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Home >Opinion >Views >What must be done to make the most of a sweet spot India is in

What must be done to make the most of a sweet spot India is in

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Venkatraman Anantha Nageswaran. Photo by SaiSen/Mint.

Charles Goodhart and Manoj Pradhan’s The Great Demographic Reversal could not be timelier

Charles Goodhart and Manoj Pradhan’s The Great Demographic Reversal could not be timelier. It talks about the return of inflation due to a reversal of demographic trends that had suppressed it. The timing, of course, is a matter of speculation. In the last few weeks, bond investors have thrown a tantrum in America and elsewhere because they fear a return of inflation, and, even more, that central banks will do nothing about it, thus reducing the real returns that they earn on bonds. So, they are selling bonds. Central bankers have reassured them that inflation won’t rise so much and that there is plenty of time before it happens, if it does. Bond investors are not fully convinced. The next step for central banks would be to suppress bond selling. That will almost complete the nationalization of financial markets and herald the arrival of central planning in the West three decades after the US claimed to have vanquished a rival power that swore by it.

Charles Goodhart and Manoj Pradhan’s The Great Demographic Reversal could not be timelier. It talks about the return of inflation due to a reversal of demographic trends that had suppressed it. The timing, of course, is a matter of speculation. In the last few weeks, bond investors have thrown a tantrum in America and elsewhere because they fear a return of inflation, and, even more, that central banks will do nothing about it, thus reducing the real returns that they earn on bonds. So, they are selling bonds. Central bankers have reassured them that inflation won’t rise so much and that there is plenty of time before it happens, if it does. Bond investors are not fully convinced. The next step for central banks would be to suppress bond selling. That will almost complete the nationalization of financial markets and herald the arrival of central planning in the West three decades after the US claimed to have vanquished a rival power that swore by it.

In the second chapter of the book (I have not gone past that yet), the authors narrate the story of China. For all of China’s debt accumulation, they do not expect that it would face a crisis for the simple reason that both its borrowers and lenders trace their parentage to the Chinese state. It is possible for China to cancel debt. It is not so easy for other countries, including Japan. This interesting observation apart, their tracing of the trajectory of China’s economic liberalization indicates something useful for India. China got the sequence of its economic reforms right.

In the second chapter of the book (I have not gone past that yet), the authors narrate the story of China. For all of China’s debt accumulation, they do not expect that it would face a crisis for the simple reason that both its borrowers and lenders trace their parentage to the Chinese state. It is possible for China to cancel debt. It is not so easy for other countries, including Japan. This interesting observation apart, their tracing of the trajectory of China’s economic liberalization indicates something useful for India. China got the sequence of its economic reforms right.

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It liberalized the real economy. In the first phase, its farm sector was de-collectivized and private enterprises were encouraged. The second phase was about restructuring public sector enterprises. In the third phase, in the new millennium, China joined the World Trade Organization (WTO). Now, in the fourth phase, after its economy has attained middle-income status, China is accelerating its financial sector liberalization. In contrast, India had put the cart before the horse.

Take foreign direct investment (FDI). Since financial investment options were limited in China, thanks to financial repression and extensive capital controls, FDI flowed into its real sector. In contrast, India attracted large portfolio flows because India liberalized foreign financial investment faster and also offered capital account convertibility for such investments, along with a liberal capital gains tax regime. It is remarkable that this approach has not changed under different governments. There was a de facto political consensus on rolling out the red carpet for foreign financial capital.

India pursued trade and financial liberalization before it could restructure its real economy. Thanks to the institutional caution of the Reserve Bank of India, India’s financial liberalization has not caused as much damage to the real economy as it could have. India was an enthusiastic early member of first the General Agreement on Tariffs and Trade (GATT) and then the WTO. The country liberalized external trade before its real economy had achieved a semblance of efficiency and competitiveness. So premature trade openness led to premature de-industrialization. This point was made elegantly by Diva Jain in these pages (‘India must look beyond its Atmanirbhar Bharat policy’, 20 January 2021).

India is currently trying to make up for its failure to address its real-sector competitiveness nearly three decades into its economic liberalization process, not just with its initiative on the privatization of public sector enterprises, but also with its farm sector reforms, labour code revisions and production-linked incentive schemes that seek to attract global manufacturing facilities to India. The country now appears better placed to make the required changes. So this is a case of ‘better late than never’.

In the meantime, China is vacating some manufacturing spaces. Globally, tentative attempts are being made to relocate supply chains. India’s vaccine diplomacy is also working better, according to some newspaper reports. More importantly, other emerging economies are in far worse shape than they were in the first decade of the new millennium when emerging economies were all the rage. That is when BRICS became famous. Recently, the Financial Times reported that Mexico has been systematically undermining investor confidence in the last 30 months. In Brazil, Bloomberg frets about the fate of economic reforms after the president of the country removed the president of state-owned Petrobras. India, thankfully, is moving in the opposite direction. So, it is bound to remain firmly on the radar of investors—both portfolio and direct. Put differently, India is in a sweet spot, and this seems like a source of concern for some both outside and within the country.

On its part, the government can do more to consolidate India’s sweet spot. It should divest itself of LIC. I don’t mean Life Insurance Corporation of India (LIC). That will happen. I mean the Licence, Inspection and Compliance Raj. This should be the mission and mantra of the Union, state and local governments for this decade. India will not only have fully opened up then, but also have arrived as a competitive economic force.

These are the author’s personal views.

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