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THE IMPACT OF INDIAN
ECONOMIC LIBERALIZATION
ON U.S.-INDIA RELATIONS

Thomas A. Timberg

In the fall of 1990, India experienced a foreign exchange crisis

that triggered a change in the direction of economic policy in the
country. The crisis, precipitated by the Gulf War, was in many
respects a delayed reaction to shifts in capital flows from the Middle
East to India. Tangibly, these pressures were reflected in the
constraints that they imposed on fuel supplies, the ensuing rise in
fuel prices, and the drop in earnings and remittances from the Gulf
as foreign workers were sent home. In the wake of the crisis, India
began to lift industrial and trade controls and open the country to
foreign investment. This policy shift was a culmination of gradual
developments, both in the thinking of the policymaking elite and
in the nature of the world economy. Under the new economic
regime, India's actual and potential roles in the world economy
have changed significantly, affecting both its commercial and
political relationships with the United States.
The change in the direction of economic policy has sparked a
debate in India about the impact of economic growth, which, since
the crisis, has been maintained at 6 to 7 percent per year. In
general, the World Bank's annual reports, as well as official
statements of the Government of India, indicate that the results
of liberalization have been an acceleration in investment and
Dr. Thomas A. Timberg is the author of several books and articles
on India's economy, and has lectured on the topic at Georgetown,
American, and Harvard Universities. He is currently Chief of Party
with the Institutional Reform and the Informal Sector (IRIS)
Caucasus Center in Yerevan, Armenia.

123
124 SAIS Review WINTER-SPRING 1998

growth, with relatively little, if any, negative effect on the poor or the
environment.' Critics allege that growth levels have not dramatically
deviated from the trend, that they are unsustainable, and that the
impact on the poor has been negative.2 Still other critics believe that
the loss of national sovereignty required by India's entry into the new
world trading order is both contrary to national dignity and ultimately
not consistent with India's economic progress. The number of critics
is quite large and ranges from the left to the nationalist right.'
This article, however, is concerned primarily with the impact
of liberalization on India's relations with the United States. The
increased presence of U.S. investors within the Indian economy
has significantly altered relations with the United States, though
the ultimate direction of these changes is not entirely clear. Before
the 1990 crisis, trade levels between the two countries were small,
as was the volume of U.S. capital invested in India. Today both
these figures are growing, although increases in capital investment
have outpaced changes in trade levels. The increase in investment
in India comes primarily from two sources: direct investment by
American multinational corporations and portfolio investment by
mutual and pension funds. United States residents of Indian origin
have contributed funds to both sources and their influence has been
essential to the gradual liberalization of India's policies.

THE FACTS

Since the 1990 crisis, more than $8 billion of foreign investment

is estimated to have flowed into India, of which a modal 15 to 16
percent has been from the United States (the figure was only 9
percent in 1995-96).4 India has opened considerably to foreign
trade and investment and sought to harmonize Indian norms with
international ones. Both developments reflect India's desire to
expand its participation in the new international trading order.
U.S. exports to India rose from approximately $2 billion in
1991 to $3.3 billion in 1995, while U.S. imports from India rose
from $3.1 billion to $5.7 billion. The stock of U.S. direct
investment in India also rose, from $372 million in 1990 to $818
million in 1994; this growth is likely to accelerate. Since India's
liberalization, then, exports and imports have each risen by more
than 50 percent and direct investment has more than doubled. The
 THE IMPACT OF LIBERALIZATION 125

fact that the effect on the proportion of trade accounted for by each
country has been small reflects the general buoyancy of all
international trade in this period.
The rupee is now convertible for trading purposes and the
government has committed itself to a time-bound freeing of the
capital account. (In a report published by India's central bank, the
Committee on Capital Account Convertibility recommended a 3-
year plan for opening the capital account. Whether this
recommendation will be accepted, however, remains to be seen. )5 In
most sectors, investment and capacity licensing are no longer required.
In addition, the government has pursued relatively generous policies
on permitting foreign direct investment, especially in joint ventures.
However, remaining regulatory constraints continue to hinder
business activities. These legal complications are often the source
of complaints from business, particularly foreign investors. Although
tariffs are scheduled to be reduced, they remain high. As recently
as 1990-93, mean tariff rates were 56 percent, among the world's
highest, and 63 percent of imports were affected by non-tariff
barriers.6 Today average tariffs are reported to be 20 percent while
maximum tariff rates have been reduced to 40 percent.
High tariffs are not the only constraint on business activity in
India. Labor laws make it difficult to dismiss workers or close plants,
a hurdle commonly referred to as the "exit" problem. Foreign
investment remains limited in certain sectors; recent controversies
have centered on air transport and the media, although the Indians
point out that these areas are also restricted in the United States.
In some industries, such as power generation, appropriate regimes for
investment have yet to be developed. Moreover, public monopolies
-

such as those in the insurance and telecommunications industries

-

make competition difficult because they influence the formation of

the rules governing market entry. The Indian economy is still
permeated by subsidies. A recent discussion paper issued by the
Finance Ministry estimated that subsidies account for 15 percent of
national income, of which only 4 percent is directed toward so-called
"merit goods" such as health, education, and food for children.'
Furthermore, foreign investors argue that dealing with the
Indian polity is difficult, and complain that their projects get caught
up in both local government and neighborhood politics. Although
some of the difficulties are unique to India, similar complaints are
126 SAIS Review WINTER-SPRING 1998

made by European business interests operating in the United States.

Unfortunately for India, the opportunities it offers are not as
appealing as those available in the United States.

THE STATUS OF U.S. - INDIAN RELATIONS

The continuing development of Indian-American commercial ties

remains central to New Delhi's ongoing program of liberalization
and economic integration. Moreover, cultural ties and migration
have increased significantly over the last two decades, although
they tend to be one-sided; the United States dominates as a
receiver of migrants and a disseminator of ideas. The relative wealth
of the United States, even in terms of purchasing power parity,
underscores why the United States will remain a more significant
partner for India than vice versa. Overall, however, the influence
of each country on the other is necessarily marginal since both have
very large economies and are physically distant from one another.

Signs of Encouragement: Commerce and Culture

The United States accounts for about 10 percent of India's
exports and imports. Conversely, India accounts for a mere 0.5
percent of U.S. exports and imports. These proportions have
remained fairly constant during the 1990s.
Commercial, as well as cultural, ties between the two countries
are certainly facilitated by the large number of Indian immigrants
in America. According to the 1990 U.S. Census, there are more
than 600,000 U.S. residents of Indian origin and 34,000 Indian
students in the United States (an increase of 10,000 since 1976).8
U.S. popular culture is quite influential in India, particularly after
the penetration of satellite TV and audiocassettes in the 1980s.9
Much of Indian academic culture is also heavily influenced by the
United States, but American-educated professors are a direct
presence only in a limited number of institutions. In contrast,
relatively few U.S. students study in India, few American colleges
offer semesters or years abroad in India, and only a small number
of graduate students and professors are pursuing research there.
From 1960 to 1970, some U.S. academic interest in India existed,
but that interest has since faded. As an older generation of
American academics with some Indian focus is retiring, it is
 THE IMPACT OF LIBERALIZATION 127

generally not being replaced with new blood, particularly in the

social sciences., Despite the lack of formal academic interest,
however, works by Indian authors in English have been popular
in the United States among more sophisticated readers. The New
Yorker, for example, devoted an entire issue in 1997 to Indian
writing, and several exhibitions of Indian art, classical music, and
dance have been successful nation-wide.

Political Ties
Although political relations have improved since the end of
the Cold War, they have rarely been very good, and even today
important sections of the U.S. national security bureaucracy have
reservations about India, particularly with regard to its efforts to
develop advanced weapons. The U.S. government has tried to
block India's expansion of its arms arsenal on two fronts, pressing
against India's development of the Agni ICBM weapons systems
while working to halt the Indian purchase of Russian weapons
systems. At the same time, efforts have been made to limit India's
access to the highest levels of U.S. technology - much to India's
chagrin - for fear that the technology would be misused. The
Indians, of course, would like to obtain a technologically current
defense system to counter the threat of Pakistan to which the
United States has supplied defense technologies. India also feels
threatened by China. These tensions over security policy have
meant that India frequently finds itself opposed to the United States
in international forums.
India also continues to find itself at odds with the United States
on matters of trade and investment. One thorny example is the
linkage of trade with labor and environmental standards. There
are, however, signs of progress. The Government of India now
believes that obtaining the full benefits of participation in the world
trading order depends on improved relations with the United States
and, in general, India's posture toward the United States has
warmed since the change in policy direction in 1990.
Consequently, India has dropped its opposition to U.S. positions
on international property rights. Indian leaders have also placed a
high priority on building relations with Europe and Japan. This
diversification of economic relations, however, should not hurt relations
with the United States; whose continued importance as a source of
128 SAIS Review WINTER-SPRING 1998

capital and technology for India will ensure that ties remain
fundamentally sound.

THE FUTURE OF U.S. INVESTMENT FLOWS TO INDIA

Attempting to discern the sustainability of the present level of

investment and trade and its future impact on US-Indian
relations requires an analysis of the current context of trade and
investment. American investment flows mainly from three
sources: nonresident Indians (NRIs), multinational corporations
(MNCs), and foreign institutional investment (FII) by mutual
and pension funds. There is overlap between the three in that
certain MNCs are owned by NRIs, and considerable NRI funds
are placed through foreign institutional investors. Official Indian
statistics only distinguish between FDI, FII, and Eurofinance."
The first two are roughly comparable to the MNC and foreign
institutional investor categories. Eurofinance, the direct floating
of Indian issues in European markets by Indian companies, is a
relatively new phenomenon. The first issue was floated by
Reliance Industries in May 1992 for $150 million. In 1996-97,
for the first time in many years, FDI, mostly by MNCs, was higher
than FII ($2.6 billion compared to $2.4 billion), accounting for
40 percent of total investment. The types of foreign investment
by category are shown in Table 1.

Table 1. Foreign Investment, by Category and Year

1997-1996 1996-1995 1995-1994
FDI (%) 40 42 27
FII (%) 37 44 32
Total (U.S. $ Billion) 6.4 4.6 4.8

Non-Resident Indians (NRIs)

As might be expected, the 600,000 U.S. residents of Indian
origin (NRIs) have made a variety of investments in India.
Moreover, the Indian government has encouraged these
investments for several decades, and has granted them a special
 THE IMPACT OF LIBERALIZATION 129

protected investment regime. Before the 1990 liberalization, NRI

deposits, flowing principally from the United States, already
amounted to several billion dollars in what are specifically identified
as NRI bank accounts. This is in addition to the considerable sums
that NRIs have invested in the Indian stock market." Several NRI
business groups whose fortunes began overseas, such as the
Hindujas, have entered the Indian market as major investors. Other
NRI investor groups have always maintained close links to India.
The London-based Caparo group, which was already an active
investor in India in the 1980s, is closely connected to a major
Calcutta-based industrial group. Between January and March 1995,
NRIs accounted for 10 percent of all investment in new public
issues of shares, roughly triple the amount of foreign institutional
investment not explicitly identified as NRI." Because NRI investors
hail from specific regions of India, predominantly Gujarat, the
Punjab, and Rajasthan, one might expect that these regions would
especially benefit. Though there has been some concentrated
investment in Gujarat, in general NRI investment has tended to
go to the same industrial centers as non-NRI investment (Bombay,
Delhi, and Bangalore) or to undeveloped areas that are relatively
close to them.
The prospects for future NRI investment, however, appear mixed
at best. Growth in absolute numbers of NRIs appears to be leveling
off. Although today's NRIs are growing richer, it is likely that over
time their ties with India will erode. While fewer NRIs mean less NRI
investment, wealthier NRIs will be able to invest more. At the same
time, NRIs who are less attached to India will invest less.
Non-resident Indians contribute to foreign involvement in
India's economic situation in forms other than bank deposits and
other investment. NRIs play an important role in mediating other
investments by MNCs and foreign institutional investors, for whom
they serve as guides and interpreters in dealing with the Indian
market. Official figures show NRI investments as accounting for 10
percent or less of foreign direct investment but there is reason to
believe that NRIs account for a larger proportion of foreign
institutional investment, particularly because FII has grown as NRI
bank deposits have declined. NRI "human bridges" represent a
significant competitive advantage for the United States, as they
hold a key to many aspects of commercial relations.
130 SAIS Review WINTER-SPRING 1998

MultinationalCorporations
Many MNCs had relationships that predated Indian
independence; others developed joint ventures in the first wave
of Indian industrialization. Overall, however, the level of foreign
investment, particularly new foreign investment by multinationals,
was quite low, partially because the Government of India was quite
selective in permitting multinational investment. The 1990
liberalization was targeted at these multinationals and, as a result,
FDI has surged.
Foreign direct investment by MNCs has been primarily
influenced by two motives: an interest in Indian markets for the
goods and technologies MNCs have to sell, and a demand for
Indian products - particularly those involving skill and labor - that
can be exported elsewhere. The second motive accounts for the
many firms that use India as a source of inputs. Within some
industries, such as garments and software design, the patterns of
investment predating liberalization were simply accelerated.
However, because of India's cheap, skilled labor pool, interest has
surged in entirely new areas such as automobile parts. This type of
MNC investment in India appears to be sustainable. There is reason
to believe that because India and its partners increasingly know
more about each other, and because many industries involved in
foreign investment are particularly dynamic (e.g. information
technology), there will continue to be growth in investment for
the purpose of sourcing inputs from India.
Many MNCs, including a number of computer hardware firms,
have taken advantage of the liberalization to gain entry into the
Indian market. Several major U.S.-based MNCs that, for historical
reasons, had not been active in India, have now become leading
investors. For example, until World War II, General Electric and
DuPont operated in India primarily through British affiliates. Now
that India has opened up to foreign investment, both companies
have founded extensive operations on their own. The sustainability
of market-seeking foreign investment depends on whether India
will continue to pursue openness. Progress has been uneven, marked
in the last year by dramatic steps backward in air transport and
communications. However, both the pace of global liberalization
and the requirements of the global trading order suggest that Indian
 THE IMPACT OF LIBERALIZATION 131

liberalization will continue, and that more and more MNCs will
invest in expanding the market for their goods in India.
Both motives for MNC investment in India - its large market
and its potential as a source of inputs - respond to a variety of
impulses. Still, it is probable that investment will increase steadily
as India becomes more familiar to MNCs. India's production
advantages will persist; unlike East Asia, India is unlikely to lose
its wage advantage in the near future. Constraints on infrastructure,
however, continue to be potential obstacles to growth and
profitability. In fact, some fault these constraints for the current
industrial slowdown. As with the other sources of U.S. investment,
the "burst" effect of liberalization may pass. But there is no
indication yet that this is the case; rather, the pattern seems to be
one of steady growth. The National Council for Applied Economic
Research (NCAER) recently published a study projecting that the
consumer durable market in India will triple by 2006.14

Foreign InstitutionalInvestment
Only in recent years has large-scale international portfolio
investment assumed its current importance. It has been permitted
only since 1992; investment through individual foreign portfolios
that are not NRI-owned is still not permitted. Today, large portfolio
investors, as well as speculators, are interested in international
diversification, particularly when they recognize undervaluation of
equity in emerging markets. India was just such as case earlier this
decade, and so funds streamed in. In the case of FII, the "burst"
factor has been critical, as investors have rushed to add Indian
securities to their holdings. One would now expect a more gradual
growth of investment by non-NRIs to occur as they acclimate to
Indian markets and as certain operational problems are addressed,
such as transferring and registering shares. Initially, these problems
created difficulties simply in accommodating the rapid inflow of
funds into the markets. Now that they have been addressed, foreign
institutional investment is likely to continue to grow, although
perhaps more slowly than in the past.

InfrastructureInvestment and Privatization

Two additional areas in which U.S. and other international
investment in India are gaining importance are the financing of
132 SAIS Review WINTER-SPRING 1998

infrastructure and India's ongoing process of privatization. Although

a large number of firms have been attracted to opportunities in
infrastructure investment, the real value of this investment has not
yet reached a level commensurate with the interest expressed by the
government.
According to the Government of India, both the potential and
the need for infrastructure investment is enormous; sums of $200
billion and even higher are sometimes proposed." International
interest in investing in infrastructure is immense, and vast sums are
already flowing to economies with far greater credit risk than India.
Euromoney rates the risk for India at 63.7 percent, versus 71.3
percent for China, 60 percent for Mexico, and 67 percent for Brazil.
Moody's rates Indian debt slightly higher than China's.16
The impediments to investment flows in the area of
infrastructure are due largely to the Indian government's difficulty
in reaching agreements with investors. More than 75,000
megawatts (MW) of new electricity-generating capacity is under
consideration for funding by private investors." The first of the large
projects, pushed through by Enron and located near Bombay, will
cost $2.5 billion and will generate more than 2,000 MW. Another
1,100 MW project, proposed by Cogentrix, is still clearing final
barriers. Among the more ambitious projects under consideration
by the Indian government are the construction of light rail systems
in Bangalore and Delhi, and a new Krishnapatnam Port in Andhra
Pradesh, which will serve a new power project there. In addition,
one Build-Own-Transfer contract for a $200 million container
facility has already been executed. A number of smaller projects,
often with a lower level of foreign participation, have also been
approved.
A backlog of projects inching through the maze of approvals
also exists for proposed road and port projects. Despite the difficulties
involved in this lengthy process, investors' interest and India's need
should ensure that the two sides will eventually come to terms,
resulting in a significant increase in foreign investment. The World
Bank is characteristically optimistic that their recommended policy
changes will create the appropriate political environment for
private infrastructure investment. Toward that end, the
government has outlined sensible policies and set up administrative
institutions for almost all of the categories of infrastructure mentioned
 THE IMPACT OF LIBERALIZATION 133

above. If foreigners were permitted to invest directly in infrastructure,

additional inflows would likely result.
Privatization of state enterprises is another, related potential
source of potential increased foreign investment. Though such
privatization appears to be proceeding, currently only minority
shares are being sold on the market. Therefore, any impact from
this process would result simply in an increase in FII, rather than
actual structural economic change or increased FDI. The
government has indicated that it will sell all of its shares in "non-
strategic companies," but has so far taken little action.
In general, the trend of foreign investment appears not only
sustainable, but likely to increase if infrastructure development
accelerates. The inflow of funds will be even more substantial if
large-scale privatization occurs. Similarly, if recent trends persist,
U.S.-Indian trade seems both sustainable and likely to increase.
While noting the poor state of infrastructure and remaining
regulatory and political impediments to investment, the World
Bank, in a recent report, offers a sanguine outlook for India's
economy. According to its study,

"South Asia is now well placed to accelerate integration and

growth... .the combination of a favorable external environment, the
implementation of the Uruguay Round, the abolition of the Multi-
fibre Arrangement and increased regional cooperation is potentially
formidable and should result in faster growth. Simulating the effects
of the these factors on South Asia's exports, this study estimated
significant gains for South Asia and for India in particular.""

IMPACT ON OVERALL U.S. - INDIA RELATIONS

Larger MNC interest in India will increase the business

community's interest in, and influence on the decisions of both
governments. However, the broad variety of corporate interests
may de-emphasize the importance of particular industry groups that
have had special influence on U.S. policies because of their specific
grievances (e.g. film distributors and almond growers). The Indian
Interest Group (IIG), which represents a large number of U.S. MNC
investors, has played an important role in lobbying Congress,
particularly against attempts to target India on specific nuclear and
134 SAIS Review WINTER-SPRING 1998

human rights issues. Foreign institutional investors have yet to have a

major influence on policy, but the growing presence of U.S. funds in
the Indian economy anticipates a sizeable reaction should a crisis occur.
Two powerful factors that are not tied to liberalization continue
to influence U.S.-Indian relations. First, NRIs are playing an
increasingly influential role in both the United States and India.
The recent negative reaction in the United States to campaign
donations by Asians will likely have little impact on American
perceptions of India because the donors of Indian origin are usually
U.S. citizens. Second, the revival of commercial ties between India
and Russia will probably continue to be complementary to, rather
than competitive with U.S.-Indian relations. Nonetheless, India
is likely to have a relatively small economic presence on the U.S.
market in the near term, and the sectors in which it has a
competitive advantage (skilled and labor intensive operations, such
as information technology and gems, and garments, respectively)
are likely to remain the same.
The emergence of the IG, coupled with the NRI lobbies, gives
greater substance to Indian interests in U.S. politics than in the
past. Especially in the U.S. Congress, relations with India are no
longer viewed as a disembodied issue of political principle with no
political payoff. In India today, the NRI lobby and India's need
for U.S. capital and markets have a major influence on
governmental policy compared with earlier periods. Nevertheless,
conflicting commercial interests between U.S. and Indian residents
may exacerbate relations at the same time that their diversification
reduces the focus of conflict. The emergence of major U.S. stakes
in the stock market and the infrastructure sector may mean more
active U.S. concern for India, both in terms of pressure on Indian
policies and support for India in times of crisis. The result is that
U.S.-Indian commercial relations will be more important than ever
before. However, whether they will dominate political relations,
as they sometimes do in the case of China, remains to be seen.
 THE IMPACT OF LIBERALIZATION 135

Notes:

'See Cassen, Robert and Vijay Joshi, eds., The Future of Economic Reform
(Delhi: Oxford University Press, 1995) and Vijay Joshi and I.M.D. Little,
India's Economic Reforms, 1991-2001 (Oxford: Clarendon Press, 1996).
'Bhaduri, Amit and Deepak Nayyar, The Intelligent Person's Guide to
Liberalization (New Delhi: Penguin Books, 1996).
3Dattopant B. Thengadi, Nationalist Pursuit (Bangalore: Sahitya Sindhu

Prakashan, 1992).
'Statistical Outline of India, 1996-1997 (http://www.meadev.gov.in).
5 The Annual Report on the Working of the Reserve Bank of India for] July 1996
to 30 June 1997 (http://www.reservebank.com/annual/1.html, pp. 25-27).
6 Table 5.6, World Bank Development Report 1997 (Washington, D.C., World

Bank), pp. 252-254.

7 (http://www.nic.in/finmin/press/SUBSIDY.HTM)
8Both figures are from the Statistical Abstract of the United States (Washington,
D.C.: Government Printing Office, 1996). The 1990 Census reported 815,000
people of Asian-Indian origin and 81,000 of Pakistani origin. Clearly, a
significant number of the reported Asian-Indians are of Pakistani or other
non-Indian origin. A more accurate estimate could be made using Census
tapes, but we can assume that the number of non-Indian Asian Indians is
200,000. This correction would also account for the number of Asian-Indians
with third-country origins, especially in East Africa, Guyana, and Southeast
Asia.
9 See S.C. Bhatt, Satellite Invasion of India (New Delhi: Gyan Publishing
House, 1994); Peter Manuel, Cassette Culture: Popular Music and Technology in
North India (Chicago: University of Chicago Press, 1993); Ananda Mitra,
Television and PopularCulture in India (New Delhi, India: Sage, 1993).
10 The reason for this lack of replacement is difficult to pinpoint. Government
support for and the academic focus of area studies in the United States is at an
all-time low, despite a certain increased interest in Indian matters evinced by
U.S. residents of Indian origin. They have endowed several professorships
(mostly in the humanities), and constitute many of the undergraduates in
courses oriented toward India. Conversely, we may simply be witnessing a part
of the internationalization of academia, in which those who want to know
about India go to where most expertise exists, generally India itself. Business
firms typically get their Indian orientation from their own employees and
partners in India. Those who want to survey the Indian experience in various
matters can commission studies by Indian institutions. If an occasional course
or lecture is needed on an Indian topic, someone may be brought in from
India on a visiting basis.
136 SAIS Review WINTER-SPRING 1998

" "Foreign Direct Investment Pips FII Funding in '96-'97." Economic Times, 19
May 1997 (http://www.economictimes.com/190597/home2.htm).
1" There are an estimated total of 15 million NRIs throughout the world, who
are believed to own approximately $40 to $60 billion worth of financial
assets. "NRI Investment: Laying the Golden Eggs." India World, 27 July 1995
(http://www.indiaworld.co.in/subscribe/news/bgnd/0727-000.html).
" Ibid.
14 "India Consumer Market Set to Treble." Financial Times, 28 May 1997.
"Report on the Commercializationof InfrastructureProjects. The Indian
Infrastructure Report: Policy Imperatives for Growth and Welfare (New Delhi,
India: Expert Group, 1997).
" Table 5.9, World Development Indicators 1997 (Washington, D.C.: World
Bank) pp. 264-266.
" "At Last, the Selloff Gets Under Way." FinancialTimes, 16 September 1996.
" Miria Pigato, et al., South Asia's Integration into the World Economy
(Washington, DC: The World Bank, 1997) pp. 57-58.