India-U.S. Economic Relations
Released: 2005-02-10T00:00:00

RS21502 -- India-U.S. Economic Relations

Updated February 10, 2005

India's Economy

Upon achieving independence from British rule in 1947, India pursued policies that sought to assert government planningover most sectors of the economy and strove to promote relative economic self-sufficiency. These policies includedextensive government spending on infrastructure, the promotion of government-owned companies, pervasiveregulatoryauthority over private sector investment, and extensive use of trade and investment barriers to protect local firmsfromforeign competition. While these policies achieved some economic goals (such as rapid industrialization), theoverall effectwas to promote widespread inefficiency throughout the economy (e.g., unprofitable state-run firms and a constrainedprivate sector) and to greatly restrict the level of foreign direct investment (FDI) in India. India's real GDP growthwasrelatively stagnant during the 1970s, averaging about 2.7%. Piecemeal economic reforms and increased governmentspending during the 1980s helped boost average real GDP growth to 6.0%. (1)

1991 Economic Crisis and Reforms. India suffered a major economic crisis in 1991, largely due to the effects of oil price shocks (resulting from the 1990 Gulf War), the collapse of theSovietUnion (a major trading partner and source of foreign aid), and a sharp depletion of its foreign exchange reserves(causedlargely by large and continuing government budget deficits). (2) The economic crisis led the Indian government to cut thebudget deficit and implement a number of economic reforms, including sharp cuts in tariff and non-tariff barriers,liberalization of foreign direct investment (FDI) rules, exchange rate and banking reforms, and a significantreduction inthe government's control over private sector investment (by removing licensing requirements). These reformshelpedboost economic growth and led to a surge in FDI flows to India in the mid-1990s (annual FDI rose from about $100millionin 1990 to $2.4 billion by 1996; more than one-third came from U.S. investors). Reform efforts stagnated, however,underthe weak coalition governments of the mid-1990s. The 1997/1998 Asian financial crisis and U.S.-imposed sanctionsonIndia (as a result of its May 1998 nuclear tests) further dampened the economic growth. (3) Following parliamentaryelections in 1999, the government launched second-generation economic reforms, including major deregulation,privatization, and tariff-reducing measures.

Current Economic Conditions. India's economic growth has been relatively robust over the past few years. Real GDP grew by 8.2% in 2003 and by an estimated 5.7% in 2004. GlobalInsight , an economic forecasting firm, projects India's real GDP will rise by 6.3% in (FY)2005 and 6.0% in2006. (4) Bysome measurements, India is among the world's largest economies. While on a nominal U.S. dollar exchange ratebasis,India's 2003 GDP was $577 billion. However, on a purchasing power parity (PPP) basis (which factors indifferences inprices across countries), India's GDP is estimated at close to $3 trillion. By this measurement, India is the world'sfourth-largest economy (after the United States, China, and Japan). (5) However, its per capita GDP on a PPP basis (acommon international measurement of a nation's living standards) was $2,780, equal to only 7.4% of U.S. levels. Povertyis perhaps India's greatest problem. According to the World Bank, India has 433 million people (44.2% of thepopulation)living below the international poverty measurement of less than $1 per day. (6)

India's trade is relatively small. According to the World Trade Organization (WTO), India was the world's 31st-largestmerchandise exporter, and the 25th- largest importer, in 2003. (7) Merchandise exports and imports totaled $63 billion and$77 billion, respectively. India's principal exports were pearls and precious and sem-precious stones (14.8% oftotal),textiles (10.8%), and clothing (10.5%). Its top three imports were petroleum (27.0% of total), pearls and preciousandsem-precious stones (9.6%), and gold and silver (8.3%). (8) India's major export markets were the United States (18.1% oftotal), the United Arab Emirates, and Hong Kong, and its top sources for imports were the United States (6.5% oftotal),China, and Belgium.

India's IT Sector. The Indian government has made the development of India's Information Technology (IT) a top priority. Over the past few years, IT has been one of India'sfastest-growingeconomic sectors and a major source of service exports. (9) For example, software and service exports in 2003 totaled $12.5billion, 30% higher than the previous year. The Indian government's Information Technology Action Plan seeksto boostsoftware and service exports to$50 billion by 2008 and to increase the contribution of IT to India's GDP from thecurrentlevel of 2% to 7.7%. Currently, more than 60% of India's software and service exports go to North America, mainlyto theUnited States. (10)

Comparisons Between India and China. Many analysts argue that India's economy has failed to live up to its potential, especially relative to other developing countries, such as China,whichhas a comparable population size but has enjoyed far greater economic development in recent years. In 1990, India'seconomy (GDP on PPP basis) was about three-quarters the size of China's, but by 2003 it had fallen to 44% ofChina'ssize. India's living standards (per capita GDP on PPP basis) were slightly greater than China's in 1990, but by 2003theyhad fallen to about half of China's. India made small gains in FDI flows relative to China from 1990 to 2003 (risingfrom2% to 7%); however, the total level of FDI stock in China remains substantially higher than in India. In fact, FDIflows toChina in 2003 alone (nearly $54 billion) were 54% higher the cumulative stock of FDI in India through 2003 (about$35billion). Many economists attribute the sharp widening economic gaps between India and China to differences inthe paceand scope of economic and trade reforms undertaken by each country, where China has substantially reformed itstrade andinvestment regimes (which has contributed to sharp rises in GDP growth, trade, and FDI flows), India's economicreformshave been far less comprehensive and effective. For example, China's average tariff has fallen from 43% in 1992to12% in2002. India's average tariff during this period dropped substantially, from 128% to 32%, but still remains amongthehighest in the world.

U.S.-Indian Economic Relations

Trade between the United States and India is relatively small, but has risen sharply over the past few years. In 2004, U.S.merchandise exports to and imports from India are estimated to have totaled $6.1 billion and $15.5 billion,respectively(see Table 1 ), making India the 24th largest U.S. export market and the18th largest supplier of U.S. imports. (11) In 2004,U.S. merchandise exports to India rose by 22.6%, while imports rose by 18.4%, over 2003 levels. Major U.S.exports toIndia included electrical machinery, chemicals, unfinished diamonds. Top U.S. imports from India werenon-metallicmanufactured minerals (mainly processed diamonds), clothing and apparel, and miscellaneous manufactured items(mainlyjewelry).

According to Indian government data, the United States is India's second largest source of FDI with cumulative FDI at$4.1 billion or 10.6% of total FDI in India. Major sectors for U.S. FDI include energy, telecommunications, andelectricalequipment.

Table 2. U.S.-India Merchandise Trade: 2001-2004* ($ millions)

*Data for 2004 estimated based on actual data for January-November 2004.

Source : U.S. International Trade Commission DataWeb.

Major U.S.-Indo Trade Issues. India's sizable population and large and growing middle class make it a potentially large market for U.S. goods and services. (12) However, a number of factorshamper increased economic ties. First, in addition to maintaining high tariff rates on imports (especially on productsthatcompete with domestic products), India also assesses high surcharges and taxes on a variety of imports. Majornon-tariffbarriers include sanitary and phytosanitary restrictions, import licenses, regulations that mandate that only publicsectorentities can import certain products, discriminatory government procurement practices, and the use of exportsubsidies. (13) A variety of restrictions are placed on foreign services providers and on the level of permitted FDI in certainindustries. Second, India continues to maintain a number of inefficient structural policies which affects it trade, including pricecontrols for many "essential" commodities, extensive government regulation over many sectors of the economy, andextensive public ownership of businesses, many of which are poorly run. Third, despite India's attempt to developinternationally competitive IT industries (such as software), U.S. government officials charge that India has a poorrecordin protecting intellectual property rights (IPR), especially for patents and copyrights. The International IntellectualProperty Alliance estimated U.S. losses of $420 million due to trade piracy in 2003 -- nearly three-quarters of thisin thecategories of business and entertainment software -- and noted "very little progress in combating piracy."

India's extensive array of trade and investment barriers has been criticized by U.S. government officials and businessleaders as an impediment to its own economic development, as well as to stronger U.S.-Indian ties. (14) For example, in September 2004, Alan Larson, U.S. Under Secretary of State for Economic, Business, and Agricultural Affairs,stated that"trade and investment flows between the U.S. and India are far below where they should and can be," adding thatAmerican exports to India "have not fared as well" as have Indian exports to the United States and that "the pictureforU.S. investment is also lackluster." He identified the primary reason for the suboptimal situation as "the slow paceofeconomic reform in India."

Some U.S. interest groups have expressed concern that closer U.S.-India economic ties could accelerate the practice bysome U.S. firms of outsourcing IT and customer service jobs to India. (15) Various proposals have been made in Congressand various State governments to restrict outsourcing. work overseas. Bush Administration officials have expressedopposition to government restrictions on outsourcing, but have told Indian officials that the best way to counter such"protectionist" pressures in the United States is to further liberalize its markets. Other U.S. interest groups haveraisedconcern over the outsourcing of financial services (such as call centers) to other countries that entail transmittingprivateinformation of U.S. consumers. (16) U.S. officialshave urged India to enact new privacy and cybersecurity laws to addressU.S. concerns over identify theft. (17)

Prospects for India's Further Economic Reform. India faces a number of significant challenges to its goals of sustaining healthy economic growth and further reducing poverty. Many economists argue that India needs to substantially liberalize its trade and investment regimes, accelerateprivatization ofstate firms, cut red tape and crack down on corruption, and substantially boost spending on its in physical and humaninfrastructure. (18) However, large and continuinggovernment deficits, and the high level of public debt (equal to 62% ofGDP in 2003) severely hamper the ability of the government to boost spending for needed infrastructure projects,withoutmajor reforms to the tax system and significant cuts in government subsidies. In October 2004, the World Bankcountrydirector for India lauded the country's economic achievements, but called accelerating reforms "essential" forsustainedgrowth and poverty reduction there, and a top International Monetary Fund official said that "India remains arelativelyclosed economy" and urged greater trade liberalization and regional economic integration. (19)

Organized resistance to desired reforms has come from Hindu nationalist groups that were influential under the BJPgovernment from 1998 to 2004. As a "sister organization" to the Rashtriya Swayamsevak Sangh (RSS) -- a leadingHindunationalist organization -- the Swadeshi Jagaran Manch (SJM) has taken the lead in efforts to forward the swadeshi (orself reliance) cause. According to the SJM, "The Western notion of a global market does not fit into the swadeshi approach," nor does the "Western notion of individual freedom, which fragments and compartmentalizes family,economy,culture, and social values ..." Such anti-globalization policies continue to enjoy limited, but still substantial backingamongIndians. Moreover, the surprise May 2004 election upset defeat of the BJP seated a new national coalition led bytheCongress Party that is supported by a group of communist parties. Early alarm was sounded that the influence ofcommunists in New Delhi might derail India's economic reform efforts; however, Indian industrial leaders havesought toassure foreign investors that Left Front members are not "Cuba-style communists," but can be expected to supportthe UPAreform agenda. The communist Chief Minister of West Bengal has himself actively sought corporate investmentin hisstate. (20)

Despite the sometimes considerable resistance to further progress with India's economic reforms, most analysts believethat the Congress-led coalition will not alter New Delhi's policy direction in any meaningful way. Prime MinisterandOxford-educated economist Manmohan Singh served as finance minister from 1991-1996 and has been the architectofmajor Indian economic reform and liberalization efforts. The new government's first budget, released in July 2004,generally was lauded by Indian industrial groups as "progressive and forward-looking." (21) Still, New Delhi's movement onkey reform issues could remain slow in the near- and medium-term.