India's Goldilocks Globalization
by Arvind Subramanian, Peterson Institute for International Economics
Op-ed in Newsweek
June 15, 2009
The Congress Party's big win in the recent Indian election was a double surprise. Recent Indian politics have featured a strong strain of anti-incumbency, and the global financial crisis has spelled trouble at the polls for many other governments worldwide. True, before the trouble hit, India had enjoyed five years of the fastest economic growth in its history, reaching 9 percent—almost the same pace as China. But the global crisis could easily have erased all the happy memories. Yet that didn't happen, and for one big reason: India has not been a gung-ho globalizer.
The crisis that began in the United States spread abroad through two channels: finance and trade. Countries that sucked in a lot of foreign capital—like those in Eastern Europe—suffered huge disruptions to their exchange rates, asset prices, and financial systems when this capital fled to safety. Meanwhile, countries that relied heavily on exports—like Singapore, Taiwan, and China—also suffered when foreign demand collapsed.
India managed to avoid both extremes. That's because it followed a strategy that can be called "Goldilocks globalization," relying neither too much on foreign finance nor too much on exports. On the financial side, unlike the Eastern European countries that ran a current account deficit of more than 10 percent of GDP, India kept its own at about 2 to 3 percent of GDP. India also cannily insured itself against turmoil by building a healthy cushion of foreign exchange reserves: about $315 billion worth, among the highest in the world. As a result, when the crisis hit, India was able to provide dollars to investors that were selling rupee assets and demanding dollars in return. This reassured investors, leading many to keep their money in India.
On the trade side, India's exports of goods and services never accounted for more than about 20 percent of its economy, compared with about 45 percent for China and up to 100 percent elsewhere in Asia. Thus when foreign demand for products collapsed, this hurt India far less. Indeed, between March 2008 and March 2009, India managed to grow at 6.7 percent, well above the rate of most industrial countries.
It's worth asking whether all this was a result of a conscious strategy—whether Prime Minister Manmohan Singh deserves credit for following this middle road on globalization. Determining intent or purpose is always tricky when dealing with a weak and decentralized polity such as India. Yet there's no question that New Delhi did deliberately choose to follow a steady and gradual approach to reforms in general and globalization in particular. As Montek Ahluwalia, one of India's leading economic policymakers, has put it: In Indian politics, there is a strong consensus for weak reforms.
Such an approach wasn't an unalloyed good. It meant that India never enjoyed the kind of benefits—such as greater efficiency and productivity leading to even higher growth—that big-bang reforms can deliver. But it did have the huge advantage of ensuring stability when conditions got rough. Perhaps the most telling example of how this worked can be found in the Indian banking system, which is still three-quarters owned by the government. During the crisis, the only bank that was seriously endangered with exposure to toxic assets was a private one. India's cautious government-owned banks had nothing to do with these dangerous assets and were thus able to provide a safe haven to depositors fleeing the private system.
Now that the election has delivered Singh a big win, many observers expect him to abandon his caution and press forward with dramatic changes. Indeed, he will probably try to push for bolder reforms, such as greater infrastructure development and foreign investment in key sectors. Yet India's political system features numerous checks and balances, making rapid progress unlikely. The country's political system is often said to have the wheels of an ox cart and the brakes of a Rolls-Royce. No matter how much change Singh manages to accomplish, he'll never make the rest of the machine resemble a Rolls. Yet the country would happily settle for a Nano: India's revolutionary $2,000 car that's far from fancy but a good metaphor for the country's modest, and successful, approach.