Ebook Global economic and financial crisis: India’s trade potential and future prospects
The origin of India’s current prosperity was not known until July 1991, when a crisis forced the Government to take the path of economic liberalization. Crisis means opportunities, as one Chinese proverb says; India has now emerged from the crisis that peaked in July 1991 when the country’s foreign exchange reserves were reduced to finance for three weeks’ worth of imports. It stemmed from large fiscal deficits in 1980s that culminated in an external payment crisis in 1991. In non-technical terms, the balance of payment crisis in 1991 pushed the country to near-bankruptcy. India responded to the crisis by initiating far-reaching policy reforms under a New Economic Policy (NEP), primarily to reduce excessive government controls, liberalize trade, allow foreign investment, encourage private sector business, and gradually embrace globalization. The crisis of 1991 thus gave birth to a modern India. A fascinating story unfolded thereafter.
The NEP unleashed India’s latent economic potential. India remarkably transformed itself from a slow-growing economy to one of the fastest growing economies in the world. The trade liberalization initiated in India in the aftermath of July 1991 has undoubtedly led to a perceptible change in the performance of the external sector. As a result, India’s share in world exports of goods and services increased from about 1 percent in 1990 to about 4 percent in 2007.The rapid growth of India’s trade, especially in the past decade and a half, represents both a structural change in gross domestic product (GDP) and a marked shift in export orientation. The share of trade in GDP increased from about 15 percent in 1990 to about 49 per cent in 2007, and average trade per capita increased to US$ 389 in 2005-2007 from a meagre US$94 in 1990-1992. Undoubtedly, India has benefited from the globalization process.
India is now facing another crisis, which, unlike 1991, has its origins abroad. The entire world is witnessing a financial turbulence following the sub-prime mortgage crisis in the United States of America. While the exact reasons are not yet known at the fundamental level, the crisis could be ascribed to the persistence of large global imbalances, which, in turn, is the outcome of long periods of excessively loose monetary policy in the major advanced economies during the early part of this decade (Mohan, 2009). The unfolding global financial crisis is, however, having major repercussions in India that are different from that witnessed during 1991. Although the magnitude of the impact on India is still low, it could potentially weaken the economy through trade channels if not tackled properly, at a time when India is much more globalized than in the early 1990s (Acharya, 2009; Rakshit, 2009). Being in the midst of the global crisis, India too is facing deceleration in growth. The overall economic situation thus remains serious.
The current crisis threatens to undo the economic development achieved by many countries and to erode people's faith in an open international trading system (Lamy, 2009). According to the World Trade Organization (WTO) (2009a), “the collapse in global demand brought on by the biggest economic downturn in decades will drive exports down by roughly 9 per cent in volume terms in 2009, the biggest such contraction since the Second World War.” With the increasing integration of the Indian economy and its financial markets with rest of the world, there is recognition that the country does face some downside risks from the global economic and financial crisis (Mohan, 2008; Subbarao, 2009). Nonetheless, if the crisis is prolonged, it will damage India’s trade pattern and production structure, which have been built up over time.
In turning the present crisis into opportunities, there is no doubt that India has to unfold another set of reforms as it did in the aftermath of the 1991 crisis in order to enhance its global trade and to strengthen the globalization process. It should be remembered that, India comes much behind other emerging economies such as China in international trade. With a population of more than 1 billion and a US$ 1 trillion economy, India’s trade potential is largely unrealized.
In view of the above, estimating India’s global trade potential is therefore very topical in the context of the ongoing crisis. To estimate the global trade potential for India, this paper uses an augmented gravity model equation with maximum possible geographical coverage of world trade flows. The policy implications will therefore highlight the need to anticipate relevant structural changes due to the effect of the ongoing crisis in the medium to long term.
Section 1 of this paper discusses two important issues in India’s trade, which motivates the other part of the paper. Section 2 represents the gravity model methodology and data sources that are used to estimate India’s trade potential. The main results are presented in sections 3 and 4, while section 5 provides the conclusion.
Contents
Abstract
Introduction
1. India’s trade and two critical issues
2. Measuring trade potential: The gravity model
3. India’s trade potential: Estimation results
4. Unlocking India’s trade potential: Influencing factors and
trade remedies
5. Conclusion
References
Annexes
Annex 1: List of data and sources
Annex 2: Correlation matrix
Annex 3: Non-linear regression: Alternative estimates
Annex 4: Selection of model: FEM vs. REM
Annex 5: Regression results: REM vs. 2SLS
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