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Global Financial Turmoil and India’s Look East Policy
Mukul G. Asher*
The ongoing global financial turmoil represents an end of an era of exuberant financial
capitalism. But the transition to a more sedate and scaled down financial sector will be traumatic for the
world as a whole, as well as for Asia. Since Asia does not appear to be the epicenter of the current
turmoil, its growth is likely to be relatively less seriously affected. There is however no reason for Asia to
feel complacent, as even moderately diminished growth prospects could exacerbate economic
hardship and adversely impact on social cohesion. What then are the future directions for
India’s look east policy?
*Professor of Public Policy, National University of Singapore. E-mail: [email protected]
I
Introduction
The main objective of this paper is to examine the implications of the current global
financial and economic crisis for India’s Look East Policy (LEP). This policy was initiated in the
early 1990s to revitalize India’s age-old civilizational and economic links with the rest of Asia,
particularly with Association of South East Asian Nations (ASEAN), China, Japan, and South
Korea. More recently, economic and political links between India and Australia have also
strengthened considerably [Drysdale, 2008; Palit, 2008].
The paper is organized as follows. The ongoing financial turmoil and its possible impact
on global economic growth, external trade, and investments are discussed in Section II. This is
followed by a discussion of recent developments concerning India’s relation with the rest of Asia
in Section III. The ongoing global financial turmoil signals the end of an era of essentially
unregulated, excessively leveraged global financial capitalism. Under these new circumstances
what are the future directions of India’s LEP? This is discussed in Section IV. The final section
provides the concluding observations.
II
Global Financial Turmoil and Its Economic Consequences
The ongoing financial turmoil1 has brought into sharp focus the inherent consequences between
unchecked financial innovations in products (e.g. credit-default swaps) and in institutions (e.g.
hedge funds, Sovereign Wealth Funds or SWFs, and private equity firms), and excessively loose
credit conditions over a prolonged period on the one hand and the nation-state based regulatory
structures on the other. Rapid and extensive globalization of finance2 has outpaced limited
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institutional and regulatory capacities.3 IMF, usually given to understatements, has warned of
financial meltdown, underscoring the gravity of the current crisis.
Excessively large budget and trade deficits of the United States (U.S.), and
correspondingly large trade surpluses by China and resource-rich countries, have also played a
part in prolonging unsustainable global macroeconomic imbalances (Wolf, 2008). The surpluses
were largely reinvested in the U.S. and Europe, lowering the interest rates. Some argue that these
led to substantially increased risk-appetite by the financial institutions, contributing to the types
of financial innovations, and accounting practices which have now proved to be excessively
risky. Global macroeconomic imbalances will therefore need to be addressed as part of
comprehensive strategy for tackling the current global financial turmoil.
The global financial turmoil has led to the effective nationalization of the large chunks of
the financial sector in the U.S., U.K. and Europe.4 Recapitalization of banks, primarily from
governmental resources; and extensive, in some cases blanket guarantees for bank deposits have
been the major instruments. In the U.K., the inter-bank loans have also been guaranteed. Such
recapitalization is a complex technical exercise. The current Plan also implies shouldering
unknown amount of contingent liability by the state.
The plan of action of the G7 Finance Ministers and Central bank Governors aims to
stabilize financial markets, restore flow of credit, and support economic growth
(www.rgemonitor.com). The Plan also promises better accounting rules5 and disclosure norms.
There is widespread perception that the financial institutions have not yet made full
disclosures of their balance sheets and risks they have accumulated. Reestablishing confidence in
and among financial institutions is essential to deal with the current turmoil. Any unexpected
significant disclosure could adversely affect the confidence.
The details of the Plan are still not available (as of October 13, 2008). There is a debate in
Europe whether to pursue synchronized national strategies or agree on a Europe-wide Plan. The
decisions about bearing recapitalization and contingent liability costs involve differing political
economies and legal and regulatory structures. So the manner in which broad objectives are
translated into specific measures will naturally differ across countries. The fiscal costs involved
will have opportunity costs requiring foregoing of expenditure in other areas such as
infrastructure and the social sector.
It, however, appears that the financial sector will henceforth not play as dominant a role
as in the past. More sedate and scaled-down financial sector is likely as the regulators will
henceforth be cautious about the automatic acceptance of the new financial products and players.
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The epicenter of the current financial turmoil is the industrial countries, particularly the
U.S., U.K. and Europe.6 For Asia, the key question concerns the likely impact of the ongoing
financial turmoil on its economic growth, external trade, and investment flows.
The IMF (2008) projects that the global economy will grow at only 3.9 per cent in 2008
(5 per cent in 2007); and by just 3 per cent in 2009. In the past, the IMF has called global growth
of 3 per cent or less as equivalent to global recession.
IMF (2008) projects that the growth in the world trade volume for goods and services
will decline from 7.2 per cent in 2007 to 4.9 per cent in 2008 and to 4.1 per cent in 2009. This
represents a sharp decline from its July 2008 projections. External trade dependent economies,
many of which are in Asia, could therefore be severely impacted. Slower growth could also
negatively impact flow of remittances in some of the Asian countries, particularly Philippines,
Vietnam, Indonesia, and India. Those countries relying on remittances to help finance large
current account deficits could experience pressures on their exchange rates. To the extent
remittances support domestic consumption, poverty levels may also be adversely impacted.
Inflation is also expected to remain high. With a concerted lowering of interest rates by Central
banks around the world, the negative real interest rates could continue to distort financial and
capital markets.
The above projections by the IMF were made before the policy initiatives by the Western
governments outlined earlier. It is probable that even the revised projections of the IMF may be
too optimistic.
Goldman Sachs (2008) has projected pan-Asia (including India) growth to be 5.5 per cent
in 2009, and growth in ASEAN and Newly Industrialized Economies (NIEs) at 3.2 and 3.1 per
cent respectively. Figure 1 shows the expected reductions in selected Asian countries in 2009 as
compared to the base period of 2007. It suggests that not just highly external-trade dependent
economies of Singapore and Hong Kong, but also other Asian economies are likely to exhibit
lower growth. But for most countries, the reduction in growth rate will be moderate, at least until
2009.
Figure 1: Expected reduction in Growth in Asia, 2007-09
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Source: Goldman Sachs (2008)
III
India’s LEP: Recent Developments
Since India initiated LEP in the early 1990s, it has consciously used the external sector as
one of the engines of growth. In 2006, its total external trade in goods and services was US$ 434
billion (48 per cent of GDP)7. It received FDI of US$ 25 billion in 2007-08, and the target for
2008-09 is US$ 35 billion. In 2007-08 the gross capital inflows into India were US$ 429 billion,
while the gross outflows were US$320 billion, resulting in net inflows of US$109 billion
(www.rbi.org.in).
However, as compared to East Asia, India’s growth strategy will continue to rely
relatively more on domestic markets, consumption rather than investments (though its saving and
investment to GDP ratios now exceed 30 per cent), and decentralized entrepreneurial, rather than
state-led development, and more market-based allocation of savings.
Thus, in addition to the size of its GDP (US$1200 billion), and gross external flows,
India’s growth model provides the rest of Asia an avenue for global risk diversification and
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ample commercial opportunities. The turmoil may also increase the attractiveness of India as an
avenue for channeling East Asia’s excess savings, and pension reserves.
India, however, will need to undertake regulatory reforms, and lower cost of doing
business to realize its potential as an investment destination. India has continued to engage the
rest of Asia bilaterally as well as multilaterally since initiating the LEP [Asher, 2008; Kumar,
2008]. India has been a low-key but constructive participant in the East Asia Summit (EAS),
launched in Kuala Lumpur in December 2005. It comprises 16 countries – 10 ASEAN members,
China, Japan, South Korea, India, Australia, and New Zealand. India is a member of AsiaEurope Meeting (ASEM); and ASEAN Regional Forum (ARF), devoted to security issues. It is
also a dialogue partner of ASEAN.
India-ASEAN FTA
An important recent milestone in India’s LEP is the India-ASEAN FTA, which will
reportedly be formalized at India-ASEAN Summit in Bangkok in December 2008. It provides for
gradual elimination of tariffs on 80 per cent of tariff lines by 2015 [Kumar, 2008]. For an
additional 10 per cent of the tariff lines that are on the sensitive lines, the tariffs will be brought
down to 5 per cent.
The static as well as dynamic effects of India-ASEAN FTA will depend on two crucial
factors. The first concerns the details of the agreement, as the fine print may negate the intended
and advertised impacts. The second concerns the implementation integrity. The initial euphoria
over the signing of the PTA should not divert attention from the importance of effective
implementation. Substantive gains will flow only if the PTA is implemented sincerely in letter
and spirit, and with low transaction costs.
The ASEAN Free Trade Agreement (AFTA), for example, after many years of
implementation has been able to bring under its purview only 5 per cent of total intra-ASEAN
trade, which in turn is only a quarter of ASEAN’s global trade. Many businesses do not find it
worthwhile to utilize AFTA as transaction costs are higher than the benefits which may be
obtained.
Both India and ASEAN therefore need to ensure implementation integrity and low
transaction costs. As far as India is concerned, it should strengthen its trade monitoring
mechanisms including enhancing surveillance and commercial intelligence systems both within
India and in individual ASEAN countries. India should continue efforts to enhance monitoring
and strategic functions of its Electronic Data Interchange (EDI) and build requisite human
resources. As India is set to introduce a comprehensive Goods and Services Tax (GST) by the
beginning of the next decade, these measures will also assist in its smoother implementation.
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Indian policymakers consider introduction of the GST as essential to realize the full potential of
India’s large internal market.
In strengthening commercial intelligence in ASEAN particular attention should be paid to
thorough understanding of the trade documentation and reporting procedures of key ASEAN
countries. Those countries with large re-export sectors such as Singapore will require careful
study for analyzing the trade documentation procedures and trade recording for identifying the
trade flows.
India-ASEAN PTA must also be made consistent with the bilateral agreements which are
already operational between India and Thailand and India and Singapore. This aspect can only be
analyzed further once the full details of the PTA are known. Any large differences between the
PTA on one hand and bilateral agreements with Thailand and Singapore respectively on the
other, may adversely impact on implementation integrity and potentially reduce economic
efficiency gains.
India-ASEAN PTA is a credible step forward in India’s LEP. Both parties however
should not overlook the gains obtainable from an efficient multilateral rule-based liberal trade
regime. The attention of the policymakers in the industrial countries will however be diverted to
tackling the current global financial turmoil. So their energies are unlikely to be devoted to
reviving the Doha round. Nevertheless, multilateralism should be preferred option whenever
feasible.
As part of its LEP, India is negotiating FTA-type pacts with Japan, South Korea, and
Malaysia. Japan and South Korea are major investors in India. Demographic complementarities
between India (relatively favorable demographic profile) on the one hand and Japan and South
Korea which are rapidly aging also provide opportunities for cooperation. India’s negotiations
for economic agreements with Australia, China, and Indonesia are in the early stages, but are
likely to receive impetus due to the current global financial turmoil.
The above discussion suggests that as a result of the LEP, India has been far more
intricately integrated with the rest of Asia then is commonly perceived or acknowledged. This is
particularly the case if contribution of Indian humanpower in Asia is included. Even in the
electronics trade, location of R & D labs of some of the MNCs in India (for example, by Intel,
and GE) suggest that it is making vital, , contribution (though in quantitative trade terms small)
to the electronic supply chain.
India’s integration with rest of Asia has been primarily market and private-sector driven,
the government’s commercial diplomacy has also played a positive role. Strengthening of the
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Indian Diaspora can have positive impact on market-based integration between India and rest of
Asia. India’s commercial diplomacy and foreign policy should facilitate such strengthening.
IV
Future Directions of India’s LEP
The current global financial turmoil is likely to preoccupy energies and resources of the
Western policymakers in the near future. Asia has self-interest in ensuring that the current
turmoil does not diminish its growth prospects too severely, or over too prolonged a period.
The turmoil lends even greater force to Drysdale’s observation that:
On all the big global issues that beg coherent Asian initiative – dealing with climate change,
reforming the trade regime, and international financial system, promoting deep structural reform
and global integration – the broader framework for cooperation in the EAS alone is capable of
effective delivery. As yet there is no effective Asia coalition for negotiating these issues. The
EAS is a platform for building one” (Drysdale, 2008).
The Asian countries and their think-tanks should therefore focus on making the EAS as
an effective forum for thinking about the future role of Asia in the global economy.
There are also opportunities to deepen India-ASEAN relations now that the negotiations
have been concluded. ASEAN and India are net importer and net exporter of commercial
services (communication, telecom, finance, IT etc) respectively. On the other hand, India is a net
importer of travel services, whereas ASEAN members such as Malaysia, Singapore, and
Thailand are major exporters of travel services.
India anticipates more generous commitments from ASEAN in commercial services as
the relative market access gains in the goods PTA are expected to be relatively greater for
ASEAN. It also should put in place measures which seek to learn from the expertise that ASEAN
countries have in tourism, transport, and logistics sectors. Temporary movement of natural
persons is intricately linked with commercial services. India will therefore be seeking greater
flexibility by ASEAN countries in this area.
India-ASEAN PTA, in conjunction with the removal of obstacles for India to resume
civilian nuclear trade and commerce could bring benefits to Southeast Asian countries 8.
Indonesia and Vietnam in particular have announced plans to build civilian nuclear power plants.
Strategist analyst Rethinraj has argued that India’s expertise in building and operating land-based
small size nuclear power plants (220 MW and 440 MW heavy water reactors) better suited for
Southeast Asia’s power grid. Most international vendors specialise in building large (1000 MW
to 1600 MW) light water reactors [Rethinraj 2008].
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The global financial turmoil will negatively impact some of the low income Asian
countries, including some of India’s immediate neighbors such as Sri Lanka, Cambodia, and
Myanmar. India should be willing to assist and deepen linkages and connectivity with these
countries.
The turmoil has also underlined the importance of food security and environment
management. The poor countries have much to gain from better environment, and use of readily
available environmental management techniques. India should be an active participant with
Asian partners in these forums.
If the negative impact on growth persists, it will seriously erode the existing social safety
nets and resources devoted to the social sector. Civil society and not-for-profit organizations
have much to contribute to bringing about better delivery of social services. The turmoil has
increased the importance of accelerating linkages between such organizations in India and in
other Asian countries. It is only through continuous dialogue and participation in wide variety of
official, as well as people to people fora that the necessary trust for deeper and sustained
engagement can be formed.
V
Concluding Remarks
The ongoing global financial turmoil represents an end of an era of exuberant financial
capitalism. But the transition to a more sedate and scaled down financial sector will be traumatic
for the world as a whole, as well as for Asia. Since Asia does not appear to be the epicenter of
the current turmoil, its growth is likely to be relatively less seriously affected. There is however
no reason for Asia to feel complacent, as even moderately diminished growth prospects could
exacerbate economic hardship and adversely impact on social cohesion.
India’s LEP has over the last two decades strengthened its economic, political,
security, and civilizational links with the rest of Asia. To cope with the global financial turmoil,
India however should become even more persistent and proficient in deepening its linkages with
the rest of Asia, while strengthening its capacities to meet its developmental challenges.
To accomplish this task, India will need to develop far greater expertise in geoeconomics, an area which has not received the requisite attention. Suggestions emanating from
various sources about vastly expanding post-graduate education in international relations and
strategic studies merit urgent consideration. India should also consider establishing a wellfunded, resources, think-tank for researching, debating, communicating, and influencing foreign
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policy issues and options. This will also enable India to better communicate its intentions to rest
of the world, including its partners in Asia.
The current global financial turmoil represents an opportunity for Asia to assume global
responsibilities commensurate with its strength. The EAS is an appropriate forum to begin
structuring Asia’s future role in the global order as its membership is more inclusive, involving
all major countries.
[First Prepared for Asian Management Review]
Notes:
1
There are many websites which chronicle daily developments of the crisis, and which also host comments on these
developments. For example, see RGE Monitor (www.rgemonitor.com); Bloomberg (www.bloomberg.com);
Financial Times (www.ft.com); and the Economist (www.economist.com).
2
Indeed, the term financial capitalism has been used to characterize the era since the 1980s.
3
It may be argued that this is also the case in other areas during the current phase of globalization. The financial
sector is however special because of the systemic risk that it poses to the economic system, and consequent
extremely high contingent liabilities on the state.
4
This represents a sudden reversal in the prevailing intellectual climate concerning the state-market mix in favor of
the former. Historically, the role of the state (more loosely government) has increased at times of major crisis, such
as wars, financial crisis, and deep recessions. So this reversal is not unusual. It is hoped that the state-market debate
will henceforth be conducted from a realist rather than an ideological perspective.
5
The mark-to-market rule has come under criticism as sudden collapse of market value of financial assets creates
vicious cycle. There is a view that the role of accounting rules should be to provide an alternative valuation to the
market. The rules about recording profits are also likely to receive scrutiny.
6
The geostrategic implications of the current global financial turmoil are beyond the scope of this paper. See
however Stephens (2008) and the Economist (2008)
7
India’s total external trade is expected to be around US$550 billion in 2008 (www.ibef.com)
The Indian side has taken note of New Zealand’s unhelpful role during India’s negotiations with the Nuclear
Supplies Group (NSG) for ending “nuclear apartheid”. New Zealand’s efforts to increase its participation in India’s
growth may be hampered by this role for some time to come.
8
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