Finance liberalisation, path dependence and the prospects of an alternative: India

A case of success? India (along with China) considered one of the economies in the developing world that is a “success story” of globalisation. Success defined by the high and sustained rates of growth of aggregate and per capita national income; rapid expansion of (services) exports; substantial accumulation of foreign exchange reserves; and the absence of major financial crises that have characterised a number of other emerging markets.

Sources Seen a consequences of a “prudent” yet extensive programme of global economic integration and domestic deregulation that involves substantial financial liberalization, but includes capital controls and limited convertibility of the currency for capital account transactions. Such prudence is also seen to have ensured that India remained unaffected by the contagion unleashed by the East Asian financial crisis in 1997.

Some issues During the 1980s liberalisation had resulted in a widening of its trade and current account deficits, a sharp increase in external borrowing from private markets and a balance of payments crisis in 1991. Financial liberalization was partly an outcome of the process of adjustment chosen in response to that crisis. India had been on the verge of substantially liberalizing its capital account, when the East Asian crisis aborted the process.

Other influences Obstacles to import-substituting growth. Trade liberalisation adopted on the grounds that it would help restructure domestic economic activity, render firms and other economic agents in India internationally competitive, and put the country on an outward-oriented, export-led growth trajectory. But BoP constraints. ‘Opportunity’ created by the rise of finance capital. External liberalisation to facilitate capital inflow. Internal liberalisation to attract the carriers of capital.

The post-1991growth story Why 1991? Crisis driven turning point. Comes decade after post oil-shock changes in global financial environment. Dramatic shift in policy regime. Three episodes of high growth: 1994/95-96/97 and 2003/04-07/08 to 2013/14-15/16. 2003-07 particularly remarkable: High growth, high savings and investment rates, higher corporate saving and investment, strong reserve position However, the growth story less convincing now.

What (besides policy) really changed after 1991? Post 1991 crisis: India becomes an attractive “emerging market” for foreign portfolio investors. Rose sharply to $4.2 billion in 1993-94 and averaged about $6 billion during the second half of the 1990s. Max $8.2 bn in 2001-02. Capital surge from 2003-04 starting at $15.7 billion and rising to an average of around $65 billion during 2009-12 and $74 billion in 2014-15. The stock of foreign institutional investor capital increased from $827 million at end-December 1993 to US$ 226 billion recently.

Real Growth: The long view

After 2003 Huge excess of capital inflow into the country when compared to its current account financing needs. If we take the cumulative sum of the excess of the capital inflow relative to the current account deficit, this has increased consistently since the first quarter of 2001-02 to the fourth quarter of 2008-09, and since then has more or less remained near that level.

New financial framework Transformation of banking Expansion of non-bank financial activity Financial sector becomes a site for profit appropriation. Capital gains replace dividends as source of financial gain, leading to engineered asset price inflation. Activities outside the financial sector reshaped by finance.

Growth impact Financial investors respond adversely to excessive debt financed public spending putting pressure on the government to deliver on its promise of fiscal reform and consolidation Since that requires trimming government expenditure to reduce the deficit, growth is impacted adversely. But in the new environment growth rides on a credit bubble.

The credit splurge One consequence of this surge in flows was a significant increase in liquidity in financial markets as foreign investors converted hard currency capital into rupees for investments. This triggered a credit splurge, with banks that were flush with funds providing loans to a much larger universe of borrowers. Growth ensued.

Credit Expansion

Where did the credit go Sharp increase in the retail exposure of the banking system, with overall personal loans increasing from slightly more than 8 per cent of total non-food credit in 2004 to close to a quarter by 2008. Use of the banking system as an instrument to further an aspect of larger liberalisation agenda, which was the entry of the private sector into core infrastructural areas involving lumpy capital intensive investments in power, telecommunications, roads and ports and sectors like civil aviation.

Prospects of a downturn? Dependence on capital flows for growth. Uncertainty and policy impact. Debt drives high growth, but signs of slowdown. Public expenditure difficult to revive. Monetary policy ineffective. Distorted development.

Path dependence Any effort to challenge and/or reverse neoliberal economic policies inevitably leads to the exit of portfolio and “footloose” productive capital, precipitating a crisis of sorts that must be endured if an alternative strategy is to be experimented with. Gives rise to the view that any attempts at a transition to some form of an alternative to neoliberalism would lead to capital flight and precipitate a crisis, making the alternative impracticable in the new world dominated by finance.