Summary and Recommendations
and Recommendations Observation 1: The Indian economy recently encountered serious turbulence and will require important reforms to stabilize it. To some extent, India's problems reflect India's deep and ongoing financial integration with the world economy. For example, between 2010 and 2012, India received about $160 billion in foreign capital inflows. With the US Federal Reserve planning to reverse its unconventional monetary policy, and as the US economy has rebounded, some of this money is
... e of this money is flowing back to the United States, causing currency declines and turmoil in several emerging markets, especially India. But India's problems also have deeper domestic origins, and require serious reforms to overcome them (elaborated in my recent New York Times article). Fiscal consolidation, based on eliminating wasteful subsidies and introducing new taxes, will be critical. But looming elections could complicate reform actions and perpetuate uncertainty and turbulence. Observation 2: Economic uncertainty over the last year has triggered unprecedented liberalization of foreign direct investment (FDI) and other capital inflows. This seems paradoxical, at first blush, but is consistent with international experience that governments take action when a sense of crisis looms. In the last year, India has liberalized its FDI regime in several sectors-multi-brand retail, defense, petroleum and natural gas, stock exchanges, telecommunications, infrastructure-to a greater extent than in recent history. In order to attract foreign capital, the government also relaxed a number of constraints to foreign equity, portfolio, and debt inflows. Prediction: Further opening to foreign investors, especially providers of financial services, is likely. A new pension-related bill has just cleared one of the two chambers of the Indian legislature. This bill paves the way for foreign investment-up to 26 percent-in the sector, with additional increases in the foreign limit linked to the draft insurance legislation. This insurance legislation, if passed, would allow for increased foreign ownership of insurance firms from 26 percent to 49 percent. The new governor of the central bank has signaled an openness to reforming the financial sector and to encouraging foreign participation in the Indian banking system. Recommendation 1: The time may be ripe for pursuing a bilateral investment treaty (BIT). The recent spate of FDI liberalization-as well as competitive pressure from US-China investment negotiations-could pave the way for India to pursue a BIT. Although negotiations will have to address some difficult issues, including investor-state disputes and visa issues, the domestic actions necessary to allow international negotiations are being taken. Recommendation 2: A BIT is but a stepping stone for creating a broad and strategic framework for US-India trade. This framework would include embracing the principle of, and initiating preparatory work toward, a free trade agreement (FTA) in the medium term. This framework is necessary for a number of reasons. First, the prize is big. India has had 30 years of close to 6.5 percent growth, and about 8.5 percent in the last decade. In 2012, it became the world's fourth largest economy after the United States, China, and Japan (PPP dollars). Its trade in goods and services is about a billion dollars. It will need investments in infrastructure, and imports of natural gas and services. The United States has comparative advantage as a supplier. Moreover, India-US trade is well below potential (about 50 percent), which a free trade agreement could rectify.