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 INDO-ARAB ECONOMIC RELATIONS: THE ROAD AHEAD    by Dr. M. A. Hasib Former Executive Director, Reserve Bank of India

In discussing Indo-Arab economic relations, one may focus on different dimensions of the subject, including the historical, cultural, political and economic relations between the two regions related to trade and investments. But I will not deal with them, except in broad terms. I could look at Indo-Arab economic relations, as I see them, as an Indian focusing on economic conditions and opportunities in the Arab region in the years ahead, or alternatively, I could look at the Indian economic scenario from the perspective of an Arab. I would prefer to look at the contemporary economic scenario in India in a global perspective and in respect of the future prospects for the Indian economy.

Let us start with the global perspective. The major economic powers in the world today are USA, Europe, Japan and Asia, particularly China and India. Looking at the latest trends, it appears that the world growth is lopsided. In 2004 the world economy grew by about 5 percent. Among the developed countries, the highest growth was achieved by the USA (4.4 per cent) while Europe and Japan grew only by 2.1 per cent and 1.7 per cent respectively. In the newly emerging economies the highest growth was recorded by China (9.5%), followed by Argentina (9%), Malaysia (7.1%), and India (6.9%). The current growth rate in India exceeds 8%.

Europe and Japan have been struggling for the past few years. It is the USA, the world’s largest economy, which is a major driving force for the economies of the rest of the world. Should I, if I were an Arab trader or investor, look to the USA, while keeping in view the fact that profitable relations should be consistent with safety and stability? Undoubtedly, there are vast opportunities in the USA, but one needs to take a deeper look. The long-term growth rate of an economy depends on the quality of its institutions, technology, investments and savings. American institutions, with some exceptions, are among the best in the world. But is its growth rate, which is the prime determinant of international economic relations, sustainable? The American economy is consumption-driven; its per capita consumption is the highest in the world, and much of the consumption is wasteful. The American economy is debt ridden. Its households savings are close to zero. It is the rest of the world which is accumulating dollars and pumping them back into the US to finance its consumption. A vast majority of American households are under debt. Home prices driven by low interest rates are going up. But it is like a bubble which may bust any time as it has happened in the past. The main point is: will the rest of the world continue to finance the fiscal deficit of America? How long can one go on enjoying exotic foreign holidays or fighting costly wars with borrowed funds? When a bank ultimately asks a borrower to repay the loans he had taken, he will go bankrupt in similar conditions. That may happen to America, although it may not happen tomorrow or the day after. But the day of reckoning will come when international confidence in the American economy will be shattered.

So if I were asked to advise an Arab financial institution about its investment preferences, I would advise it to put only a few eggs in the American basket.

It is the newly emerging economies, mainly China and India, which have been recording high growth rates. What is even more important is that their future is brighter than that of Western economies. From the Arab point of view, India could be a better destination because of historical, cultural and religious factors. Let us look at the Indian economy in a wider perspective. The Indian economy is passing through high growth phase and I dare say that, unless some unforeseen situation arises, it seems to be a secure, long-term trend. The latest estimate of the growth of GDP is more than 8%. Let us take a critical look at the growth rate of Indian economy in a historical perspective, particularly in the context of the last five decades since 1953. In the first 20 years, the growth rate varied between -3.7% and 7.6%. There were two years with negative growth rates. In ten out of twenty years, the growth rate was less than 5%. In the next twenty years, the rate varied from -5.2% to 10.5%, again with two years of negative growth rate. So the Indian economy was growing during this period, but at a relatively slow, halting rate, based as it was on mainly agriculture and government-directed policy investments. Government rules and policies hindered, rather than promoted, entrepreneurial initiative and skill. India remained a marginal player in world economy. The world seemed to have lost trust in the Indian economy, so much so that when India had to borrow from England in a critical balance of payments position in 1991-92, the Bank of England insisted on gold as security for the loans to be shipped physically to Bank of England. Fortunately the gold has been returned to India.

Things have changed for the better since 1991-92. Since then there has not been a single year with a negative growth, despite some bad monsoon years. During the last three years the growth rate has accelerated and is expected to exceed 8% in the current year. So a new trend has set in, which has been recognized and appreciated by the world. The apprehensions about the health of the Indian economy have been laid to rest and foreign investors now find India a very promising and profitable place to invest. Foreign exchange reserves, which covered less than 2 months of imports in 1990-91, now cover more than 14 months of imports. Total reserves are more than the external debt, a sure sign of the growing strength of the Indian economy. Is this a short term, sustainable trend? Or is it only a bubble which may burst, as I fear it might happen to the American economy?

The answer to this question lies in certain far-reaching changes which are currently taking place in the Indian economy. Savings and investment are two important determinants of growth. Gross domestic savings, which were around 9% in 1952, have steadily increased to an estimated 29% in the current year. Capital formulation, which was about 8. 7% in 1950-51, is estimated to have gone up to above 30%. These are sure indications of dependable growth. Despite poverty and low per capita income, households contribute 22% out of 29% of Gross Domestic Savings.

Second, the composition of Indian output has undergone significant changes in recent years. About half a century ago, agriculture contributed more than half of GDP; its contribution now stands at 25%. It is not a weakness, but an indicator of positive changes in the economy. An economy which was largely dependent on the vagaries of the weather is now depending more on industry and services, including trade, the hospitality industry, construction, communication, and financial services (eg banking and insurance), which now contribute more than half the national output. The contribution of industry is about 24%.

Third, this transformation has come about as a result of fundamental changes in policy. Following the liberalization of the economy, entrepreneurial and technological skills have been harnessed. Indian Institutes of Technology (IITs) are rated among the best in the world. The literacy rate and life expectancy have improved appreciably in recent years.

Fourth, investible resources and the quality of investment have improved. There is a healthy investment climate, which is conducive for reposing confidence in the future. India receives more than a quarter of global portfolio investment to emerging market economies. Fifth, financial stability has played an important role in the process. The banking system in India is fully compatible with Basel 1 norms, which means that the capital adequacy ratio has improved appreciably and its non-performing assets have declined. Capital and reserves have been ascending to new heights. An important factor in the current investment climate is the strict regulation of the financial system and capital market by the Reserve Bank of India and the Securities and Exchange Board of India. I may add in this context that since the majority of Arabs are Muslims, the capital market in India offers them opportunities for investment which are compliant with Shariah norms. My young friend, Dr. Shariq Nisar, has done useful research in this area, which shows that a major part of stock equity index is Shariah-compliant in accordance with internationally accepted norms. I may add, finally, that no investment opportunities are without risk but the risk should be calculated and manageable.

A major risk to the Indian economy may be caused by high oil prices and external shocks like an adverse international political climate and the possibility of loss of trust in the American economy. Undoubtedly, there are weak spots in the economy. Infrastructure, primary education and health care need radical improvement. Agriculture is in need of investment. But the important point is that things are changing in a positive direction.

Therefore, I would advise my Arab friends to take advantage of the growing opportunity for investing in India. Put a few of your eggs in the Indian nest; they will hatch and may well lay golden eggs, hopefully without catching bird flu.

(This paper was presented as the Presidential Address at a symposium on "Indo-Arab Economic Cooperation--The Road Ahead” at Islam Gymkhana, Marine Lines, Mumbai, on February 27,2006. It is reproduced here with grateful acknowledgement to Dr Hasib.)

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