Economic Diplomacy

OBOR: Economic, Diplomatic and Strategic Dimensions

by Arvind Virmani

OBOR was presented to the world by China in March 2015, as a comprehensive infrastructure & economic development program. Its land component, the new Silk Road, echoes ESCAP’s Asian highway, Asian Railway and Asian Economic Corridor Plans from the 1980s and 1990s. But more importantly it fills in what may be considered missing links, connecting China to the rest of Asia and into Europe. The naval parts echo what was termed the “String of Pearls” in the Indian Ocean, but extends these Westwards to Europe through the Red Sea and Eastwards to the South China Sea. Questions and concerns have however been raised about its less defined Strategic aspects, just as they were raised about the “String of Pearls,” which was also presented as an economic infrastructure project for development of ports.
The economic development part is driven and supported by massive overcapacity in China’s manufacturing and construction industries and zero or negative returns to domestic investment on the margin. Thus the opportunity cost of funds is low enough to allow low profit, high economic risk investment in foreign infrastructure that could support its quest for future raw materials supplies and open its markets to sale of manufactured goods, a modern version of the Prebisch-Singer hypothesis of trade between the colonial “Center” and the colonized “Periphery”. As current account surpluses are a basic feature of the existing “party capitalism” model of development, a moderate reduction of foreign exchange reserves through capital outflows, leaves substantial net foreign exchange assets to finance the foreign exchange costs of these investments. As much of the foreign investment in OBOR will be done by Chinese companies, Chinese labor and Chinese materials, the foreign exchange component is a small fraction of the total cost of these projects. The primary purpose of AIIB is therefore not to supply foreign exchange funds to OBOR projects, but to herald the arrival of China on the global financial state and to act as the foundation for its global financial diplomacy.
The land based infrastructure(road, rail, pipelines, digital backbone) aims to connect China to all parts of the Eurasian continent and to the Seas & oceans surrounding Asia. The countries that such infrastructure passes through(rail, road, pipeline, fiber optic cables) or is located in(port, airport, industrial estate) have to provide the land on which it is built. They may also have to take on debt to pay for part of the real/full cost of this infrastructure. It is uncertain whether the economic benefits they will receive will exceed the costs they incur in terms of land, debts to China etc. I know an economic expert who has been hired by a Central Asian country to evaluate the benefits of a China proposed rail line that will cross its territory, and he was hard put to think of the benefits to this country which may become feasible(eg new exports). OBOR countries have to be extremely careful in evaluating the benefits and costs to them of any infrastructure built by China. The cost of permanently transferring land to Chinese Companies and/or taking on debt on behalf of projects, could prove very onerous in the medium-long term.
If the infrastructure is genuinely economic & not strategic, every country in the World should be able to use it once built, as this improves its economic viability, given sunk cost. So third countries, including India, have nothing additional to gain from “joining” the OBOR which will be built by Chinese Construction/ infrastructure companies. All Commercial companies, including Indian ones, have the option of using the infrastructure(roads, railway, ports, airports, industrial estates) if it reduces costs and improves profitability.
The AIIB is unlikely to be the primary source of funding for the OBOR, which from available numbers, requires funds of an order way beyond the capacity of the AIIB. As the bulk of financing will be domestic currency financing needed by Chinese construction companies, all that the AIIB can do is to provide the fraction of funds needed in the form of foreign exchange. More importantly, the AIIB is(in my view), needed to provide an international stamp of respectability to OBOR projects. This is suggested among other things, by the timing of the announcement of AIIB so soon after the formation of the New Development Bank (NDB) also referred to as the BRICS bank. The agreement to form the NDB was signed in Brazil in July 2014, after years of discussion. China signed an MOU with 24 countries in October 2014 for the formation of the AIIB, five months after the unveiling of the new silk road and three months after the agreement to form the NDB.
A Chinese scholar was recently asked about his estimate of the economic risks and returns to China of OBOR projects. His answer as reported without attribution, was that he didn’t expect repayment of 80% of loans to CPEC projects, while repayment on other OBOR project loans would be between 30% and 50%. It is not too far-fetched to assume that the rest of the benefits to China would be non-economic, i.e. Diplomatic and Strategic.
The OBOR is however, much more than a connectivity cum economic program, it is also a comprehensive diplomatic initiative of a rising China. It is a an instrument of China’s diplomatic objective of ensuring that the Asia and the World recognize China as a Great Power. According to the Virmani(2004) Index of Power Potential (VIPP), China became a “potential great power” about seven years ago, with its economic power exceeding 25% of that of the USA. Its relative economic power has grown rapidly since then to reach 42% in 2015, as per this index VIPP. The OROP is viewed by the party leadership as an umbrella program for interaction with every country in Asia and the surrounding Seas.
The diplomatic initiative can be seen at three levels: Intellectual, Political and Financial:
(1) Intellectual: OBOR provides a framework for interaction with Academics, Think Tanks and Media, interested in economic development, infrastructure investment and trade & economic relations. This can work in both directions; Chinese financed visits of foreign interlocutors to Chinese institutions and invitations for Chinese academics to these countries.
(2) Political: OBOR provides a framework for interaction with the political establishment, including government ministers, of each country. As in the case with intellectuals and academics, the Chinese can facilitate the visits of foreign politicians to China for the purpose of discussing OBR. It provides a very useful cover for Chinese experts to explain their national position on every issue, including the South China Sea, Japan and USA.
(3) Financial: Every government minister is looking for funds to relieve budget constraints and finance pet projects. OBOR provides a framework for Chinese officials (party, govt) concerned with Chinese economy to interact with their counterparts in potential host countries, on their projects programs and economic development objectives. At some stage it also involves the highest political authorities such as the Finance Minister and the Prime Minister/President of the country, allowing China’s views on any subject of their choosing to be heard respectfully.
Announcements of large financial projects and Programs attract widespread attention of all segments of society, even without any hard economic & financial analysis to determine viability. The personal contacts built during discussions can also be used to finance individual pro-China leaders, politicians & others, as allegedly happened in some S E Asian countries.
The general strategic objective of OBOR is to increase its influence in the countries covered, to reduce US influence in these countries, and to pre-empt any potential increase in influence of US or its allies, existing or future. More concretely, the goal is to establish a strategic presence in these countries, including through sale of military equipment. The strategic dimension of OBOR has two clear components. The continental and the maritime:
(1) Continental: This takes the name of the old silk road’s disparate tracks across Central Asia, and applies the name to a “Hub and Spoke” system of highways and railways radiating from China at its Center or Hub. Given that oil pipelines and fiber optic info-ways exist then, this is obviously a modern and valid add-on to traditional highways. Given China’s dependence on imported energy, the oil and gas pipelines are particularly important for diversifying both sources and supply routes for energy. The immediate strategic objectives are, (a)To secure Central Asian and other neighboring Islamic States (Pakistan, Afghanistan, Iran) from becoming a base for Xinjiang Liberation Movements, and (b) A revival of the old “Great Game”, to develop land routes from continental Asia to the Indian Ocean (through the Bay of Bengal, Arabian Sea and Gulf of Iran).
(2) Maritime: As silk is associated with China and the “Silk road” with connectivity, the Maritime dimension has disingenuously been called “Maritime Silk Road”. The “maritime silk road”, clearly represents an evolution of what many called the “String of Pearls” strategy. All analysts agreed “String of Pearls”, agreed that what had been done and planned so far was primarily economic. However, those who were most suspicious about the “string of Pearls” warned that it was not just possible, but likely for these Pearls to transform into strategic bases once the economic part was developed. The “Maritime Silk road” concept has brought this potential development right into the present. The strategic maritime dimension of OBOR is to develop a string of logistics basis in the Indian Ocean region, with likely conversion in future, of a few of them into naval bases. From China’s perspective, the most desirable geographical locations for naval bases are those at the intersection of the “Maritime silk road” and the “New silk road” i.e. those Ports that can be connected by overland route to China.
The post World War II, Marshall Plan was explicitly designed to help the revival of devastated European allies and to complement the makeover of Germany in its own image. This paid good social, economic and diplomatic dividends to the USA. However it was complemented by creation of NATO & other military blocks explicitly designed for Strategic purpose. Eventually each complemented the other, even though they may not initially have been part of an integrated economic, diplomatic and national security strategy.
OBOR is presented to the world by China, as an infrastructure & economic development program. It is in reality an umbrella for a comprehensive but evolving, Economic, Diplomatic & Security strategy. It is part of a “Middle Kingdom Doctrine” (authors characterization) that seeks to make China the Central power in Asia: A super power that dominates Asia and its surrounding Seas and Oceans & exercises varying degrees of “suzerainty” over peripheral areas (including less well off parts of East Europe). One strategic implication of this doctrine is to reduce and eventually eliminate US strategic power and influence in Asia

India and Japan : A Symbiotic Mutualism Relationship

By Somindu.S.
Ahmedabad, 12 December 2015

The short yet most path breaking Abe’s visit inspired me to look at some of the parallel developments and how Modi-Abe partnership is transforming the bilateral relationship and who are the key people to watch for.

Modi is fond of PPP model and incidentally Prabhu, Parikaar and Piyush (PPP) are cornerstone of ‘Make in India’ through their respective portfolio. Coupled with Modiplomacy led by Sushma Swaraj, the team is working hard to transform India. Unfortunately our friends in mainstream media do not even find amusing to focus on this. Let us take case of Railway Minister Suresh Prabhu and Japan.

Prabhu’s Japan Visit

Suresh-Prabhu

When Suresh Prabhu visited Japan in low profile short September visit, he was surprised how Japan received him. While everyone knows Japan was keen for Shinkansen project after losing out one in Indonesia, what Prabhu wanted was more than that. He was very candid in his interactions with his Japanese counterparts. He clearly told them, if I see you as partner then I want you to be my partner in many other things also not just Shinkansen. In his one daylong interaction with various stakeholders he shared his vision on India-Japan rail cooperation. The meetings ranged from industry heads to financial institutes to Government heads and R&D departments and with his counterpart ministers. Everywhere Prabhu presented his ideas as per the positions of counterparts.

Japanese sides were all keen ears. In normal old days, they would be polite not to confront nor agree but would tell him what more India had to do and then things would remain status quo. Indian officers would then blame it on over cautious Japan and minister would return.

Speed of Bullet Train:

Shinzo-Abe-Japan

But this time, something spectacular was about to happen. Next morning, Railway Minister went to meet PM Abe and to his surprise he saw many of the familiar faces by the sides of Abe. The same people with whom he had long discussion yesterday. Abe made his team read out what Japan would be willing to offer. To Prabhu’s pleasant surprise it enlisted all the points shared by Prabhu in such beautiful way that he never even thought of. Starting from tech transfer on existing Rail infrastructure to R&D cooperation to extremely attractive loan.

To put the things in perspective not only this was unprecedented but also would be path changing. Elated Prabhu told Abe. “Mr. Prime minister there is a race of speed now. I am not sure, what is faster, speed of Bullet Train or Indo-Japan relationship”. Abe could only smile and it conveyed that besides speed Japan is also known for reliability and safety. Prabhu told his counterpart which echoed both Modi and Abe’s vision on India-Japan relationship. In bilateral relations globally, there are no two countries that can claim a bond that India and Japan shares. Prabhu emphasized this point and explained that many a time when you negotiate with other countries, you initially have to spend energy in negating some past negatives before you can move to work on positives. With Japan and India there is zero negatives and hence we can put our energy on constructing the positives.

The Crisis of Past

JaiShankar

Having said that, it is a time to look at another aspect of India-Japan relationship.

To people who have been following Indo-Japan relationship know that all was well on surface but if you dig deeper, India was a very far country for Japan.

While there were no negatives, there were no common positives as well. The relationship hit the lowest nadir and suddenly India looked bad for Japanese leadership in 1998 just after Vajpayee government did the Pokhran test. Japan being only country in the world to be have gone through the horrors of nuclear attack are always sensitive. But what surprised the world especially Indian authorities was reaction of Japanese PM Hashimoto (a known Sinofile, or China sympathizer). He condemned India in most stern words and also joined sanctions. This was the toughest time for India-Japan relationship. There was one officer in Indian Embassy in Tokyo the Deputy chief of Mission. He worked arduously behind the scene with officers in Delhi. While Vajpayee Govt was busy in bringing America in tune with changing world geo political reality. The Japan team was busy in dousing the unexpected fire.

The man on Mission The deputy chief of mission then was Mr. S. Jaishankar. The quiet upright man with impeccable understanding of Japan, (his wife’s home country), was working hard to restore the normalcy in India-Japan relations.

While India was getting USA on her side, political wind in Japan was also flowing differently. Hashimoto had to resign and subsequently Mori faction of Liberal Democratic Party won the mandate, let by Mori himself. India by the time realized to have friends across political spectrum to keep bilateral relations not getting hijacked. Jaishankar worked very hard behind the scene to do the same. New breed of young politicians and some old who were scared of China’s might saw sense in India’s resurgence. Current PM Abe then was young politician but like Modi he was also post war born leader and had a very different idea on India. Jaishankar had found a good friend in him. Jaishankar and his team finally succeeded when PM Mori landed in Delhi in year 2000 and told Vajpayee that India and Japan were now strategic partners. Interestingly today in Joint press conference Jaishankar as India’s foreign secretary was in the midst of action where Modi and Abe announced that India-Japan strong relationship is unparalleled in the world now. He must be happy to know how far the relationship has travelled and he now as foreign secretary has to build on a strong foundation.

The Author Diplomat

Vikas-Swarup

In 2012, Narendra Modi as CM of Gujarat, on July 26 visited Kansai region and was received by extremely energetic Consulate General of Osaka. The pleasant diplomat was one of the few who had a very good command over language and was popular among both Japanese and Indian community. Vikas Swarup the Oscar fame author and wonderful communicator was in charge as consulate general (CG) of Osaka. Modi landed in Osaka in afternoon from Nagoya. In short time available to him at Kansai, CG Swarup had arranged plentiful. The first program was round-table interaction with Industry captains of Kansai region (whose economy is bigger than Canada). So impressed was Modi with this program that he spoke out of turn in the end to thank profoundly CG and organizing bank that gave him an opportunity to meet investors directly and learn few things from them. The stay in Kansai was very different from Tokyo and very warm for Modi. A town hall meeting with Indian community to next day official visit to Hyogo Prefecture, CG had done his job to the perfection. Now as a chief Spokesperson of India, Vikas Swarup is close to PMO, and he remains India’s finest communicator. His credentials were so high with Japan that even previous PM Manmohan Singh entrusted him to negotiate successfully for historic visit of Emperor couple’s visit to India. No doubt when it comes to Japan, he is another person Modi can lean on.

And the Gujju Connection:

Sujan-Chinnoy

Gujarat and Japan has deeper connection when it comes to student exchange. Gujarat university and Osaka’s Otemon Gakuin University has one of the oldest student exchange program running for last 46 years now. Every year two students from India and Japan spend three months in respective countries. The program has produced many Indofile and Japanofile over a long period. Early 80s, a student named Sujan Chinoy visited Japan under the exchange program and did exceedingly well. Later he joined foreign services and has been India’s one of the best diplomats with versatility in many sports, arts and language. His closest stint to Japan came, when he was Consulate General of India in Shanghai.

December 3, 2015 he took position of Ambassador designate to Japan. (he is yet to go through the credential formalities, due to PM Abe’s visit). Long back, there were two other ambassadors from India Dr. Seth and Dr. Asrani who went to Japan as a student. H. E. Chinoy will actually be the first from India to have deep understanding of both Japanese and Chinese. In fact he is the only Indian diplomat with hands on experience on national security and China of more than two decades. He is man of action and has left lasting impression wherever he has been posted. His last posting was in Mexico. Not only it will be easier for him to communicate with Japanese in their own language, he will be able to do the same smooth and candid talking with Indian PM in his own mother tongue. The next 2-3 years are very crucial as Japan breaks out of old mold and makes unprecedented exception for India. India will have to equally flexible. Be it defense cooperation or civil nuclear technology, something totally unthinkable even five years back is taking shape. I would say Ambassador Chinoy’s posting has indeed come at a right time. Considering his counterpart in India H. E. Hiramatsu is policy veteran and security expert, India and Japan would be looking to break many status quo within their own policies and push governments from both ends to do more.

I would like to conclude by quoting PM Abe’s words. “A strong India is good for Japan and Strong Japan is good for India”. There is nothing that describes better a symbiotic relationship of mutualism than this statement. The two nations complement each other in perfect ways. Both Japan and India have common problem in China. Both the nations have one neighbor respectively who is source of nuclear weapon. On economy front, Japan’s ageing population needs India’s young talent and huge pile of Japan’s underutilized Capital needs a better deployment option such as for India’s Infrastructure needs.

For many years, Aid from Japan was single point in Indian diplomacy. In recent years, Investment joined Aid. Now as we Usher in Modi-Abe Era, the relationship has truly become multifold. From make in India to Malabar exercise, From Defense cooperation to DFC, from UN reforms to Uniting against Chinese hegemony in Ocean routes. A lot is on the plates. I can only say the Symbiotic relationship of mutualism is only going to go stronger.

Courtesy: Desh Gujarata Website

What they didn’t discuss!

By Mohan Guruswamy

With the global economy showing no signs of recovery and with the Chinese economy turning out to be weaker than previously expected, Prime Minister had a well publicized meeting of the usual suspects to discuss lifting the economy out of the morass it finds itself in. He had a bevy of top private sector honchos, some sarkari economists, some FinMin bureaucrats and a handful of PSU bosses and the RBI governor.

From what has been reported the meeting went the usual way. Such meetings usually end up seeking magic wand solutions and the magic wand most in demand was an interest rate cut. To be sure some others wanted tax cuts and more exemptions ostensibly to make them more competitive. With some big holders of Non Performing Assets (NPA’s) in attendance, this rate cut demand will soon be translated into reducing the debt burden by applying the reduced rates with retrospective effect. Businessmen will be businessmen and success to them comes by not passing up any opportunity for a little gain? But there are no magic wand solutions to our predicament.

India’s crisis has been in the making for a very long time now. Our GDP has acquired the profile of a post industrial economy, which is excessively skewed towards the service sector, in turn giving our economy a post-industrial look despite not having industrialized in any significant way. 52% of China’s GDP comes from industry, while it is exactly half that for India. Agriculture employs 58% of our workforce and now contributes about 15% of our GDP.

In absolute terms the number of people in agriculture has doubled since the advent of reforms in 1991. It just means that in relative terms more people got poorer. In other words, as the supply of labor kept increasing the rise in wages did not keep pace with the cost of living, and hence a critical and most essential expansion of the market did not take place.

This is not to suggest that the reform process was wrong. On the other hand the reform process never really got underway, as beyond scrapping the Industrial Licensing Act of 1951 and dismantling the DGTD, little happened. Everything else including “social control” of banking remained as it is. Instead of patronage being sold at Udyog Bhavan, the place where it is dispensed is now in North Block, which is closer to South Block than Udyog Bhavan ever was.

All those who became spectacularly rich after 1991 mostly became so due to public assets, whether under the ground or in the skies, being allocated to them at ridiculously low rates. The logic that these surpluses will be invested back in the economy didn’t work, because capital flows to where it is easier deployed, meaning abroad. With a few exceptions, these overseas expansions have been largely funded by accumulating NPA’s at home. According to a recent report released by UK Trade and Industry (UKTI), the U.S. remained the largest source of inward investment, with a total of 564 projects in 2014-15, followed by France (124 projects) and India (122 projects). That year the UK attracted over one billion pounds as FDI, giving you some idea about the scale of investment from India.

That India was not significantly buffeted by the crisis of 2008 and seems equally well insulated from the current crisis, does not suggest strength but primitiveness of the economy. China’s economy is thrice as big as India’s and it is twice as integrated into the world economy than us. China’s foreign trade to GDP ratio is now over 70% and twice as much as ours. Then again China has a much higher value addition factor and hence when the sea rolls harder it needs to absorb more shock. So we need not be sanguine about our situation.

When the Americans were bombing Vietnam’s logistical system, they found that it had little effect as most of the war supplies from the north to the south went by head loads and on bicycle pillions. So bombing a bridge or a railroad junction didn’t do much to stop the Vietnamese war effort. Our economy is in a similar situation. If we were as dependent as China is on exports we too would have been buffeted by the outside world. But these macro issues would not have been discussed. The NPA people would have wanted relief and when they are breaking biscuits with the Prime Minister in his premises, the bankers present would have registered the signals.

Not surprisingly India doesn’t face anywhere as near an immediate crisis as China does. Our crises are more systemic in nature and need a long-term perspective. Our first great challenge is to create 12 million new jobs each year, to make the demographic dividend an economic dividend. We are nowhere near that. To be able to create millions of more jobs, we need to make huge capital investments. This can only come from the State. Private capital is locked into an April 1 to March 31 perspective, and so to expect them to take a long-term view of investment is unreasonable. The question now is whether there was any advice forthcoming from the participants on how the government should go about improving its investment to GDP ratio, which in turn depends on the savings to GDP ratio?

The state of the Central Governments Public Sector Undertakings is pathetic. The private sector manages to hold its head above water by better management of the environment and its resources, and also by constantly rolling over debt. But it is the public sector that is a bigger part of our economy. In 2014 the total capital employed in the 383 CPSU’s is a huge Rs.330, 626 crores, with an additional Rs.881, 774 crores as long term loans, almost all of it from government financial institutions and from the central government directly.
These companies together have a market capitalization of Rs.1, 106,657 crores. Of these CPSU’s, 202 were profitable registering a cumulative profit of Rs.153, 907 crores, and 124 had losses amounting to Rs.49, 612 crores. They also employ 15.59 lakh workers and managers. This investment generates a turnover of Rs. 14,13,992 crores or about 10% of our GDP.
The 41 PSU’s in the oil, coal and power three sectors together provided Rs.100, 369 crores or 65.22% of PSU profits. If you keep these three sectors aside, the rest of the PSU’s together earned about Rs.1000 crores. This is a sorry state of affairs.
Soon after he assumed office, Narendra Modi indicated plans to do more with state-controlled companies than use them as piggy banks to break into whenever the government needed a revenue boost. He said he had plans to sell off the traditional laggards and to fix the ones with potential. He also signaled the government had plans to privatize state-run firms and unfetter them from the clutches of the middle bureaucracy of deputy and joint secretaries. There is no sign of this any of these happening.

One thing I am fairly certain they would not have discussed is the flight of capital from India. According to Global Financial Integrity, a Washington DC based research organization, the total illicit financial outflows from India between 2003 and 2012 were $439 billion —$94.8 billion of that in 2012 alone. There is no sign of this abating. Since so many of the players in this game had come together under his tent, this would have been a good time for the Prime Minister to broach the subject of re-investing some of that capital in India?

Global Financial Crisis, Contagion and Grexit

By Arvind Virmani

Introduction
The worst Global crisis since the “Great depression”, hit the World in 2008. The “Great recession” triggered by the Global Financial crisis(GFS) fundamentally changed the external environment, while the Euro countries continued to believe that the World was undergoing just another cycle like the dozens they had seen & dealt with in the post-war period. Thus in our view (as ED IMF 2010-12), their economic approach and solution to the fiscal problem, of putting overwhelming emphasis on austerity was fundamentally flawed and highly likely to fail in the absence of a quick return of the World economy to high growth and moderate inflation. A speedy return to higher growth, was however, made impossible by the flawed emphasis of the governments/politicians of the Euro Area, UK and the US on hard & immediate fiscal squeeze on their own economies, thus reducing global demand and exacerbating the global excess capacity in tradable goods and services. On the supply side China, continued to create new capacity in manufacturing by pumping credit into the economy, offsetting the natural process of depreciation and obsolescence that would have gradually reduced total capacity.
Greece Loan
A number of High Income European Countries including Greece, were among the worst affected by the GFS & associated recession. The IMF changed its rules, to make loans to Greece that were > 10 times the ratio limits applicable to loans made to developing countries during the previous 50 years. The only argument for making such an exception was to minimize the risk of contagion to other vulnerable European countries such as Portugal, Ireland and Spain. An IMF ED(a professional economist) pointed to the flaw in the economic analysis and projections underlying the Greek loan: “The scale of fiscal reduction without any monetary policy offset is unprecedented… (It) is a mammoth burden that the economy could hardly bear. Even if, arguably, the program is successfully implemented, it could trigger a deflationary spiral of falling prices, falling employment, and falling fiscal revenues that could eventually undermine the program itself. In this context, it is also necessary to ask if the magnitude of adjustment…is building in risk of program failure and consequent payment standstill… There is concern that default/restructuring is inevitable.”
Austerity or Fiscal Reform
Our experience of the Asian & Latin American crises, had taught us that that the domestic private and international sovereign debt overhang had to be dealt with quickly and effectively, to stave of a “Balance sheet recession” and give the economy a chance to recover. Further, that growth recovery depended critically on offsetting required Govt. expenditure compression (austerity) by expenditure switching (real depreciation and/or monetary easing). Clearly both the global demand situation and domestic supply side had to be conducive to produce a sustained increase in net exports and investment to stimulate and sustain growth. In the absence of exchange rate flexibility in Greece (PIIGS), austerity could only work by reducing the real wage rate. Given the deflationary post crisis situation, austerity would reduce not just the nominal wage rate(w) but also the price level(p) thus having (at best) a small effect on the real wage rate(w/p). We concluded that restoration of Greek competitiveness within the euro zone would require a level of austerity that was socially and politically infeasible. We therefore argued that in Greece(& contagion candidates) the focus should be on fundamental fiscal (tax and expenditure) reform, which would put it on a sustainable fiscal path through a gradual reduction in expenditures and increase in tax ratios, which follow from such reform(e.g. of Pensions). Instead of an immediate reduction of government expenditures, the focus should be on limiting and reducing the growth of expenditures, perhaps in some cases to zero and not on cutting everything drastically. The overemphasis of the Trioka on “austerity” distracted attention from more fundamental fiscal reforms that still remain unimplemented by Greece.
Lender of Last Resort
There were three other issues critical to success of Greek macro adjustment. The immediate problem for Greece and other Euro zone countries in danger of contagion was the absence of a normal Central Bank or lender of last resort. The European Central Bank was hemmed in by rules and constraints that kept it from acting like a normal Central Bank (FRB, USA; BOE, UK; RBI, India). We argued that contagion couldn’t be stopped unless the ECB got complete freedom to lend to illiquid but solvent Euro area Banks and financial institutions (Virmani(2011) This problem was gradually solved after the appointment of Mario Draghi as the Head of the ECB in November 2011 and the risks of contagion have been largely eliminated due to ECB empowerment and tightened financial regulation. However, subsequent to the No vote in the Greek referendum, the ECB has raised the collateral requirements for providing liquidity support to Greek Banks. Greece is therefore effectively without a Central bank to fulfill the lender of last resort function for its Banks and payment system. If this support is not restored, Greece has no option but to reintroduce its own currency (Drachma) and Central Bank.
The introduction of currency has two parts: Bank deposits(financial deposits), which can be converted instantaneously into Drachma, and by letting the market set a Drachma-Euro exchange rate. If a one to one conversion is done and the market exchange rate is 1.3 Drachamas to the Euro, say, then the implicit haircut on all deposits is 30%. The second part is for the Greek Central bank to get Drachmas printed and then offer to exchange Euro cash held by the public for cash in Drachmas, at the market exchange rate. To minimize disruption, the Euro would continue to be legal tender in Greece, but all prices would have (gradually) to be specified in Drachmas.
Debt Sustainability
The second important problem was Greece’s Sovereign debt. It was very clear to us in 2010, that Greek debt was unsustainably high i.e. there was no credible time path of nominal GDP growth that would result in a sustained & continuing decline in the Debt-GDP ratio (Virmani (2011) op cit). Without a substantial debt restructuring, resulting in an effective reduction in the present value of outstanding debt, any delay in debt reduction/restructuring would worsen the debt problem. Thus we argued that IMF, Euro and other sovereign loans would merely result in repayment to private lenders and a substitution of private by public debt. Those who facilitated Greek government profligacy would get away without bearing the consequence of their bad decision or sharing in the pain of adjustment. This is precisely what happened. The debt crisis reappeared as predicted and a partial debt write-off occurred in 2012, with a Trioka mediated agreement between private lenders and the Greek government. It was too little too late. The Debt-GDP ratio moved back to its earlier peak, triggering the loan default to the IMF and the latest crisis of 2015.
Structural Reform
Finally there was and still is the problem of broader economic reforms to improve the competitiveness of the Greek economy. It is often alleged that the Greek economy is riddled with monopolies and oligopolies. The policy & regulatory structures that encourage monopolies and oligopolies must be reformed urgently to encourage new entrants and promote competition. Whether Greece remains in the Euro or leaves it, fiscal and economic reforms will be essential for restoring economic growth.
Effect on India
The Greek crises, being a mixture of economic and political factors (dozen Euro countries) has created great uncertainty in the investing community. This uncertainty affects most of the World including India, and is likely to continue for the duration of the crisis. Normally such financial uncertainty leads to heightened liquidity needs in Europe, the sale of Indian equity and an outflow of capital and exchange rate depreciation. This time there is an offsetting factor. If the crises slowed EU recovery, as is likely, the expected outflow of capital from India to the EU could be inverted. Thus as I predicted a week ago, India could have a rise in equity markets cum capital inflow on one day and the opposite another day, for the duration of the Greek crisis.
From a medium term perspective, the conventional Wisdom is that the Greek economy is too small a part of the Euro area, the EU and the World to have any effect on the economy. In my contrarian view the Greek crisis, is likely to slow Euro recovery and thus affect India’s exports to it. Further a setback to EU recovery would also affect its exchange rate with USA and other countries. This could be a factor in the US FRB’s decision on the QE program in September. If Euro growth slows sharply, leading to capital inflow into US and USD appreciation (indicating a natural tightening of monetary policy) the FED could effectively moderate the anticipated rise in interest rates. This would offset any negative effects on Indian exports and growth from the Euro slowdown.
The main long term lesson of Greek crisis for India is to eliminate its revenue and fiscal deficit and thus eliminate the major policy driver of the increase in net external indebtedness. Cyclically adjusted revenue deficit should be reduced to zero by 2020 and the cyclically adjusted fiscal deficit should be reduced to zero by 2025.

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A version of this article appeared on the editorial page of the Indian Express on Thursday July 9, 2015 under the banner, “Trojan Loans,” http://indianexpress.com/article/opinion/columns/trojan-loans/

Foreign Policy Under PM Modi

by

Arvind Virmani
May 2015

Policy Paper No. WsPP 4/2015: https://sites.google.com/site/drarvindvirmani/policy-papers . I would like to thank Ashley Tellis, Adm Premvir Das, Amb Hemant Krishan Singh, Radha Kumar and Sanjaya Baru for comments on earlier versions of this paper.

Introduction
In an earlier note, the author outlined the emerging and potential changes in India’s Foreign Policy under the Modi led Government (October 2014). Foreign policy actions of PM Modi’s government since then have fleshed out the predicted changes in foreign policy. The foreign policy developments over the seven months that have elapsed since then broadly support the expectations and predictions made last year. The current policy paper, therefore spells out the new Foreign policy approach of PM Modi’s Government in greater detail and with greater confidence. Indian Foreign policy experts may argue, with some justification, that this exactly how they have thought about India’s foreign policy for the past ten years, but in democratic India, it is the approach and mindset of the political parties and the political elite that ultimately determines how policy is operationalized. This is the emerging change that this paper is about.
Non-alignment to Tri-polarity
The most fundamental change in Foreign policy, is the one referred to in October 2014 as “India First.” The choice of words was perhaps not the most diplomatic, but the implications remain the same and are amply supported by subsequent developments. One of the important foreign policy events in during the last five years was a CPR paper titled “Non-alignment 2.0” i.e. the 21st century version of the post War (WW II) foreign policy of “non-alignment” between the two poles of that time, USA and USSR. By definition, Non-alignment starts with a definition of the “poles” or countries and their policies, between which one is non-aligned. “India first” turns this approach on its head, by defining India itself as one of the poles, with a clear set of domestic and international objectives and expectations from other countries. Instead of looking first at what other country’s objectives and expectations are, and weaving our way through the contradictory objectives of other poles, we as a fixed pole, first define our own objectives and our expectations from other countries, including the “poles.” We then try to convince them to support our objectives, making whatever bargains necessary for achieving these objectives. An essential element of this changed perspective, is the new government’s “pragmatic actions and view of the world, ” Therefore there has been a search for deals with every pole to further India’s “primary objective of closing the economic and technological gap and building national power, in a pragmatic forward looking manner jettisoning ideological blinkers and minimizing historical baggage (Oct 2014).” This is neither ‘non-alignment 3.0’ nor ‘multi-alignment’, but the first step in the “Multipolar transition to a Tri-polar world” (Virmani(2005)). India in 2013, ranked third behind USA and China in terms of size of GDP at PPP and ranked tenth behind Russia (9th) in terms of current dollar GDP. It ranked sixth in terms of economic power, as measured by the VIPP index of potential power. Author’s projections indicate that India’s VIPP rank will rise to number three by 2020, but it will take another decade to become strong enough to become the third pole. The Modi government’s aspirations of India becoming a ‘leading power’ not just a ‘balancing power,’” as outlined by the foreign secretary, reveals an appreciation of the emerging possibilities.
Some analysts have called India’s new foreign policy approach as ‘multi-alignment.” But this is a misnomer, because India is not aligning either with the sole super power USA or with the fast rising great power China, nor with the Great powers of the past (Japan, Germany, Russia, France, UK). It’s a “multipolar transition” because the relative position of these powers, with different strengths and weakness, is undergoing rapid change. India is on the way to equaling and/or excelling them in certain dimensions, while still being in a position to benefit from their historical strengths. This uncertain world, with the old equilibrium slowly crumbling, but a new one could take two decades to emerge, can be characterized as a multipolar transition.
Changes
The October 2014 note envisioned a change in policy along five dimensions: “There are five areas in which I see an emerging change in foreign policy: The centrality of economic & technological development, the integration of domestic and foreign policy with respect to this objective, the emphasis on “national power” including “military power” and “Soft power” and a reduction in self-imposed constraints on actions that third counties may construe as inimical to their interests.”
Economic Objectives
The alignment of foreign policy with domestic economic and technological objectives has proceeded as fast as, or perhaps even faster than predicted. The economic objective has become less diffused and more sharply focused with the fleshing out of the “Make in India” campaign. The focus of foreign policy is to attract foreign direct investment, risk capital (equity and long term loans) and foreign technology and expertise to make this objective a success. Defense production, is now a fundamental part of the ‘Make in India’ campaign. Hence attracting defense technology and joint ventures partners is a critical element of the foreign policy objective. As investment in infrastructure is an essential element of success of this campaign, attracting foreign capital and technology into infrastructure remains important. Other infrastructure intensive programs like “100 cities” are also part of the foreign outreach. Similarly, improving the “Ease of Doing Business” is essential for higher investment, production and productivity of both domestic and foreign investment and has therefore figured in the PM’s statements to potential foreign investors.
There is however a difference between the approach to the private sector in market economies (at one end) and the approach to State controlled or directed enterprises in non-market economies at the other. In non-market economies like China, where the party and/or the State, directly or indirectly , controls outward investment, tourism and imports, the approach has perforce to be to discuss & resolve economic issues with the government and its key economic organizations and State enterprises. In market economies like USA, Germany, Canada & Australia & UK the governments (and legislatures) of these countries can play little positive role in investment decisions, though they have sometimes played a negative role in supporting rent seeking by their firms. Thus in these countries, the PM has correctly made an effort to interact directly with major FDI investors and intermediaries in financial centers like New York, to convey the Indian Government’s commitment and determination to change India’s reputation of having one of the most obstructive bureaucracies in the World. Other countries fall somewhere within this spectrum and a dual approach has to be adopted of discussing selected economic issues like infrastructure development with the governments which drive them, but addressing issues of concern to FDI and equity investors directly with the private sector. Japan, which lies in the middle of the spectrum, the Government has considerable influence and capacity to influence the behavior of large corporates. Even France has a legacy of Government invested firms, which have been privatized, but the government still exercises varying degrees of influence.
The entire government has participated in identifying the expertise and capabilities of each High income country (Japan, USA, Australia, France, Germany, Canada, S Korea), that the PM has visited, with the view to attracting to India companies and organization that contribute to India’s economic & technological development objectives, with the latter covering both Defense and civilian areas. With France both Civilian nuclear co-operation and defense production have been advanced. In Germany the objective was to get the renowned high tech industry and Mittlestand to participate in India’s development. This has been followed by a visit by the German Defense Minister to India. The defense Minister’s trip to S Korea preceded that of the PM, with a view to cooperation in Shipbuilding and related industry in both civilian and defense sectors. Even though China is still a lower middle income country(LMIC), like Sri Lanka, India or Mauritius, an exception was warranted because it has investible surpluses and expertise in infrastructure & mass labor intensive manufacturing.
With the abolition of the Planning Commission, the submission & acceptance of the 13th finance commission report in early 2015, and increased devolution of funds for social sectors to States now have the funds to gear up their social sector bureaucracy and fulfill their social responsibilities. Thus, the salience of socio-economic development issues in foreign policy is likely to be less than it appeared in October 2014, though NRI audiences may continue , to be encouraged to participate in campaigns like “Swach Bharat” in their home States/Districts/towns.
National Power
Though Economic development is the foundation of Power, the Strategic (Nuclear, Space) and Defense element of National Power are receiving the personal and sustained attention of the Prime Minister. Starting with appointment of a full time Defense Minister, the backlog of pending and gridlocked procurement decisions is being rapidly cleared. The decision to allow FDI in Defense and to proactively involve the Private sector in production and design has been taken and has started being implemented. A more decisive thrust is also being imparted to development of border infrastructure. In Arunachal Pradesh and J & K, which was either gridlocked (eg environmental clearances) or moving at snails pace (BRA, funds), the Home Minister has taken a personal interest in building peace time border defenses to deter creeping encroachment.
It can be argued that much of this merely a speeding up of decisions that have been in the pipeline for half a decade to a decade. Budgetary trends are however, quite disturbing: On a (polynomial) trend basis India’s defense expenditures have declined from over 3% of GDP in 1985-86 to less than 1.9% of GDP in 2014-15. The sharpest decline occurred in the late 1980s & during the BOP crisis of 1990-1991. From 1991-92 there has still been a (linear) trend decline from about 2.4% of GDP to below 1.9% of GDP in 2014-15. Since 2011-12 defense expenditures are running even below this negative trend line and remain so even in the 2015-16 budget. Thus, there is still no change in the declining trend in budgetary allocations for Defense.
However, the statements of the Raksha Mantri (RM) suggest that more fundamental reviews and reforms in strategy, policy, rules and procedures can be expected. Some of these reforms require the setting up of new committees(procurement, offsets), others involve a re-look at old neglected committee reports (K Subramanian’s Kargil Review, Dr. V Kelkar’s on Private production & R&D, Prof Rama Rao’s on DRDO revamp) and still others may require completely new initiatives (National security doctrine, Asymmetric Defense strategy). There are enough indicators and statements to suggest that virtually all these issues are under the government’s lens, and we can expect in principle decisions by 2016 and concrete operational changes by 2019. RM has also promised that his recommendations to the Cabinet Committee on Security will be ready by July. The appointment of a tenured CDS with authority over strategic planning and budgetary allocation would provide a solid foundation for reversing the declining trend in defense expenditures as a per cent of GDP.
As far as the foreign policy aspects of national power are concerned the message of a more muscular policy of deterrence has already gone out to potential aggressors and their supporters and well wishers.
Unconventional Threats
As expected from a NSA who is an expert on counter terrorism, there is (as predicted in Oct 2014), “an increased focus on unconventional threats (cross-border terrorism, use of non-state actors, foreign ideologues-mercenaries). The buildup of World class equipment and skills over a spectrum of warfare & covert capabilities and a willingness to boldly attack the aggressor in his safe havens.” This is already in the process of change, “both in terms of capabilities in counter-terrorism and defense against non-state actors, but even more importantly in (operational) doctrines incorporating a willingness to take calculated risks in using asymmetric capabilities.” As the the Raksha Mantri has said, this may involve, “using a thorn to remove a thorn.” We can now expect the Govt to develop an Asymmetric Defense Doctrine (ADD) and an Asymmetric Defense strategy (ADS) to deter State sponsored terrorism against India.
Soft Power
The October 2004 note predicted, “a greater emphasis on global socio-politics and “soft power”, the third dimension of national power, including the expansion of common ground based on religious and cultural heritage & history of India (e.g. Hinduism viz. Nepal, Buddhism viz. E & SE Asia, Yoga viz. West, modern/moderate Islam viz Indonesia), as well as the Indian diaspora across the World.” This has now been noted by every foreign policy analyst and its beneficial impact acknowledged by most. They have noted the use of this cultural affinity in China, Mongolia and S Korea. The missing element of this approach (our affinity to and encouragement of modern, moderate Islam), will hopefully, emerge during PM Modi’s visit to Bangladesh in June and a (so far unscheduled) visit to Indonesia during the second the year. Another change in emphasis is a less apologetic approach to highlighting democratic affinities with like-minded countries.
The semi-soft elements of “soft power” have also been given a greater thrust by quick and decisive action and naval & air deployments to rescue Indians and citizens of friendly countries, from areas of heightened conflict zones like Iraq, Syria and Yemen, and disaster relief effort in earth quake-hit Nepal.
The Stronger Poles
India’s Foreign Policy towards the USA and China is beginning to reflect the abandonment of past ideological-political baggage and self-imposed geo-political constraints. It is based on more realistic understanding of the strengths & weakness of these two important poles by the political leadership, and of how they can help fulfill or thwart India’s reformulated objectives of Economic and Technological Catch-up.
The USA and China are both economically and militarily much stronger than India. In terms of the authors VIPP index, China’s economic power is about half of US, while India’s economic power is about 0.28 of China’s. The strategic-military gap between China and USA is much greater than that between India and China. China is 15 % of US military power but rising quite rapidly, while India’s military power is about 42% of China’s but falling (VIPS).
Super Power USA
The US is still the sole super power, with yet unmatched technological capability in the field of Strategic and Defense Technology and Production and in Assets built using this technology. As often pointed out by analysts, its defense expenditures are greater than the aggregate expenditures of the next ten countries. According to an index developed by the author (VIPS), the USA has more than six times the strategic capability of second ranked Russia. Following 9/11 and even more strongly after discovery of extraordinary efforts by a rising power to acquire this technology covertly, the USA has strengthened its already stringent confidentiality-secrecy-security net around these technologies. Japan and the European countries like France (0.12 x US), UK(0.1 x US), Germany & Italy have strategic production capabilities that India can and will attempt to acquire from them. However, even their equipment often incorporates critical components or sub-assemblies from the US, which are subject to the USA’s comprehensive security-secrecy net. Thus USA policy on supply of critical defense & strategic technology & production capabilities to India, can play a critical role in acquisition of a technological edge viz any adversary with greater financial resources and expenditures on defense. The new government fully understands this potential, and has demonstrated it by resolving the nuclear issue and accelerating India’s strategic engagement with the USA by signing the US-India Joint Strategic Vision for the Asia-Pacific and Indian Ocean Rim.
There is, however, a gap in US (government and Congress) understanding, of India’s quest for economic and technological development, which is driven by the reality that India is a lower middle income country (LMIC), with unacceptable levels of poverty. Thus India’s financial capability and ability to take risks is limited and will remain constrained for a decade or so. US analysts like Ashley Tellis (2015) have understood and appreciated this fact and suggested that the USA act with generosity, instead of trying to extract concessions at every turn. He (correctly) argues that the economic & strategic development of democratic, diverse and plural India will act as an example to the rest of the World, help spread US principles and ipso facto serve US interest in a stable balance of power in Asia. Such an approach could revolutionize the Strategic Partnership.
Second Pole China
On China, a “symmetry strategy” seems to have been adopted by PM Modi. This involves holding a mirror to China, by demonstrating a carefully modulated, but symmetrical response to China’s actions affecting India’s national security environment. Thus China’s core interest in Tibet is being mirrored by a clearer enunciation to China, of India’s core interests in Arunachal and J&K. Similarly China’s thrust into South Asia is being mirrored by India’s foray into N. E Asia (Japan, S Korea, Mongolia) and into S. E. Asia (Vietnam & other ASEAN). The Indo-USA vision for the Indo-Pacific, including the S China Sea, can be viewed as an effort to complete the “symmetry strategy” with the assistance of USA, given India’s limited capacity for sustained operation outside the IOR. Though India launched its Indian Ocean initiative more than a decade ago, it has not been pursued with consistent vigor. China’s thrust into the Indian Ocean region, has however, helped to reinvigorate the relationship with Australia and the IOR islands of Mauritius & Seychelles and will re-activate the dormant Indian Ocean Region Association for Regional Co-operation (IOR-ARC). Greater interaction with Indonesia is also to be expected.
Asian Highway
China’s “Silk road” initiative has not however, been mirrored by India, so far. India has protested against the routing of the Sinkiang-Gwadar economic corridor through parts of the Indian State of Jammu & Kashmir, under the (disputed) control of the Pakistan and Chinese Governments. The government should revive and actively pursue, the ESCAP initiated, ADB supported, Asian Land Transport Infrastructure Development (ALTID) project, including the Asian Highway and the Asian Railway. The new Japanese infrastructure fund of $110 billion, along with the Asian Development Bank (ADB), could fund the missing links between Vietnam and India and beyond, helping clear the hurdles in its completion. It could also be expanded to serve as a beacon of development of the backward, interior regions of ASEAN, India’s North East, Bangladesh and West Bengal.
Asymmetry
The symmetry policy required a build-up of Indian border defenses to neutralize the build-up of Chinese military capabilities in Tibet. It doesn’t involve holding security relations hostage to economic ones or economic relations hostage to security. Thus in our view, criticism of the Indian government for delinking economic issues from security issues viz China is misplaced. The border settlement and the economic relations with China must be evaluated on their own merit in terms of net benefits to India. We also disagree with those who argue that economic relations must be deepened just to solve border or security issues, as they have little historical evidence to back such claims. Analogously, the symmetry policy doesn’t require holding relations with any other country hostage to relations with China or relations with China hostage to those with any other country. This is the standard approach of Great powers and also of China itself vis a vis the USA, Japan and most countries. Only a super power like the USA has the multi-dimensional power to gainfully link security & economic issues through World-wide economic sanctions, but even it is only able to organize such sanctions under extreme provocation and/or against much weaker countries.
Economic Possibilities
China has long seen India as a potential market for Chinese exports of manufactures and construction services, an attraction that has been heightened by the sharp deceleration in growth of world trade after the global financial crises. The non-market nature of China and its Party led growth strategy of investment-net exports, raises suspicions about the enormous trade imbalance and the low imports of products in which India has a worldwide revealed comparative advantage(RCA) e.g. drugs and pharmaceuticals, auto parts, agriculture goods. The effort to find mutually beneficial areas of economic co-operation has, however, been deepened and expanded. India will clearly benefit from greater tourism, if the e-visa facility offered to Chinese tourists is matched by Chinese government encouragement to Chinese tourists and tour operators to treat it on par with ASEAN. India would also benefit from, China’s shift of labor intensive mass manufacturing to India as Chinese wages (are allowed to) rise; As China’s per capita GDP is 4.5 times India’s, unconstrained wage rates in China should be about 4.5 times India’s. Thus it would be in mutual interest for China’s to gradually shift labor intensive(LI) manufacturing of electronics, plastics, garments to India, starting with those items it is already exporting to India. Similarly it would be in the interest of both countries for Chinese infrastructure developers to set up joint ventures with Indian companies in India, and get debt financing from China to undertake infrastructure projects in India. MOUs valued at $22bi have been signed in railway & highway corridor and industrial park projects & industrial projects, though not all fit into the categories suggested above. The key issue to be kept in mind is the balance between cost competitiveness and risk bearing.
Boundary Settlement
In the 1960s China made an explicit proposal to formally recognize India’s claims in the Eastern sector, in return for China’s claims in the Western sector (which was more or less the so called “MacMohan” line). To our understanding the Chinese premier even enclosed a map defining the new boundary and/or marking the areas which may have to adjusted/exchanged to accommodate geographical imperatives. In the 1980s there seem to have been some disagreement within Chinese Communist Party, on the Chou proposals to India, and some pull-back with respect to the area/district of Tawang, in the Eastern sector. But no clear diplomatic demarche was made to India or a public statement made to an Indian or English speaking audience.
A further advance on the boundary issue was made with the signing of the 2005 India-China agreement, which accepted the principle of “not upsetting settled populations” along with the well-known and universally accepted “watershed principles”, which was implicit or explicit in PM Chou’s 1960s proposal. This would be helpful in a few areas of ambiguity that may have remained if the water shed principle was used to locate the precise formal boundary. In a sense the internal disquiet that simmered in China during the 1980’s, against PM Chou’s proposal, appeared to have been quelled during General secretary Hu Jin Tao’s tenure, with China returning broadly to the position it had held in the 1960s.
In 2006 the Chinese government (suddenly) changed its formal public position, by declaring that the Indian State of Arunachal Pradesh was part of South Tibet. The Chinese ambassador to India criticized the Indian President/PMs visit to AP in the rudest and most offensive language (for a diplomat). This was followed by a series of orchestrated actions, like stapled visas for Arunachal residents and vetoes on multilateral loans for Arunachal Projects. Contrary to gullible recipients of Chinese propaganda, India is ready for a full settlement of the Sino-Indian border on the basis of the 2005 agreement. A return by China, to the letter and spirit of the 2005 agreement can lead to a complete settlement of the boundary issue. With China not in a position to step back from the aggressive posture adopted by the CCP since 2006, India has from that time proposed an alternative approach of clarifying the actual ground position, areas of interweaving patrols etc. so that progress could be made in small steps.
DCs, ASEAN and SAARC
India’s foreign policy towards developed countries (DCs)/high income countries (HICs) will be focused on technological development of India in both the civilian and defense fields. As most of these States are competitive market economies, the Indian government can interact directly with the private sector on market goods and services. G2G will therefore focus more on defense production and infrastructure where even DC/HIC Govt’s exercise greater control or have some expertise and influence. The converse of this policy, is that India will frown on efforts by developed country governments and their Civil society organizations, to arrogate for themselves the role that India’s State & local Governments, think tanks and civil society can and do play.
Though, formally, the “Look East” policy has been changed to an “Act East” policy, the mention of the freedom of navigation in the South China Sea in the US-India vision statement presages greater interaction with ASEAN. Enhanced security partnership with Vietnam is a reflection of this approach. As Indonesia is the largest member of ASEAN and treats other members of it as its closest partners, India-Indonesia relations await a new thrust. A visit by the PM to ASEAN would more clearly signal a change fro “Look East” to an “Act East” policy
Similarly, as noted by every analyst, India is taking a more pro-active role in economic development of the SAARC region and in the security of the IOR region. Though, Bruce Reidall may be a little premature in calling this, the “Indian Sphere of influence”, but a new ‘national security doctrine’ for the entire region stretching from the Himalayas to the Antarctic and from the Gulf of Suez to the Malacca/Lombok Straits is likely to emerge within a decade.
As the second largest country in the SAARC region and a country that been called an Incubator of terrorism, Jehad Central, and the “mother of Islamism”, Pakistan merits special attention within SAARC.
Pakistan
After some initial hiccups, the policy towards Pakistan is also emerging more clearly. This is the two pronged strategy of welcoming development of economic integration and social interaction (without pushing it) but repaying any aggressive actions, conventional or unconventional, with quick, appropriate & effective counter action. On cross-border terrorism and related cross border firing on the India-Pakistan border, a much firmer and decisive response strategy seems to have been decided on and appears to be under implementation. This recognizes the need for changing the old paradigm followed since 1990, with a new one for dealing with non-State actors, State sponsored terrorists and failed or failing States. India’s protest to China regarding its agreement with Pakistan to build road, rail or other projects in parts of Jammu & Kashmir occupied by Pakistan, is also part of this approach.
On economic and social interaction, SAARC is the best umbrella for carrying forward economic development, given the political reality of the deep State in Pakistan and the constraints imposed by it on the elected Governments (1st PPP then PMLN). As all seven members of SAARC are equal and each has veto power over new initiatives, it gives the nominal government of Pakistan the political cover it needs. Further, as Pakistan holds the chair of SAARC during 2015 and the other six members have already demonstrated their desire and commitment to move speedily on all fronts, it can choose the pace and timing of economic integration. Thus for instance, at the last summit, held in Nepal, Pakistan accepted only one of three major initiatives that the other six countries had approved. The focus of economic & social interaction with Pakistan is therefore shifted from the bilateral to the pluri-lateral aegis of SAARC. Given that the other six members are eager to move, any aspect which Pakistan wants to pursue can easily be incorporated as a SAARC initiative. If Pakistan is not interested in economic co-operation, it is best for India to leave it pursue its own course, without engaging in periodic, futile attempts.
Conclusion
The tentative conclusions reached in October 2014 have been strengthened: “The PM Modi led Indian government is changing the emphasis of India’s Foreign and National security policies. Elements of this change in approach are already visible. These involve a clearer definition of Indian interests (“India First”) in terms of economic and technological development, a greater focus on these goals in foreign policy and a consequent integration of domestic and foreign policies. Other changes involve a greater focus on the development of national power, in particular an enhancement of the somewhat neglected element of military power, its broader definition to include asymmetric warfare of which State financed-directed non-state actors are a dangerous part, and a jettisoning of self-imposed constraints of ideology and misplaced fear of offending other countries who display no such squeamishness in their behavior. Overall a much more confident, credible and effective national security-foreign policy is predicted to emerge over the next five years.” Some of these elements have been operationalized while others a re still works in process.
A philosophical under pining cum broader direction for India’s new foreign policy is also emerging. This is implicit in the government’s formulation of India going from being a “balancing power to a leading power.” The government plans to pursue a policy that accelerates the development of India to the position of the third most powerful economy in the World. It will also attempt to raise India’s rank in strategic-military power, an effort that is more difficult and costly, and therefore can benefit greatly from help from super power USA and other historical Great powers like Russia, France, UK, Japan and Germany. India has also begun playing a greater role in the economic development of the SAARC region and has initiated the process of raising security co-operation in the Indian Ocean, South China Sea and Pacific Ocean.

China-India Growth Inversion & GDP gap

By Dr. Arvind Virmani

Introduction
The long anticipated deceleration in rate of the growth of China’s economy is under way. Even normally conservative World Bank and IMF, are confirming that China’s growth is slowing down and is likely to fall below 7%. Even those analysts who had forecast a deceleration in China’s growth were unsure about when exactly the slowdown would start. The author had estimated in the 2000s that China’s growth would decelerate below 8 per cent, around the middle of the decade starting 2010. The global financial crisis of 2008 sharply raised the probability that the slow down would occur within the following decade, despite risky efforts by China to prop up growth.
In contrast India was forecast to achieve its potential growth rate of about 8 per cent, given its Export-import neutral growth model. The surprise in India’s case was the sharp slowdown from 2011-12, largely attributed to complacency and domestic policy mistakes. Despite these mistakes, however, India’s growth rate from 2002-03 to 2013-14 was among the ten highest in the world (using the old data series). Though, the correction of these mistakes, may no longer be enough to restore growth to earlier levels, India can and must restore growth to the average rates achieved earlier. Again, this has been recognized by both the World Bank and the IMF. These two developments taken together, imply that India trend growth rate is poised to exceed that of China’s in the next few decades.
GDP Levels vs Growth rate
This will start the long, slow process of closing the GDP gap with China, which was 1.4 times India’s real GDP in 2013. There is a common tendency to confuse relative levels of GDP with growth rates, so it is important to understand that China’s real GDP measured at Purchasing power parity in 2011 international dollars is now 2.4 times that of India’s. The two economies were almost equal at the end of 1980s (China’s GDPppp was 1.1 times India’s in 1990). During 1990 to 2013 China’s growth rate averaged 9.9% per annum, 3.4 per cent points faster than India’s 6.5% average. Even if the growth differential was inverted (ie China grew at 3.4% points slower than India ie -3.4%), it would take 30 years to close the GDP gap, double the time it took to open this gap.
Previous Growth Forecasts
The basic theory and empirics of growth, show that fast growing economies like Japan, S Korea, Singapore and Thailand, which grew fast when they were at low or middle income levels of per capita GDP, maintained growth at high levels for one to two decades and then slowed down as their per Capita GDP approached that of the (lower end) of the High Income economies. The surprise in the case of China was that it maintained an average growth of almost 10% for thirty years, despite reaching middle income levels of per capita GDP about a decade ago. Many analysts, whose predictions about China’s growth deceleration had been proved wrong in the 1990s, became much more cautious thereafter. Those of us who were willing to take a reputational risk, have been proved right, as China’s economy slowed below 8% in 2012 and is now projected to slow below 7% by the multilateral institutions.
The global financial crisis ensured that growth of World trade would slow sharply below the very high growth seen in the previous decade, aided by a correction of the bubble like growth seen just prior to the crisis. This meant that China’s (net) export-investment model was no longer sustainable and would produce slower growth in the 2010s. To delay this slowdown China pumped large amounts of credit into the economy, with the official Debt-Gdp ratio rising from 55.2% of GDP in 2008 to 88.1% in 2013, an average increase of 6.6% points of GDP per annum. Analysts have estimated that the debt in the shadow banking system may have increased by an equivalent amount, with total debt rising to dangerously risky levels. Based on historical experience of such debt bubbles, some analysts predict that this bubble is likely to burst and reduce China’s growth rate to 3 to 4% range. Analysts who have greater confidence in the ability of the Chinese Communist party to manage economic crisis, nevertheless predict a deceleration of the trend rate of growth to a range of 6% to 7%. A gradual growth slow down to 5 to 6 per cent rate over the next 10 years is quite possible.
Comparative Growth
Based on World Bank, World Development Indicators data till 2013 (till which year India’s GDP base 2004-5 was fully available), we can examine and compare the growth rates of China & India. A plot of these rates shows that the growth rate difference has been narrowing since 1990, due to a gradual deceleration of China and a stronger acceleration of India. Underlying this narrowing growth difference are variables that are drivers of, or correlated with, GDP growth and productivity. These include FDI and exports, which are indicators of competitiveness and Imports which reflect openness.
The difference between China and India’s FDI-GDP ratio has been on a declining trend, from about 3.5% of GDP in 1990 to a little over 2% of GDP in 2013. Underlying this is slow but steady progress in attracting technology and risk capital to India, with a milder decline in China’s attractiveness. China’s Export GDP ratio which was 8 per cent points higher than India’s in 1990, rose 10% points to an average of 18% during 2005 to 2007. It then narrowed rapidly to about 1% in 2013, indicating that India’s exports have held up to the global decline in world trade since 2008, much more effectively than China’s. The difference between China and India’s Import-GDP, which fluctuated around an average of 7.1% points between 1990 and 2007 declined dramatically to -5.2% by 2011-13, indicating that the Indian economy is now significantly more open than China’s.
Base Change Implications
Analysis and forecasting of Indian growth has been confounded by the appearance of a new GDP series (2011 base) which has made some fundamental changes in methodology and data sources used. As this new series provides less than three years of growth data it is impossible to estimate the underlying trend growth rate using this series. After the mid-year 2014 budget I had written that “The measures taken in the budget will be sufficient to increase growth by about 1 per cent point over the last year’s 4.7% to 5.7%. Actualization of some of the measures indicated in the budget will however be necessary to raise growth to the 6.5 to 7% range in 2015-16.” Given that the average growth rate as per the new data is about 1% point above that, using the new data, a projected growth rate of 7.5% to 8% is quite conservative. This seems to be the reasoning underling the World Bank’s and IMF’s projections for India’s growth in 2015 and 2016.
The CSO has however projected a growth rate of 7.4% for 2014-15 and a growth acceleration to 8% in 2015-16 would not be wildly optimistic. As many observers have pointed out however, high frequency data, such as the Index of Industrial production for manufacturing, quarterly results for companies and tax revenues from excise and corporate income tax, do not appear consistent with these high growth levels. The author has argued in the policy paper, “Indian Growth Puzzle,” that the global financial crisis (GFC) and the consequent global demand recession and excess capacity, have affected not only the export led Chinese economy, but also the globally competitive and connected corporate sector of India. Thus, post GFC, the GCC corporations will lag overall recovery, instead of leading it, as they did in 2002-3 to 2007-8. Thus all indicators connected with these companies, such as IIP, corporate profits, corporate & excise tax revenue would also lag the GDP recovery. The Indian Government needs to be aware of this issue and be prepared to manage expenditures subject to a slower recovery in tax revenues.
Conclusion
Based on the theory and empirical evidence provided by high growth economies, some analysts had predicted since the 2000s, a slowing of the Chinese economy during the decade of the 2010s to rate of growth below that of the Indian. By making the export-investment led strategy of development unviable, the global financial crises made this highly likely if not inevitable. It was also assumed in the forecasts that the Indian government would continue to carry out the minimum reforms necessary to maintain India’s growth rate at an average of the previous decade. Because of complacency and policy mistakes by the Indian Government between 2010 and 2012, the Indian economy, faltered seriously. The corrections introduced in the last two years, have restored some of the momentum. However, sustained growth of 8 to 8.5% over the next few decades requires implementation of the reform agenda and continuing sensitivity to shocks that can derail growth, given that the World environment is far from conducive to sustained high growth. If this is done we should expect to see India growing faster than China and beginning to close the wide gap that has opened between the per capita GDP of the two countries.
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A version of this article appeared as the Lead article in the Hindu dated 29th April 2015 under the banner, “Tracking Two Growth Stories.” http://www.thehindu.com/opinion/lead/india-and-china-tracking-two-growth-stories/article7151377.ece

Jaimini Bhagwati: Effective economic diplomacy

We need a systematic approach for selecting and training officers to promote foreign trade and investment, and facilitate scientific-technological tie-ups

Jaimini Bhagwati, Posted on 27th April 2015
The new National Democratic Alliance (NDA) government has stepped up the intensity of India’s summit-level interactions with major powers, neighbouring countries and the non-resident Indian (NRI) diaspora since May 2014. Refreshingly, in addition to political and strategic ties, these external engagements have focused more overtly than in the past on raising trade and investment levels. Economic diplomacy has become a tired expression and any reference to it usually elicits a yawn. It has become de rigueur for governments to repeat too often to their diplomats that trade and investment along with technology transfer are crucial elements and even drivers of foreign policy. This article explores how India could use its relationships with the rest of the world to push employment-generating growth and acquire appropriate technology.

In today’s world with instant low-cost written, pictorial and voice communications, publicly available information is adequate to quickly put together an accurate picture of political and strategic developments. In such an environment, traditional diplomatic despatches from embassies are often redundant. There could be exceptions during armed conflicts or if relationships are tense, but such situations are not the norm.

Diplomats are expected to further the economic interests of their home countries with the time freed up by not having to, for example, analyse host country political developments in excessive detail. Technological content constitutes an ever higher proportion of the value added in the total volume of traded goods or services. Hence, protection of intellectual property rights and availability of skilled human resources take higher priority than in the past. It follows that diplomats need to follow innovations in technology more closely.

Indian embassies in the larger countries have economic-commercial wings. These wings spend most of their time in engaging with our industry associations, such as Confederation of Indian Industry and Federation of Indian Chambers of Commerce and Industry, and with the visits of delegations from the ministry of commerce and industry or of finance. Annual work-programme targets are drawn up by our missions in consultation with the commerce ministry. These targets are more in the nature of the number of meetings, seminars, and trade and investment promotion exhibitions to be held annually. All this can be useful, but specifically targeted interaction with individual Indian and foreign companies is needed. For example, auto components is an important Indian export item and our commercial wing representatives need to be aware of what is happening in this sub-sector. This would not be possible without practical experience, which would happen only if government allows deputation between the government and the private sector more freely. There is no a priori reason to assume that if officers were to go on deputation, say, to Bharat Forge or Mahindra & Mahindra, they would on return to government push what benefits those companies to the detriment of public interest.

In India, the commerce ministry is responsible for trade and foreign direct investment. The ministry of external affairs is staffed by foreign-service officers and the commerce ministry by administrative-service officers. At the working level, there are often instances of lack of communication or inter-service rivalries to protect turf. This could be overcome in specific cases by better coordination at the ministerial level, but may not percolate downwards systemically. The Indian government uses Cabinet committees for resolving inter-ministerial differences. All things considered, for faster decision-making and better follow-up action, the external affairs and the commerce ministries need to be merged. Brazil and Australia, two G20 countries, have one minister who is responsible for both foreign affairs and trade. Their stated intention is to take advantage of the synergies between the functioning of their foreign offices and trade ministries. It is about time that India follows this Brazilian and Australian example.

Indian missions abroad are our official eyes and ears, and personnel who have opted to specialise in economic-commercial work should also report on significant technological trends. For instance, there is considerable speculation about what 3D printing has in store for the manufacturing sector. Currently, a 3D printer that costs about $1,500 can print out screw-drivers and hammers. It would be useful if our missions in developed countries were to interact with government agencies, engineering colleges and private sector firms on innovations in manufacturing.

Going back to the first half of the 1990s, after the breakdown of the Soviet Union, the United States and China were quick to offer highly trained Soviet scientists and engineers well-paid employment in their countries. Clearly, the compensation levels were much higher than what was available in the chaotic post-break-up Soviet Union. It was opportune for India with its long-standing relationships with Soviet-era defence and research establishments to have offered somewhat lower salaries than the United States and China yet attractive opportunities to ex-Soviet specialists. It seems we did think on these lines, but could not resolve what grade these experts would be equivalent to within our scientific establishments. It may be that a sense of insecurity among some of our senior scientist-engineers was the deal-breaker.

The Indian diaspora in developed countries includes highly trained scientists, engineers and management specialists. However, we tend to offer executive and advisory positions only to those who have distinguished themselves in the social sciences. We need to use our missions abroad to also identify those who have excelled in the physical sciences and technical disciplines, and are prepared to teach in India. Many of them have completed their child-rearing responsibilities once they are past 50 years of age and are receptive to spending a few months each year in India.

In select large missions, there are representatives from the Defence Research and Development Organisation and the department of atomic energy (the Indian Space Research Organisation tends to work more on its own) who are in touch with their counterparts. However, cutting-edge technology and applications are areas with which at least some of our foreign-service or administrative-service officers should be familiar. Going forward, for work involving transfer of technology or cyber security officers from technical streams in their university days could be identified early on in their careers. This should be easier than in the past since the proportion of those with a science or a technical background among those who join the civil services has increased sharply in recent years.

To sum up, promotion of foreign trade and investment, and facilitation of scientific-technological tie-ups cannot be left to the individual initiative of officers posted in our missions abroad. We need a systematic approach to the selection of officers and their training for corresponding responsibilities. This would make our diplomacy effective, and not just economic.

The writer is the RBI Chair Professor at Icrier
j.bhagwati@gmail.com

Courtesy: Business Standard

BRICS Bank

Arvind Virmani*

Introduction

The leaders of the BRICS countries approved the formation of the BRICS Bank at their meeting in Brazil, on July 15, 2014. The idea of a BRICS Bank was floated by India in 2011-12 during its chairman ship of the grouping .  A study group was formed in 2012 to explore the idea further.  The leaders of the BRICs countries, approved the setting up of an inter-governmental group at their meeting  in S Africa in March 2013, to work out the modalities. The unresolved issues have been resolved and final approval given by the leaders in their summit in Brazil.

BRICS

Plurilateral discussions among the four largest non-OECD economies, China, Russia, Brazil and India started in late 2006 on the sidelines of the UN. They were given a strong impetus by the start of discussions in 2007 on the IMFs 12th General Quota Review (GQR) slated to be completed by January 2008. It was feared that the Europeans and the US which controlled the management and equity of the IMF (and the World Bank) would continue to resist giving a greater share of equity to the BRICs and other developing countries. As a consequences the Executive directors of these four countries based at the IMF & World Bank, started meeting informally in Washington, to exchange views on the GQR and to co-ordinate their approaches to the extent approved by their “principles” in respective capitals.  The Governors of the IMF from these countries (three Finance Ministers and one Central Bank Governor) also started meeting on the sidelines of Bank-Fund annual and bi-annual meetings. The limited success achieved in the 12th IMF GQR and the corresponding review of World Bank capital, led the BRICs to heighten their interaction. A full diplomatic meeting was held in Russia in May 2008.  The global financial crisis that erupted in 2008 in the developed countries, highlighted the need for BRIC countries to provide an alternative to the philosophy and economic thinking of the G7 and to work together to change governance structures at the IMF and the World Bank. This paved the way for the first formal summit of BRIC leaders in Russia in June 2009. There has been heightened co-operation between the BRICs countries from 2009 onwards, with respect  to the IMF and World Bank, even though the interests of individual countries sometimes differed from the rest.  Efforts were also initiated to expand the areas of collective action, of which the BRICS bank and the Reserve Fund are an outcome.South Africa was invited to the BRICs summit in China in 2010 and admitted to the group thereafter.

Infrastructure Financing

India, along with other developing countries in Sub-Saharan  Africa, faces an enormous challenge of finding the financing to upgrade itsinfrastructure.   Traditional funding sources are heavily constrained, both in the total funds available for development and for the financing that they are able or willing to allocate for development of new infrastructure projects.  At the same time Chinaand oil-gas exporting countries have surplus funds, which are currently being recycled primarily through international financial markets in the Developed countries.  A New Development BRICS Bank has the potential to intermediate these savings from the surplus emerging economies to developing economies with a deficit of finance for infrastructure investment thus accelerate economic growth of developing and emerging economies.

My friend (and former colleague in Washington), Amar Bhattacharya has estimated that the Developing and Emerging economies need for infrastructure funds will increase from the current $800 bi per year to about $2.4 trillion a year in the next two decades. Of this the about $1.2 trillion a year is for new greenfield projects, essential for accelerating and/or sustaining growth and improving the welfare of its people.  Besides networks of railways, highways, ports and airports, the surge in urbanization will put huge demands on both the quantity and quality of urban infrastructure. In many countries the rural areas still lack basic facilities like clean water, sanitation and sewage, which must be built. In addition, budgetary resources of many countries will be stretched just maintaining existing stocks of infrastructure at acceptable levels of quality.  Private investment through Public Private Investment (PPP) is another source of infrastructure investment but has its own limitations.

World Bank

The multilateral institutions like the World Bank are struggling to maintain infrastructure funding at old levels, given new demands and lack of lending capacity.  The World Bank’s lending is reduced to half of what it was before the global financial crisis.  It is unable to increase its capital base for further lending, because of the fear of loss of traditional control of this institution by the developed countries. Private lending for infrastructure has shrunk to one-third of its pre-crisis level.  The BRICS bank is a small but significant step to fill this yawning gap in infrastructure funding.  Just the idea of a BRICS bank had energized the management of the World Bank to set up a special fund for infrastructure. It is likely that the actual setting up of the Bank will induce to bank to improve its own rules and procedures for infrastructure lending. However, given the large disparity in share capital, the BRICS Bank will not be a major threat to it in the next five-ten years.

Equity Shares & Power

The New Development bank (NDB)will be $100 bi Bank with an initial subscribed share capital of $50bi with equal shareholding of all five BRICS countries (i.e. $10bi each). Of this $10 bi will be put up in cash by the five countries over seven years. The remaining $40bi will be in the form of guarantees.  Thus India will have to budget about $300,000 or Rs 1.8 crore per year for the next seven years. Any future expansion of the subscribed share capital to bring in new ones, will ensure that the BRICS continue to have a majority (> 55%) shareholding.

Our experience of the World Bank and IMF tells us that this is a necessary condition for an equal share in governance of new Bank. This also ensures that all five will have an equal voice in defining the philosophy, operational rules and procedures and governance of the bank.  The bank will have to raise debt capital on international capital markets, for lending to potential borrowers. The IMF and World Bank follow the conservative practice of a 1:1 Debt-equity ratio, and the NDB may also have to follow this practice to ensure a high safety rating.  Even if China is a major supplier of this debt capital, it will be at competitive rates, through open bidding and will therefore give no additional power to China as a bond holder (not anymore than it has over the US treasury/Govt. as a buyer of US Govt. bonds).  Its equity share and power over NDB lending decisions will be 1/5th .

On issues of vital national interest to any of the shareholders, a consensus of five countries is likely to favor status quo. For instance it is likely thatthe BRICS bank will be unable to make loans to projects in parts of India like Arunachal Pradesh, expansively claimed by China, if India has already accepted such conditions in the ADB and World Bank.

Bank President

The first President of the NDB, who will be an Indian with a six year term, will play a vital role in setting up the management philosophy, rules and procedures under which the Bank will operate. It will be very important to appoint a banking-financial expert, familiar with the latest instruments, practices and procedures of a competitive private bank,  who can develop a 21st century development bank to compete with the 20th century one like the World Bank.  One possibility is an eminent Indian who rose to the top of an international bank, but has retired from the job and thus had the time to reflect on broader issues.

The Indian presidency will be followed by five year terms for Brazilian and Russian nominees. From this we can assume that the new president will have one extra year to complete all the formalities necessary to create a functioning organization.

Conclusion

  Some have bemoaned that Shanghai and not Delhi is the seat of this new Bank. For this we have no one to blame but ourselves: We have been talking about making Mumbai and international financial center for a decade or more and are no closer to it than when we started! Some analysts have raised the concern that China will have an inordinate influence on the functioning of the Bank. There is nothing in the agreed structure of the Bank that would justify these fears.  Others are concerned about India budgeting so much money for a plurilateral bank. Rationally this should be compared to our funding for World Bank, IMF and other multilateral and Regional Banks and the benefit-cost ratio of each.  In my judgement the benefit-cost ratio will not be any less and perhaps somewhat more.

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A version of this article appeared in the Economic Times of 17 July 2014 under the banner, “BRICS Bank will help fund infrastructure projects in Emerging Economieshttp://economictimes.indiatimes.com/opinion/guest-writer/brics-bank-will-help-fund-infrastructure-projects-in-emerging-economies/articleshow/38504229.cms

India and WTO

By Arvind Virmani
Introduction
At the start of the Doha Round of WTO negotiations, I warned against confusing the Economics and GeoPolitics of WTO negotiations [Virmani(2003)]. I quote extensively from this note (below) because it remains relevant today, in the context of the decision of the Indian Government to make approval of the agreement of “Trade Facilitation” contingent on a commitment to revise the agreement on Food subsidies.I conclude with an economic analysis of protection and subsidies that clarifies the economic issues and puts them in proper perspective
Distinguishing Economics from Geo-Politics
“Economic theory and empirical analysis as understood and accepted by academics in the USA, Europe and the emerging market economies, says that removal of controls, restrictions and obstacles to Imports will by and large lead to an increase in the welfare of both the importing and the exporting countries. Then why is it that each country ignores what its own academics tell it with respect to policy reforms and focuses mostly on the import restrictions imposed by other countries on its export items (whether these are goods, services or factors)? The answer is politics. In every country, politics imposes a cost on the nation as a whole while benefiting some sub-set of individuals. The geopolitics of negotiations is motivated by a desire to transfer some of the national costs of policy distortions onto other countries, while retaining as much of the benefits for sub-groups within the country. A good example of this from the rich countries is the multi-fibre agreement (MFA).
One implication of this strategic approach to multilateral economic rules is that there can be an apparent dichotomy between our domestic reform intentions and actions and our public posture and negotiating stance at WTO. Economic analysis must drive our (autonomous) reforms in the external sector irrespective of what happens (or does not happen) at WTO. That is, liberalisation is beneficial to the country and must continue independent of the WTO and at a pace and timing of our choice. Economic analysis also provides us with the true costs and benefits to our citizens, of specific policy changes. This forms the basis of our evaluation of what rules we should be willing to accept in the negotiations- those resulting in policy change that have a higher benefit to us in any case. Conversely it also determines which changes we should resist conceding (those that have higher cost). The public position that we take at the negotiation need not however lay all this out publicly for other countries. In the tactics and strategy of negotiations, politics/geo-politics will inevitably play a substantial role.”Virmani(2003)
Trade Facilitation
“Trade facilitation is the global equivalent of the Indian mantra, ‘red tape and bureaucracy’ in international trade (import-export) system. Trade facilitation would directly address this problem on which there is a national consensus (with the exception of the customs bureaucracy).”
“From the perspective of politics/geo-politics therefore, it is quite rational for India to concede to others on any of the Singapore issues if and only if we gain concessions and benefits in other areas. In other words we must use these as counters to bargain for what would not be available to us otherwise. It should be remembered however that these bargains are sometimes informal, on the sidelines of the formal negotiations or a meeting in another capital.”Virmani(2003)
WTO Negotiations on Agriculture
“Agriculture is an area where the economic arguments of rich countries are very weak (because of high subsidies) while those of poor countries are relatively strong. It is quite clear that many countries in the EU and to a lesser extent the USA are hostage to agriculture producers who constitute a small fraction of their population. On our side a large proportion of the population is dependent on agriculture, lives in rural areas, is very poor and less educated and has little access to up to date and relevant knowledge. This puts their lively hood and sometimes even their survival at risk from exogenous shocks. Over the last few years we have also raised the import duties on a number of agricultural products above the peak rate. The inter-ministerial expert group argued that in the interest of economic efficiency, these should be brought down to the peak rate, with an intermediate step of two times the peak rate. In the meanwhile, we should carry out a thorough de-control and reform of the agriculture, agro-processing and food retail sectors (as detailed in a Planning commission working paper).
As far as the WTO negotiations are concerned, however, offence is the best form of defence. We should marshal the global NGOs to expose the hypocrisy of the rich countries vis-à-vis free trade and verbal concern for the poor (while giving subsidies to rich farmers that destroy poor agriculturists jobs). The outcome of this will either be a stalemate (both rich and poor countries retain their preferred distortions) or less likely a trade-off relating to (one or more of) the Singapore issues. A commitment to reduce rich country agricultural subsidies in return for a reduction in (bound) tariff rates on agricultural goods in poor countries the third but least likely possibility.” Virmani (2003)
Economics Of Food Subsidy
In several articles during the last year I opposed the Food Security Bill on the grounds that it was barking up the wrong tree. As I showed the real problem is child malnutrition and this requires improved sanitation not more food. However, we now have the food security Act and the Govt. has to implement it as it stands, until it is amended or redirected. If the pessimistic calculations of the fiscal critics of the Act come true, implementation will involve huge subsidies. There is a fear in the Indian bureaucracy, that unless the exiting WTO subsidy limits are changed, India could be constantly in the dock at the WTO, having to answer to Global agricultural exporters for domestic subsidies. To put this fear in perspective, we need to understand the three aspects of Agricultural protection-subsidy:
(1) Production Subsidies (Sf)
Subsidies on agricultural inputs given to the farmer, such as fertilizer, electricity and water, that reduce the cost of production. If the subsidy per unit of output is Sf = s Pd this will reduce domestic market price from Pd to Pd’ = Pd – Sf = (1-s) Pd. The last WTO agreement on Agriculture puts a limit on production subsidies of 10% based on a three year average of prices prevailing at the time the agreement was signed (1986-88). This is clearly outdated and needs to be updated to current/recent price levels. Once this is done a 10% subsidy limit would mean that input subsidies cannot exceed 1.8% of GDP (as GDP from agriculture is about 18% of total GDP). Current input subsidies are less than 1% of GDP. To pump even more than this amount into agriculture input subsidies instead of into enhancement of agricultural productivity, would be reflective of very bad agricultural policy. In the medium term, direct income transfers to poor farmers could eliminate even the need for this level of input subsidy.

(2) Tariff Protection (t)
Protection of domestic agricultural/food output through tariffs (and QRs). If the effective tariff rate is t this will mean that with World Price Pw ,Pd’= (1+t) Pw or Pd= (1+t) Pw + Sf= [(1+t)/1-s)] Pw . The effective tariff rates on Wheat and rice have varied between 5% and 10% in the recent past, without exceeding the latter.
The WTO agreements on tariffs, stipulates that the “actual” tariff rate cannot be higher than the “bound tariff rates”. Even though our peak tariff rate on non-agriculturalgoods is 10%, the bound rates on agriculture are two to three times the bound rates on non-agriculture imports. Therefore elimination of input subsidies could be offset by raising the import tariffs to t’ = s + t (1+s), thus keeping the degree of import protection to farmers unchanged.
(3) Consumer subsidies (Sc)
Consumer subsidies reduce the price of food paid by the consumer (Pc) below the market price. Pc = Pd’- Sc = (1+t) Pw -Sc . There are no WTO limits on consumer food subsidies. However, our consumer subsidies are provided through the FCI which also runs the price support system for farmers. Therefore it is not always clear what part of the subsidy given to FCI is compensation for its inefficiency and corruption and how much is a subsidy to consumers.
Further, foreign producers argue that the MSP acts as a subsidy to farmers and must be included in the production subsidy calculation, as the Govt. does not allow foreign agriculture producers to supply FCI imported agricultural produce at the MSP. Though this point is debatable, it could be another issue for putting Government in the dock at the WTO. If food subsidies were provided directly to consumers through a food debit/credit card or a bank account(instead of through FCI), the issue would not arise.
Conclusion
The Indian Government has stated that it is willing to continue discussion on the Bali issues when the WTO meets again in September after a recess. It seems to me that a reasonable compromise that meets the domestic political objectives of India as well as of Agricultural exporters such as the USA and Australia is possible before the end of the year given a genuine desire to reach agreement, instead of trying to scapegoat India.

IMF Quota Formula Flawed: A simple test

The Emerging economies, particularly Brazil, India and Russia, have called for a fundamental reform of the IMF Quota Formula, arguing that the formula is fundamentally flawed.  The Advanced Economies, particularly rich countries of Europe, have asserted that the formula is just fine and minor tweaking may be all that is required.  Our earlier blogs and papers have addressed this issue from the philosophical and analytical angle. This blog presents a simple test to determine whether the formula is flawed.  the same test can also be applied to check whether any proposed change in the form represents a serious effort at reform.

One simple numerical measure of the flaws in the formula is what in the IMF’s esoteric parlance is known as “over representation” and “under representation” of member countries.  This is the difference, for each member, between the actual quota share (AQS) and the calculated Quota share (CQS).  We can easily calculate the AQS and CQS which would prevail after the 14th General Quota review based on data available in 2010 (termed the 2010 quota reform) and calculate the difference X=AQS – CQS.  In IMF parlance countries with a positive X (AQS > CQS) are defined as “over represented” at the IMF, while those with a negative X (AQS< CQS) are defined as “under represented.” Table 4 summarizes the number of such countries among the set of Advanced Economies (AEs) and Emerging Market and Developing Countries (EMDCs).

Table 1: Statistical Measure of Bias in Flawed Formula

Number (%) of countries

                                                     Over represented         Under represented

Advanced Economies (AEs)                5 (24%)                         16 (76%)

Emerging Economies (EMDCs)         100 (70%)                       42 (30%)

          Table 1 shows that 76% of the AEs are “Under represented” while 70% of the EMDCs are “Over represented.”  Thus the formula is clearly biased in favor of the AEs and against the EMDCs and needs to be reformed.

A minimal test of a Quota formula reform would be whether the quota formula reform removes this statistical bias i.e. whether the new formula yields a CQS that evenly distributes the number of AEs and EMDCs in the two categories.

Source Blog dated October 15, 2012: http://dravirmani.blogspot.in/2012_10_01_archive.html