#231 In the Interim...
The Laptop Import "Monitoring" System, Macro musings, India and China-Taiwan Tensions, Understanding India's stance on the Israel-Palestine Issue, and OpenTakshashila
Global Policy Watch: Macro Musings
Global policy issues relevant to India
— RSJ
It is good to be back after a short break. Not a lot happened in the interim, except perhaps a possibility of World War III. So, a quick update on how the global macros look at this moment might be in order for this edition.
First, the situation in West Asia. I’m sure you have possibly read every possible take on this by those more knowledgeable than us. So, there isn’t much to add here. A few things are clear at the moment. Israel has no definition of what is a proportionate response to what Hamas did. There’s no specific target to eliminate like Sri Lanka had in the shape of Prabhakaran. Occupying Gaza will mean a long, drawn-out conflict that will end in a stalemate like we have seen in every conflict in the recent past. So, it is a war without a goal, which will meander on till whatever internal investigation Israel does on its security failure that allowed Hamas a free run that weekend comes to a conclusion, and Netanyahu steps down. That might take a year. In the meantime, the Israeli regime will find a Goldilocks zone of demonstrating enough action in Gaza to keep its domestic audience satisfied while not going too far to spark a regional conflagration. Anyway, based on the evidence so far, no regional player, including Saudi Arabia or Egypt, has shown any intent of going down that path. Saudi Arabia is keener to own the rights of professional golf tournaments, own English premier clubs and win the bid for the 2034 FIFA World Cup than be drawn into a war with Israel. Egyptian economy cannot handle a million or two refugees who will then use it as a base to avenge the loss of their homeland. So, it is really up to Iran to make this a bigger war. There’s a remote possibility of it, especially if Russia backs Iran to do this. For Russia, any worsening of the Middle East situation is a blessing in taking away world attention and resources from Ukraine. So, it is possible it might encourage such forces. But I don’t think Iran has either the resources or the domestic political capital to engage in any kind of direct war with Israel. It will happily support a low-grade proxy war like it has done for a long time. The upshot of all of this is a prolonged war of the kind we have seen in Ukraine with no clear end in sight. It will just be another variable for everyone to factor in while thinking of the global economy. Oil prices will remain elevated, which keeps most players in the Middle East happy, and another set of economies will be taken off from any possible foreign direct investment, which should be marginally positive for India.
Moving on, the news from the US economy continues to confound all forecasters. After six quarters of rate hikes that saw interest rates hiked 11 times to up to 5.25 per cent and inflation down to 3.7 per cent, we had the GDP grow at an unprecedented 4.9 per cent in Q3, with unemployment being at about 3 per cent (almost full employment). Bond markets, as a consequence, have seen turbulence usually reserved for more speculative assets. Consumer spending has remained remarkably strong as the savings accumulated during the pandemic continue to run down. From over $2 trillion of excess accumulated savings, we are down to less than a trillion, and it looks like the consumption party might last only a couple of quarters more. The fiscal deficit has doubled in the past year to about $2 trillion, and it is unlikely that this spending mania will sustain because the revenue collections have been weak despite a growing economy. At the beginning of this year, I had predicted that the talk of a US recession was premature. I expected a strong FY23 and any slowdown to be seen possibly only in FY24. That is exactly how it will play out.
The high fiscal deficit across most developed economies is a problem, and it will manifest itself in medium-term pain for these economies. I expect FY24 to be recessionary for most economies. A high fiscal deficit will keep the pressure on rates and so the ‘higher for longer’ thesis that the Fed has been indicating holds for now. And that brings me to the risk of accidents of the kind we saw in the shape of Silicon Valley Bank, where the HTM losses become unsustainable for those institutions holding them. A whole raft of speculative-grade debt starts maturing from FY24 onwards, and a high rate regime will make it difficult for them to be refinanced. So, as much as the 4.9 per cent growth number might lull policymakers into a sense of complacency, things don’t look good at this moment below the surface.
Writing in the FT this week (paywall), the IMF Chief Economist, Gita Gopinath, calls for a ‘reset’ in fiscal policy thinking:
“In the halcyon days of lower-for-longer rates, governments could finance their spending through low-cost borrowing. In today’s environment — where it is politically difficult to cut spending or raise taxes — debt-financed spending may still seem tempting. However, that would be a grave mistake, setting debt on an unsustainable trajectory as borrowing costs rise sharply.
With record-high debt levels, higher for longer interest rates, and growth prospects at their weakest in two decades, restraint is required — even for reserve currency issuers. Indeed, the US has some of the largest deficits, at 8 per cent this year and expected to average 7 per cent over the next few years. At these rates, general government net interest payments in the US would grow from 8 per cent of revenues ($486bn) in 2019 to 12 per cent ($1.27tn) in 2028. Given the centrality of the US to global financing conditions, putting its fiscal house in order is paramount — for itself and others, who are getting hit by rising rates and weaker currencies.
But the US is not the only country that should heed this advice. While specifics vary, several principles of a reset in fiscal policy thinking are common to all.”
Gopinath makes three points:
Governments cannot and should not be ‘insurers of the first resort’ for all kinds of shocks. The fiscal buffers need to be built for real shocks of the future rather than continuing to build a deficit at the smallest of risks.
Revenues need to keep pace with spending, which means proposals like the minimum corporate tax that reduces the arbitrage available for corporates to avoid taxes in their domestic markets. Wealth and capital gains taxes and broadening the tax base in emerging economies are other opportunities to meaningfully increase the tax-to-GDP ratio by 5-8 percentage points.
Lastly, countries should have the right checks and balances to hold governments accountable and prevent them from runaway spending that breaches the fiscal framework put in place.
These are all sound advice, but the problem is if there’s limited political will to be fiscally conservative because it is difficult to sell it to the electorate, who will want to follow them?
As the election season gets underway in India, there’s no shortage of bad ideas being bandied about: from reversing the NPS in states, minimum basic income guarantee to women, subsidies on cooking gas and manure, free laptops and many more. These are exactly the kinds of bad ideas that get copied across the political spectrum and pose the risk of fiscal profligacy and destruction of value. This is important to understand. India has limited ability to improve its labour size through higher labour force participation in the short term. In fact, worryingly, female labour force participation has fallen. There’s no immediate fix to this social issue. Total factor productivity in the last decade has already been quite good, and further acceleration in it is difficult, especially if the global growth environment is benign.
What that leaves us with is capital formation, which, despite the many promises, has remained weak. The corporate balance sheets are at their healthiest for a long time - corporate debt to equity ratios and debt to EBITDA ratios are at their lowest since 2008. The leverage of banks (assets to equity ratio) is down to a low of 11, and the financial institutions are well-capitalised at this moment. There’s no reason for a sustained capex push at this moment, given reasonable confidence in sustaining an 11 per cent nominal GDP growth and limited options for global capital among emerging market economies. It is a good time for the government, possibly more so if it comes back to power (which looks likely at this moment), to make a real push for capital formation by debottlenecking the process for getting greenfield projects going and signalling a stable policy regime that doesn’t do variants of retrospective taxation or going after imaginary GST arrears. There’s nothing new in us batting for this, as we have been doing so for the past year or so. But there’s no better time for India to get going on this.
PolicyWTF: The Never-ending Saga of Laptop Import Restrictions
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
— Pranay Kotasthane
All policy analysts will gain by observing the changing nature of India’s proposed laptop import licensing restrictions monitoring system (third time lucky!). It is interesting that the ill-planned and ill-thought-out laptop import licensing plan has been diluted over time.
The Department to Ground Foreign Trade, I mean, the Directorate General of Foreign Trade (DGFT), first sprung up insane restrictions on laptop imports on August 3. The very next day, it clarified that this policy’s implementation had been delayed until November 1. Then came the news that the government will further “tweak” this policy to allow unrestricted imports from “trusted geographies”. Finally, on October 19, the government diluted these restrictions further, saying that it only intends to operationalise an online authorisation system that will automatically issue import authorisations once importers supply the required information regarding imports of laptops.
Small mercies.
So the government has reversed, if only partially, a stupid move. What caused this reversal?
Some analysts have argued that it was the pressure from American companies that made the government take a step back. I don’t think that’s the case. The fact that these companies heavily rely on imports from China and hence would oppose these restrictions was apriori known to the Indian government. That it still went ahead with the August 3 announcement suggests that the government was willing to face the ire.
My speculation is that the ridicule that this policy faced from domestic circles did the trick. Criticism equating these restrictions with the "license-permit-raj" really hurt the government. The fact that a minister felt the need to clarify that these restrictions weren't the same as the license raj of the pre-liberalisation era is a sure-shot indication that the criticism hurt. The government, despite enjoying an overwhelming narrative dominance, found it difficult to rationalise a policy that clearly resembled the licensing regime of a bygone era.
This is an interesting case study of how public pressure can work. Credit to the government for the climbdown after the initial stupidity. I feel this case illustrates how "free trade" can be defended using better slogans and narratives which are suited to the local context.
We are not out of the woods yet. The US and other countries have raised these restrictions at the WTO. Even the proposed import monitoring regime is a regressive step that gives arbitrary control to bureaucrats and creates incentives for corruption. The government should, for once, eat humble pie in a corner (without anyone noticing) and do away with this disastrous policy in its entirety.
Matsyanyaaya: Rethinking India’s Position on China-Taiwan Tensions
Big fish eating small fish = Foreign Policy in action
— Pranay Kotasthane
It’s surreal that even in 2023, the “Word of the Year” contender is “invasion”. Russia’s bungled invasion of Ukraine doesn’t seem to end even as Israel has invaded Northern Gaza. And so, it makes sense to talk about another much-discussed invasion: China’s takeover of Taiwan and its implications for India.
The dominant narrative in India is that any escalation in the Taiwan Strait would spell disaster for India. Thus, India should adopt a diplomatic stance aimed at de-escalation. This involves India signalling to the US its opposition to further aggravation and dissuading Taiwan from moving in the direction of independence.
However, this perspective perhaps overstates India’s influence in the matter and underplays potential strategic advantages.
First, let’s consider the issue of India’s actual leverage. Realistically, India’s ability to influence the decisions of the US, China, and Taiwan is limited. This is a high-stakes issue for all three players, and they are unlikely to pivot based on India’s stance. Recognising this limitation gives India strategic clarity rather than overestimating its diplomatic agency.
Second, the assumption that a deteriorating security situation or an outright war over Taiwan would unequivocally harm India needs re-evaluation. While economic repercussions, such as soaring prices and market instability, will indeed be harmful, the lens of statecraft requires analysing relative power gains and losses, not just absolute ones. The real question to ask is whether a worsening situation in the Taiwan Strait would hurt China more than it would hurt India. In my view, India would be better placed.
Critics highlight India’s vulnerability due to its reliance on Taiwanese semiconductors. However, this argument merits deeper analysis. If anything, there are far higher numbers of American, European, and Chinese companies that need semiconductors from Taiwan. Few Indian companies directly buy chips from Taiwan to make cutting-edge products.
Another mistaken assumption is that China will seamlessly usurp Taiwan’s crown jewel, TSMC, to the detriment of all other nation-states, including India. However, this assumption misses the point that the invasion of Taiwan directly implies TSMC's downfall. In a rare interview last year, TSMC Chairman Mark Liu categorically said that if China were to take over Taiwan, it would find TSMC’s facilities unusable because their secret ingredient is human capital and real-time international collaboration with companies for materials, software, hardware, and know-how. A China-controlled TSMC would still be dependent on ASML for EUV machines, on Japanese companies for photoresists, and on many US firms for other critical manufacturing equipment. In case of an invasion, all these lines are highly likely to be cut off.
Finally, another angle rarely discussed is the potential diversion of China’s military focus. Engrossment in a Taiwanese conflict could dilute China’s aggressive posturing along the India-China border. This shift presents strategic breathing space for India, allowing recalibration of its border defences.
Thus, India’s strategic community needs to shed shibboleths regarding China-Taiwan tensions.
Matsyanyaaya: India, Israel, and Palestine
Big fish eating small fish = Foreign Policy in action
— Pranay Kotasthane
I’m sure many of you would be on the lookout for reading recommendations for understanding India’s position on the Israel-Palestine issue. Before your mind space gets occupied by the endless stream of opinion pieces focusing on the current Israel-Hamas war, I recommend taking a step back to understand India’s position on the Israel-Palestine issue. I believe that’s important because, despite the political rhetoric, foreign policy positions of successive Indian governments on matters beyond the neighbourhood tend to change only at the margins.
So, before reading the next opinion piece on this topic, I recommend reading Nicolas Blarel’s excellent book from 2014, The Evolution of India's Israel Policy: Continuity, Change, and Compromise since 1922. This book is a scholarly treatment of India’s policy position over the last century. I reviewed the book for Business Standard way back in 2015. Here’s a draft of that review, giving a sneak peek into the book’s key arguments.
Rare were foreign policy issues the Praja Socialist Party (PSP), the Bhartiya Jana Sangh (BJS) and the Swatantra Party ever found common ground on. Fewer still were occasions when the survival of Indian government in the Lok Sabha was contested due to conflicts taking place far way from India. And only once has it ever been that India recognised a state and yet deferred diplomatic ties for as long as 42 years. Such is the enigma of India’s foreign policy towards Israel that it has caused all three aforementioned situations.
The Evolution of India’s Israel Policy is a scholarly work where the author, Nicolas Blarel, develops a framework to determine what causes changes in the foreign policies of states. Blarel, an Assistant Professor of Political Science in the Netherlands, gives a dispassionate and analytically rigorous account of India’s policy in West Asia. He uses several interviews with Indian policymakers, primary and secondary sources as evidence for the central argument.
The objective of this work is to raise and answer some key empirical and theoretical questions — why did India not establish diplomatic relations with Israel for more than 40 years? What were the enabling conditions under which this policy was finally reversed in 1992?
The traditional answers have excessively weighed major international changes of 1990-92, such as the end of the Cold War, the domestic economic reforms in India and the Israeli—Palestinian talks following the Madrid Conference. Blarel disagrees with this deep-rooted approach in international relations theory, which conceives that foreign policy changes are a binary phenomenon—they either take place with a quick, big bang or they don’t. Instead, the author offers “a new conceptual framework which can better account for the formation of India’s Israel policy as well as its evolution and transformation as it was confronted with changing circumstances, different leaders, and varying ideas.”
The central argument is that any foreign policy change occurs due to the contestation of ideas between various actors in two distinct stages. One of the actors is the old guard—which is entrenched in the existing policy. This old guard competes with a second set of actors that challenges the status quo. In the first stage, there’s a collapse of the existing dominant orthodoxy when its policy ideas lose legitimacy due to an external shock. At this point, the foreign policy position is fluid and open to debate. In the second stage, a contest between new and old thinking takes place. Eventually, the direction and the magnitude of the foreign policy change are determined not only by the arguments of the two competitors but also by their command over institutions, the resources they can command in pertinent debates, and external factors that affect the relative power of the two groups.
The author tests this framework by applying it to the important junctures in India’s foreign policy towards Israel. The first juncture (1922-1947) details how the incentives of the British government differed from those of the British government in India on the Jewish homeland question. Starting with the Khilafat movement, West Asian politics also became a competitive arena between the Muslim League and the Indian National Congress (INC) to gain the support of Indian Muslims. This approach indirectly led INC to oppose the Zionist project and resulted in the first Indian policy towards Israel, one that did not recognise its existence even after the USSR, US, and UN had done so in 1948.
A change in this policy occurred when the opportunity costs of India’s refusal to accept a legitimate state started becoming unbearable. Concurrently, Indian policymakers knew that the Arab states enjoyed numerical asymmetry at the UN General Assembly vis-à-vis Israel. This was important to India because Pakistan was actively courting the Arab states for their support on the Kashmir issue at the UN. Consequently, a policy compromise was reached whereby India recognised Israel in 1950 without setting any timeline for establishing diplomatic contacts.
Thereafter, conditions seemed propitious for establishing overt diplomatic ties on at least two occasions. In the early ‘50s, this window closed with the Suez crisis of 1956, which hardened the positions of the Arab states and Israel, making it difficult for India to make any changes to its policy. The second window of opportunity came during 1969-1971 when there was a developing internal consensus in India as the Arab states continued to oppose India at various multilateral forums. However, the new dependence on oil from West Asia meant that a new compromise took place. India recognised the Palestine Liberation Organisation (PLO) as the spokesman of the Palestinian people. Simultaneously, back-channel contacts with Israel were established through the Mossad, which acted as an alternative diplomatic agency.
Finally, India decided to establish full diplomatic relations with Israel in 1992, notably just five days after China had done the same. Using the proposed framework, Blarel explains how the old thinking was completely replaced on this occasion. Amongst other factors, he discusses Israel’s role as a supplier of arms with the decline of Russia and its role as a conduit for economic and trade opportunities with the US.
This foreign policy change has now survived for more than two decades. Throughout this period, India has voted for the Palestinean cause at the UN on the one hand and has managed to consolidate its relationship with Israel on the other. But the balancing act continues. The India—Israel relationship is now a specialised collaboration in technical fields like military and agriculture, but it has still not taken the shape of a strategic partnership.
The book adequately explains how realism rather than moral considerations have guided India’s stance in West Asia. As a consequence, India is uniquely placed—it has been able to maintain a non-adversarial relationship with every West Asian nation. Whether India will be able to utilise this advantage will be determined by India’s economic growth and pragmatism in international conduct.
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