The South Asia Channel

After the Election: The Economic Challenge for India’s New Leaders

In India, a change of government is in the offing. But whether Narendra Modi or a rival politician becomes prime minister this month, a central challenge facing India's new government will be to reemphasize the economic dimensions of the country's international strategy.

It is economics, after all, that enabled India's emergence in the first place. Prior to the reforms of 1991, India was large, populous, democratic, locked in a nuclear competition with Pakistan, and a partner of at least one of the big powers -- the Soviet Union. Yet India's Asian and global role was heavily constrained by the realities of its weak economy. India lacked a seat at the world's top tables, had virtually no capacity to move global markets, and was often seen as a peripheral player in the international relations of the Cold War.

But economic growth changed everything. An initial, partial wave of reform following the 1991 balance of payments crisis began to unshackle India's economy and yielded the conditions for rapid growth. Over the next two decades, growth gave India the capacity to act on issues of primary strategic and economic concern to the international system.

Rapid growth also allowed India's trajectory to diverge sharply from that of its South Asian neighbors, especially Pakistan. India gained influence, credibility, and a seat in the world's leading economic institutions, including the G20 and the Financial Stability Board.

There were, to be sure, exceptions, such as India's active diplomatic role in Indochina during the late 1970s and 1980s. But in ways unprecedented since the country had been subsumed within the British Empire, post-1991 India acquired influence, ambition, and a capacity for action beyond its confining strategic geography in South Asia.

As India heads for the counting of ballots, it is economics that defines the strategic problem facing its next government. Put simply, if growth has enabled a heftier Indian role both in Asia and on the world stage, then slower growth logically threatens that new role.

That is one reason why India's next government needs to wrestle with the problem of slowing growth. Beyond the question of economic performance, it will also need to deal with two broader elements of the relationship between economics and national strategy: First, how to meld economics more directly into Indian foreign policy, and second, the strategic consequences of choices about whether and how to exercise economic leadership, particularly in India's own neighborhood.

 

The economic dimensions of strategy

One reason economic statecraft will be so important to India's next government is that the emphasis in New Delhi's foreign policy lies increasingly to the east.

Two worlds -- continental and maritime -- have intermingled and collided throughout India's strategic history. Yet where continental preoccupations, not least the threat of war with Pakistan, have dominated Indian strategy, China has now begun to replace Pakistan at the center of Indian defense planning. Sino-Indian relations have become a principal focus of Indian debates about the reliability of its strategic deterrent, and whether India needs to test nuclear weapons again

Still, China is not the whole story. Growth has enlarged India's role in the East Asian economic system more broadly and increased its capacity to influence the wider balance of power.

Strategically, India has been bottled up in the subcontinent for generations, but this wasn't always so: Southeast Asia bears the hallmarks of a bygone era in names like "Indonesia" and "Indochina," and Indian sailors once plied trade routes from the Indian Ocean to the Strait of Malacca.

As maritime preoccupations, including shared concerns about China's growing naval power, have replaced continental ones, an economically vibrant India has once again become more relevant in Southeast Asia. Security of the sea-lanes offers natural affinities with Southeast Asian littoral states such as Indonesia.

 

Opportunities overlooked in East Asia

But as India once again "looks east," it risks being left behind because of the mismatch between its lofty strategic goals and more earthbound economic realities.

Take trade: Trade plays a growing role in the Indian economy, and India has signed preferential trade agreements with the Association of Southeast Asian Nations (ASEAN) and Singapore. The growth of consumption in India has also led to expanded goods-related trade with major Asian industrial nations. For instance, Japanese and Korean trade with India rose sharply from 2000 to 2008, more than doubling in Japan's case and increasing 11 times in South Korea's. Brands from both countries dominate many consumer sectors in India, from passenger cars to electronics.

Yet the backbone of East Asian economics remains integrated supply and production chains to which India is largely irrelevant. In 2012, 11.7 percent of ASEAN's trade was with China while only 2.9 percent was with India. 

The challenge for India's next government, then, is to undertake the kinds of domestic economic choices that would have direct relevance for India's reintegration with East Asia. An example is manufacturing: It has grown in India's southern states but has shrunk as a share of India's overall economy, despite a national policy that has aimed to increase the share of manufacturing in GDP from around 16 to 25 percent in a decade.

A reinvigorated national manufacturing policy could yield industrial parks, warehousing, and opportunities in special economic zones. But huge obstacles remain. Some in India view this as a backdoor to relaxing labor laws. Such policies could falter, too, on land acquisition. And there is little sign that any prospective coalition, including but not limited to a Modi government, would tackle these politically sensitive issues.

But if it fails to do so, India's next government will waste the moment. The rising cost of labor-intensive manufacturing in coastal China has scrambled the traditional production equation for export-oriented manufacturers across Asia. Some manufacturers are choosing to relocate production to interior China, but others are choosing to leave China entirely.

For India, this shift could bring benefits. Real appreciation of the Chinese yuan, alongside rising Chinese demand for imports, could help India narrow its trade deficit with China-a growing concern to the Reserve Bank of India and the commerce ministry. And with the growth of manufacturing, not least in southern states such as Tamil Nadu, India could capitalize in some areas of production as China moves up the value chain, including machinery, auto parts, and even automobiles.

New Delhi isn't the only piece of the puzzle. As the economic success of Gujarat under Modi's leadership has demonstrated, business-friendly states are another.

India's constitution divides jurisdiction between New Delhi and the states in far-reaching ways. The center has power over finance, defense, trade, telecommunications, foreign investment, and some infrastructure. But states have wide authorities on subjects that matter greatly, including electricity, agriculture, land, domestic investment, and policing.

As investors aggressively seek new opportunities in Asia, central and state-level policies -- including new investments in infrastructure, fiscal incentives, tax policies, and improvements in supply and distribution networks -- will shift Asia's industrial landscape.

In short, if India aims to "look east," it faces a problem of economics. Without the "right" domestic choices -- and without a broadened trade, investment, and financial integration policy for Asia -- India will lack a true Asia strategy. The business of East Asia is business, and naval exercises and maritime policing cannot in themselves furnish an adequate substitute.

 

What are the strategic consequences?

Economic choices will also matter in India's more immediate neighborhood. South Asia is among the least economically integrated regions of the world, in part because partition cleaved apart natural economic communities. Regions such as Bengal, which had been well integrated historically, suffered considerable ill effects, and post-1947 tariffs, production restrictions, and trade controls exacerbated the problem.

As India's outgoing national security advisor, Shivshankar Menon, has argued, economic success has raised the costs to India of not doing business with contiguous countries. One recent report from an Indian consumer research group, with support from the Asia Foundation, argued that further integration of trade among South Asian economies could yield as much as $2 billion to consumers. India-Pakistan trade liberalization alone could yield as much as $18 billion in two-way trade, according to the Pakistan Business Council.

Mohsin Khan of the Peterson Institute writes that Pakistan's November 2011 decision to grant most favored nation (MFN) status to India could prove especially significant. One constructive step was Islamabad's 2011 shift from a "positive-" to a "negative list"-based import regime. India's outgoing trade minister, Anand Sharma, noted that this step increased from 17 percent to about 90 percent the number of items that India can trade with Pakistan.

Some, such as Sanjaya Baru, argue that India should work not just for India-Pakistan bilateral cooperation, or regional cooperation within the South Asian Association for Regional Cooperation (SAARC). Given the slow pace of these two efforts, Baru argues, India should seek to expand the number of tracks through which it pursues economic cooperation, financial integration, and trade liberalization, using vehicles such as an expanded "Bay of Bengal Community." This would build eastward off of an existing effort, "BIMSTEC," which involves technical cooperation among Bangladesh, Bhutan, India, Nepal, Sri Lanka, and two Southeast Asian countries -- Burma and Thailand.

For India's next government, the bottom line is that economic choices at home and abroad will have strategic consequences. India's success will increasingly depend on how New Delhi and state governments respond to opportunities being generated beyond their country's borders.

In East Asia in particular, economics and security are colliding, as China continues to emerge as the principal player in a new economic regionalism while unsettling its neighbors with territorial claims and military displays. In the face of such strategic uncertainties, an India with an enhanced political and security profile still risks being left behind as Asian economic integration tightens.

Evan A. Feigenbaum is a nonresident senior associate in the Asia Program at the Carnegie Endowment for International Peace. He served during the George W. Bush Administration as deputy assistant secretary of state for South Asia, with principal responsibility for India.

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