking — China usually takes that prize. But the structure of bank ownership is a burden on the efficiency of the capital market in India too. Around 70 percent of commercial banking assets are held by publicly owned banks. India’s democratic government and its independent central bank are in structural conflict over the management of the state-dominated banking system.
The RBI has been trying to address the deteriorating asset quality in India’s commercial banking sector and has imposed increasingly stringent lending rules on all banks, exposing worsening profitability and the poor net worth of publicly-owned banks, says Bery. Add the fact the ‘perception of corruption has been aggravated by large frauds perpetrated on the public sector banks’ and confusion about how far the RBI’s enforcement powers stretch into publicly owned banks and there’s a major problem in financial market governance.
Reform of state-owned banks is no easy task, as politically powerful vested interests will need to be taken on. Without reform, the banking system will become more and more of a drag on growth and the RBI will be unable to do its job effectively. The reforms need to be undertaken while the RBI’s independence is protected.
Externally, the Indian government’s reform credentials are under test in its approach to integration into the dynamic East Asian economy. Economic integration with East Asia is India’s natural path to global economic integration, by playing a major role in the global value chains across the region.
India’s Look East policy strategy became Act East under Modi but has been closer to At Ease with policy action failing to match the rhetoric. India’s population and the domestic market may be large but it won’t sustain growth or become a powerhouse economy like China’s without creating jobs to absorb the many millions joining the working age population each year and the deeper engagement of its labor-using manufacturing sector in international production.
China’s wage growth has left global manufacturers scrambling to build factories in Indonesia, Vietnam, Bangladesh and anywhere with good infrastructure, low-cost labor, and economic and political stability. The opportunity for India is to become the factory of the world. It’s a strategy that’s all spelled out in Modi’s Make in India and Act East strategies.
Yet India has not been shy to exercise its veto in international economic forums, famously stalling the conclusion of the WTO’s Trade Facilitation Agreement (with Bolivia, Cuba and Venezuela). That is one of the WTO’s least intrusive and win-win agreements. India is widely recognized as a trade reform spoiler, delaying the conclusion of the Regional Comprehensive Economic Partnership (RCEP) agreement that includes the dynamic and integrated East Asian economies it should be opening up to. RCEP provides the platform for India to align and lock in its domestic reform priorities while enjoying expanded access to markets in East Asia, now the largest and most rapidly growing center of global economic activity.
Is it too much to expect that, after the national elections are settled next May, the Indian government will begin to act East and secure its strategic development interests in the region?
The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.