India—A Hub for Globalization

IMF News, January 7, 2005

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Speech by Raghuram Rajan, Economic Counsellor and Director of the Research Department, International Monetary Fund, at the Pravasi Bharati Divas Conference, New Delhi, India, January 7, 2005.
Central question posed: "Is India really ready to play a central role in the global economy?" — reframed as whether India has the collective "mindset" to be a hub for globalization.

A national "atma vishwas" (self confidence) can drive intolerance for laziness, corruption, and poor quality, and motivate sacrifice for future gains.
Such a mindset encourages:
- Willingness to open to the world and use the cheapest resources wherever produced.
- Hiring the best people regardless of origin and facing the fiercest competition.
Examples of Indian firms and projects demonstrating outward orientation:
- Expansion of the group headed by Ratan Tata as an Indian multinational.
- Heymath (Chennai) providing math homework help and lesson plans internationally, using consultants from Cambridge University and IIT Madras.
- New Delhi Metro built "to world standards and on time."

India score on the IMF's trade restrictiveness index: 8.
India's GDP accounted for 1.6 percent of world GDP in 2003.
India's trade accounted for only .94 percent of world trade (estimate based on 178 countries and World Economic Outlook data for 2003).
Anti-dumping activity, 1995–2003:
- India initiated 379 cases (15.69%) of a total 2416.
- United States: 329 cases (13.6%).
- European Union: 274 cases (11.3%).

Political incentives:
- Politicians find non-voters (foreigners) convenient targets for discrimination.
- Strong constituencies (e.g., farmers and agricultural workers, non-owner agricultural labor) oppose competition.
- Many politicians are rich, from rural backgrounds, and older—aligning with constituencies resistant to competition.
Entrepreneurial confidence and financial underdevelopment:
- Protectionism historically made beneficiaries lazy and inefficient and reduced incentives to fix distortions (e.g., high cost of finance under the License Permit Raj).
- Entrepreneurs more likely to oppose liberalization when financial systems are relatively underdeveloped.
Cultural and demographic patterns:
- World Values Survey: Indians and Chinese are amongst the most pro-competition on average, but within India poorer and older cohorts tend to oppose competition.

Demonstration effects:
- Firms such as Infosys, TCS, and Wipro showed Indian firms can compete globally and earn large profits.
- Bajaj Auto: "sells over a million motorcycles and expects to export 160,000 units this year."
Creeping liberalization:
- Crisis-initiated reforms that gain momentum and force competition on the rest of the economy.
Human capital and youth:
- Younger, better-educated cohorts entering the workforce and parliament increase tolerance for competition.

Three key steps for an enlightened government:
- Expand access to, and improve the quality of, education.
- Improve access to finance.
- Create more ownership and infrastructure in rural areas.
Government role:
- Focus on enabling functions: setting standards, ensuring supervisory, legal, and regulatory infrastructure, and encouraging competitive private-sector provision.
- Avoid discredited methods: e.g., pouring money into education without addressing teacher incentives and parental involvement; mandating wider lending by public sector banks without improving incentives and systems for credit evaluation and loan recovery.
Fiscal consolidation:
- Reducing the large fiscal deficit is a key precondition for policies such as capital account convertibility and effective monetary policy tools.
Flexibility and market entry/exit:
- Build flexibility into the economy to react to change quickly.
- Reduce petty bureaucratic barriers to entry, introduce more flexible labor laws, and develop a better and more rapidly enforced bankruptcy code.
Social insurance and safety nets:
- Create explicit safety nets—unemployment insurance, pension schemes, and health care—targeted at individual workers to cushion those who cannot adapt.
- Avoid designs that kill work incentives or expand beyond fiscal capacity.
Phased and time-bound reforms:
- Use time-bound phasing-in of competition and phasing-out of protections/subsidies to increase acceptance versus shock treatment.

Avoid short-term inducements:
- Tax breaks and financial guarantees are addictive, create constituencies for continuation, and often discriminate against domestic firms.
Treat foreign investors like domestic investors and address shared concerns:
- Policy certainty: avoid policies hatched in isolation; encourage open debate and small-scale experiments or initial rollout phases allowing adjustments.
- Transparency and fairness in decision making: where discretion exists, decision processes should be seen as fair.
- Strengthen regulatory and supervisory independence: staff with attractively remunerated professionals rather than bureaucrats of proven loyalty.
Regional diplomacy:
- Use India's size and strength to quell regional tensions; coordinated relief efforts and offers of help to neighbors increase attractiveness.

Competition brings greater volatility; governments should avoid being insurer of first resort that bails out politically connected firms.
India has opportunities to become:
- A global financial center (advantage: perfect time zone, IT, communication, and financial skills; missing: sounder regulatory environment and conditions for capital account convertibility).
- A center for higher education (advantage: core human capital in India and abroad; needs: more welcoming environment for foreign educational institutions, faculty, and students, and greater tolerance for market clearing fees and salaries).
- Growth in tourism and healthcare are additional potential hubs.
Final assessment: "The stars are well aligned for India to become a hub of globalization, but it is still some distance from that goal." Foreign investor confidence bets on potential, not reality; it is up to India to realize that potential.

Remarks by Raghuram Rajan, January 7, 2005.