RETHINKING ASIA- India: An Asian Brazil?
By Rajiv Lall
Source:Far Eastern economic Review
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February 25, 1999
W hen the Asian crisis hit, the Indian government was relieved that the country's relative isolation from the rest of the world had protected it from financial contagion. The crisis reinforced the scepticism about globalization among many Indians. Indian politicians felt comforted that their natural inertia on economic reform was not such a bad thing after all. Indian policymakers concluded--maybe justifiably so--that there was no need to rush the pace of either capital-account convertibility or the liberalization of financial markets.
However, now that Brazil has taken a tumble, I hope that the Indian government does not remain complacent in its lethargy. Brazil should be a warning to India. The fact is that there are remarkable similarities between the two economies, and if corrective action is not taken, India could soon find itself in the same predicament as Brazil.
At more than $75 billion, Brazil had substantial foreign-exchange reserves a few months ago. It did not have an overwhelming burden of foreign debt (29% of GDP compared to 62% in Thailand, pre-devaluation). Nor was most of this debt due to mature in the short term. Brazil has only $30 billion in short-term foreign-exchange-denominated liabilities, and most of this is trade related. It is true that the Brazilian currency was overvalued, having appreciated about 15% in real terms over the past three years. But even so, the country's current-account deficit was not nearly the size of some of the pre-crisis Asian economies (4% OF GDP compared to 8% for Thailand, for example). So why the crisis?
The answer has everything to do with domestic confidence, or, rather, the lack of it. The lack of fiscal discipline was the root cause of the Brazilian confidence crisis. The Brazilian government was unable to persuade its own citizens that it had the courage to put its fiscal house in order. Afraid that their government would resort to the old habit of printing money to cope with the rising burden of public debt, Brazilians began funnelling funds offshore at such a furious pace that the government was forced to abandon its fixed exchange-rate policy. Capital flight instigated by domestic residents, not foreigners, was what precipitated Brazil's crisis.
Now let us look at India. On the positive side, like Brazil, India's foreign-exchange reserves are a comfortable $27 billion. The country's foreign debt is also comparable, at 27% of GDP. And the short-term component of this debt is of the same order of magnitude, relative to GDP, as in the case of Brazil. Like Brazil's currency, the real, the rupee has been appreciating over the past three years. Yet the country's current-account deficit remains a modest 2.2% of GDP.
On the negative side of the ledger, however, India's fiscal imbalances are even larger than Brazil's. The reality is that for the past seven years, the Indian government's consolidated fiscal deficit--the combined deficit of the central and state governments and public enterprises--has been running at close to 10% of GDP each year. This is a fifth larger than the annual deficits relative to GDP run up by Brazil in recent years. Moreover, India's accumulated stock of public debt relative to GDP is already 90%, more than double that for pre-devaluation Brazil.
Why, then, is India not in crisis mode? The answer is threefold.
First, Indians save more than Brazilians do. Private savings in India account for 24% of GDP compared with 18% in Brazil. Second, India has, until quite recently, used a nationalized banking system to forcibly allocate private savings into government debt instruments. This has allowed the government to keep the interest burden on its debt artificially depressed. Despite a public debt-to-GDP ratio that is double that of Brazil's, the Indian government spends about 5.5% of GDP on interest payments compared to 7% for pre-crisis Brazil. Third, unlike Brazil, India never succumbed to the temptation of printing money to finance its deficits. India has no history of hyperinflation, so that macroeconomic policy has, at least so far, carried greater credibility with the saving public in India than it has in Brazil.
But there can hardly be any room for complacency. The Indian government now spends more each year on interest payments, salaries and subsidies to special-interest groups than it is able to collect in taxes. Even as the overall burden of public debt rises, governments at all levels--centre, state and municipal-- have progressively less available to spend on vital infrastructure and on primary health and education. In other words, they are failing to provide the most basic of public services to their constituents.
It may take Indians longer than Brazilians to weary of their government's growing and unproductive demands on their savings, but the patience of Indian households must surely be wearing thin. Without any serious and immediate effort at fiscal reform, it is only a matter of time before India finds itself in the same predicament as Brazil.
(Rajiv Lall is the Hong Kong-based managing director of E.M. Warburg Pincus & Co., an investment firm.)
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