Indian economic strategy in the new globalisation

by Vijay Kelkar and Ajay Shah.

A great global order has run astray. For over half a century, the world operated under an open system of movement of goods, services, capital and people, a system that was built by the post-war Western powers. India, for all its post-independence suspicions of the market and the world, was a big beneficiary of this order. From 1991 to 2011, India’s GDP growth quadrupled, not solely from an act of internal genius, but on the back of a global system that allowed Indian goods and services to find markets, that established the flow of capital, technology and business knowledge into India. Global companies brought new levels of productivity and knowledge into India, while foreign financial firms gave capital to India’s high-tech sector, and foreign buyers purchased Indian services exports that are at a run rate of $400 billion a year. Foreign companies provided the foundational technologies -- the CPUs, operating systems, the Internet and all the systems software -- on which India's knowledge economy was built. The champions for Indian openness, such as Jagdish Bhagwati and Ashok Desai, were proved right in abundance.

We must first confront a difficult truth: India's growth from 1991 to 2011 was partly built on a global system's benign neglect, a diplomatic dividend that has now been fully spent. In those years, India did not always play by the rules. We, as a nation, maintained a plethora of tariff and non-tariff barriers, all the while taking for granted the access granted to us by a world that was, for the most part, exceptionally indulgent. This indulgence stemmed from the West's perception of India as a decent, democratic country that would, in time, graduate to being a valuable successful country that would be a good citizen in the world economy. The West saw the idea of India; they felt India was a nation on a path to prosperity that was worth supporting, even if it did not always reciprocate with fair play when it came to economic nationalism. This benign neglect is an important element of India's growth story in the great years of 1991-2011, an element that is often neglected.

That era is now over.

The year 2016 was clear and sombre turning point. Donald Trump's rise to power and his subsequent policies of "America First" signalled the end of the post-war consensus on globalisation. At about the same time, China became estranged from the world due to its sustained use of unfair trade practices, going beyond tariffs to a dogged pursuit of economic nationalism where the ability of foreigners to operate in China is undermined. What we are witnessing is not a temporary hiccup, but a major change in the world economy. This is a new Globalisation, where the two poles of the old order (the US and China) are either hostile to the system or using it to their own unfair advantage.

So far, the US economy has endured the Trump shocks. We should not, however, be complacent about this good fortune. There are concerns about what will happen in the US economy on four fronts: local inflation which would then require tough monetary policy, loss of export competitiveness, adverse impact upon investment through increased uncertainty and punishment from the financial markets (Shah, 2025). Just as there are `gains from trade' with GDP growth induced by liberalisation, economic laws work in reverse also: Deglobalisation will harm growth, and the two epicentres of this problem are China and the US. All this paints a more sombre outlook for the world economy. A US with policy capabilities akin to those in an emerging market will be viewed with greater hesitation by global investors, inducing new stresses in financial markets. This is bad for the significantly outward-oriented economy that modern India has become: we need a successful prosperous world economy in order to sustain our rise.

For us in India, this is not a crisis moment on the scale of 1991. We are not facing an immediate balance of payments collapse. But it is an inflection point of equal, if not greater, long-term significance. The old strategies will no longer work. We cannot continue to rely on the indulgence of an open world that supports the rise of India. The path to India's ascent has just become considerably harder, and a commensurate, well-thought-out response is required.

The task of economic thinkers in India today is to strategise that response. Many good writings have emerged on this: Chinoy, 2025; Das, 2025; Ninan, 2025; Rao, 2025; Sengupta, 2025; Sharma, 2025. In this article we draw on all these and synthesise a full picture.

The New Core: Embracing the OECD (ex-US)

The first step in this new world is a pragmatic reassessment of our trade partnerships. If the US and China are now problematic partners, where does India’s future lie? The answer is to pivot aggressively and strategically towards a new core: the set of countries we can term the "OECD ex-US." This group includes the United Kingdom, the European Union, Japan, Canada, Australia, South Korea and many others. Adjacent to this are sophisticated countries such as Taiwan which are not members of the OECD. These are advanced, rules-based economies that remain committed, for the most part, to an open global system. While there are blemishes -- such as the agriculture policies of the EU -- by and large this remains the the sensible and stable core of globalisation today.

It is worth prioritising engagement with them as (a) They have a high level of GDP and (b) Their democratic and pro-globalisation policy frameworks are grounded in the Second Globalisation. Advanced mature democracies operate as institutions; policy movements are not personalised into the whim of a leader; when an agreement is made, it will stick for a long time, which is the time horizon required for private firms to commensurately respond.

We in India need to push on two approaches with these countries.

First, we should work with these countries to construct a new system of globalisation, where a variety of the unfair practices that were tolerated under the GATT or WTO are blocked [EiE Ep96 Is globalisation doomed?] That would be the best response. India has the opportunity to be in the founding group of such a new system. Once this is up and running between a core of important countries, such a system can be presented as an open system available to all countries, should they commit to deep globalisation on a defined set of conditions. The Trans Pacific Partnership ("TPP") -- which morphed into the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) with the 11 countries going ahead without the US -- and the EU are examples of modern multilateral deep trade agreements.

Alongside this, we should make it a top priority to seek a new style of Free Trade Agreements (FTAs) or Comprehensive Economic Cooperation Agreements (CECAs) with every country in this bloc. The term `Deep Trade Agreements' (DTAs) vividly suggests the nature of bilateral trade agreement that is now desirable. The recent Indo-UK FTA is a step in the right direction. But it must be seen as the beginning, not the end. A DTA is not just about reducing tariffs; it is about harmonizing regulations, setting common standards, and creating a predictable legal and business environment that supports free movement of goods, services and capital. Such agreements would allow Indian firms to integrate into advanced global supply chains, gaining access to high-quality technology, capital, and markets.

This strategy demands an Indian retreat from the traditional protectionist approach. Our long-held reliance on high tariffs and a Byzantine web of non-trade barriers, a long list of redlines that subverted meaningful trade deals, is no longer viable. The benign indulgence we enjoyed in the past is gone. Our traditional ways, in a world of rising trade tensions, will be met with a reciprocal, and likely unpleasant, response. The United States is going through the throes of a great upsurge in populism; we cannot afford to provoke a turn towards aggressive economic nationalism, and a rejection of the global trading system, from the rest of the advanced economies. The message must be clear: India is no longer an aspiring economy seeking special treatment, but a serious global player willing to offer an equal, level playing field, and engage in deep globalisation.

This idea is not unique to us. Sensible policy thinkers the world over are looking at the wreckage of the post-Trump trade environment, and thinking on similar lines (Froman 2025, Hinz et. al. 2025).

Such deep engagement would make many new kinds of economic activity possible, which are presently not undertaken:

• Consider the German automotive industry under conditions of a DTA with the EU. Indian firms could then become part of the BMW or Mercedes-Benz supply chain, not just for low end parts, but for high tech components and software of the future automobile. This would require harmonising standards and IP protections.
• Consider the Japanese electronics or South Korean shipbuilding industries. A DTA with these countries could create conditions for them to see India as a China+1 partner (or really, OECD(ex-US)+1) for their advanced manufacturing.
• There are remarkable developments in defence R&D and manufacturing currently emerging, in the coalition of Poland and South Korea. Under conditions of deep integration with these countries, there is an opportunity for India to be a manufacturing platform for this joint work, harnessing Indian skills and geographical remoteness. This would simultaneously give India access to high technology and better defence equipment.

The Inward Turn: Removing the Domestic Shackles

Maximising our engagement with the OECD ex-US bloc is only half the battle. The other, and perhaps more difficult, half is to look inwards. To trade more intensely and successfully with a smaller, more discerning group of partners, Indian firms must be more globally competitive. This requires a sweeping agenda of domestic policy reforms that remove the shackles upon the domestic economy. Eight things loom large.

I. The indirect tax system

The current Goods and Services Tax (GST) regime, while a monumental step forward, is plagued by a major flaw: it fails to fully reimburse exporters for all indirect taxes paid. For the GST to actually be the promised "destination-based consumption tax", you do not tax non-residents. The existing system leaves many taxes (cesses, electricity, fuel, municipal taxes) embedded in the cost of production, which are not refunded to the exporter, thus making Indian exports artificially expensive. Input tax credit (ITC) has to flow fully, so as to generate the complete refund at the point of export. We advocate for a move to a single, low-rate GST, coupled with a simple carbon tax (Kelkar and Shah 2022, Kelkar, Modi and Shah 2025). Such a system would not only make Indian goods more competitive but would also align with evolving global standards, such as the European Union’s Carbon Border Adjustment Mechanism (CBAM), which taxes imports based on their carbon footprint (Jaitly & Shah, 2023).

II. Regulatory reform

We need to build on the intellectual foundation of the Financial Sector Legislative Reforms Commission (FSLRC). The FSLRC’s core ideas -- checks and balances for regulators that wield legislative and executive and judicial power -- are not limited to the financial sector. They must be applied across all statutory regulatory authorities in India. When regulators are enveloped in checks and balances, their arbitrary power will be diminished and their behaviour will become more predictable. This predictability is the bedrock of business confidence, both for domestic firms and foreign investors. This agenda is the sensible interpretation of the fashionable word `deregulation' (Shah, 2025; Krishnan, 2025).

III. Improving the judiciary

None of this can succeed without fundamental improvements in the Indian judiciary and legal framework. The delays in Indian courts, and the risk of matters being decided incorrectly, are a major drag on economic activity. Businesses, both Indian and foreign, are hobbled by disputes that can last for decades. This unpredictability hinders modern business arrangements which are grounded in contracts that perform as promised, and help to create a significant "India risk" premium. There is now a body of knowledge and experience in building better courts which can be brought to play upon this problem (Shah, 2024).

IV. Cities are where production actually happens!

Whether it is services or manufacturing, export oriented production happens in cities. There is a direct connection between the Indian urban reforms agenda -- the economies of agglomeration of talented people into livable spaces -- and the ability of India to produce and export. Thus far, there is little to report on the agenda of decentralisation to city governments, and to better town planning. A great deal of knowledge has now been developed in the country and can be usefully deployed into these questions.

V. Solve the logjam in agriculture

We have long known that Indian agriculture is broken owing to the comprehensive array of state intervention. The Indian state is overseeing and subsidising a faulty system of intervention that is inducing a health crisis through bad nutrition and the burning of fields. Indian protectionism in this field is proving to be disproportionately costly for the overall Indian economy. This underlines the priority of obtaining progress in this area. The essential idea is to have a full play of the price system in agricultural inputs and outputs, with freedom for individuals to buy and sell land, to sell agricultural products, to trade in commodity futures markets in India and abroad, to store agricultural products, and to move agricultural products within India and across the border. Achieving these changes will need to be done with a comprehensive sense of all the margins of adjustment (partial liberalisation is harder for the people) and political wisdom. The metaphor of structural adjustment programs is required for solving the sites of the highest intervention in the past, i.e. Punjab and Haryana.

VI. Macroeconomic resilience

In this turbulent environment, it will be particularly important to maintain macroeconomic stability. The path to macroeconomic stability lies not in autarkic instincts, or stifling private sector innovation, but in creating institutions for resilience. India has made one big movement forward in the form of the inflation targeting system [EiE Ep68 Inflation targeting], which has now delivered better CPI inflation stability from 2015 onwards. We must keep a zealous watch on CPI inflation, and ensure it does not deviate from 4% as is specified in the inflation target. With that problem mostly under control, there are now four areas of work for establishing macroeconomic resilience:

1. There is a problem with fiscal prudence, with a debt/GDP ratio that has risen considerably, and a primary deficit which is well above zero in all years. New institutional designs such as a Fiscal Council can help in this journey.
2. There is a problem with exchange rate inflexibility: a floating exchange rate [EiE Ep67 Exchange rate flexibility] is a great shock absorber when faced with difficult times (Shah, 2024).
3. Much needs to be done to create robust and resilient financial markets, which can absorb shocks in times of need (Shah 2026).
4. The gradual dismantling of the financial repression system (Chitgupi et. al. 2024) will create a new kind of strategic depth for the Indian state in terms of its ability to borrow from voluntary lenders, both onshore and offshore.

VII. Finance as the brain, financing as the raw material

The financial sector itself needs a fundamental overhaul, again drawing on the FSLRC’s vision. Indian firms currently operate with a significant disadvantage: a higher cost of capital compared to their global peers. This is a direct consequence of the malfunctioning financial system and the partially closed capital account. The Indian system of financial repression -- where the state uses regulation to appropriate a portion of private savings -- must be dismantled. Financial reforms will increase the quality of thinking that finance, the brain of the economy, is able to put in when allocating scarce domestic savings. By liberalising the capital account in a careful, sequenced manner, we can allow Indian firms to access the cheapest possible capital from global markets, making them more competitive.

VIII. Improved engagement with the information space

Economic policy acts through the process of reshaping the optimisations of self-interested people, about the nature of government coercion and the strategy for future policy reforms and institution building (Shah, 2018). In this, the communication strategy of the government achieves importance. Central to the 1991-2011 macroeconomic boom was the trust and respect of the private sector, for a shared understanding of the strategy for reforms, carried across multiple elections and multiple teams. As the old adage runs, the policy maker must `say what you will do and then do what you just said'. The modern information environment has become more daunting, with the rise of social media. In such an environment, there is great value in a government that is known for truth telling. A strong orientation towards truth speech would be a powerful asset in improving the structure of expectations of the private sector.

All large global firms are looking to do less in the US and in China. If we play our cards right, India can be a OECD(ex-US)+1 centre of activity for many important firms. But this requires profound improvements in how the Indian state treats foreign firms. India needs to move towards a system of OECD-quality tax treaties and bilateral investment protection agreements. Most importantly, we need a clear Parliamentary law that establishes equal treatment for foreigners, moving away from a mindset of economic nationalism. This would send an unmistakable signal to the world that India is a safe and predictable place to do business.

Engaging the Giants from a Position of Strength

Once India has put its own house in order and established a new core of trade partners, it will be in a position of strength to deal with the two most difficult partners in the new world order: the United States and China.

The problems presented by these two countries are indeed knotty and cannot be solved with chest-thumping nationalism or bluster. Dealing with leaders who have an inward-looking political style requires deft handling and a deep understanding of their political economies. Public posturing or slighting them will not be consistent with Indian interests. The union government needs to create a sophisticated brains trust with a profound understanding of the US and China: their domestic politics, their economic vulnerabilities, and their negotiating styles—to do better in these complex engagements. Through border conflicts in Doklam and Galwan, the Chinese state has primed the Indian intellectual community with questions and concerns, and a significant depth of knowledge on the path forward is now understood (Bambawale et. al., 2021).

The problem of Chinese overproduction is real and immediate (Patnaik and Shah, 2024). The Chinese state's policy of subsidising its firms to maintain employment, which leads to a glut of cheap exports, is a form of economic warfare. It is not just unfair; it is destructive to the manufacturing bases of other nations, including India. A vigorous set of barriers against Chinese imports is not just justified, but necessary. However, this is not an argument for complete disengagement. There are many paths to engagement with China that can and should be pursued, particularly in areas where our interests align, such as in global institutions or in addressing global challenges. Collaboration between China and India is essential for global decarbonisation.

The United States presents a different, and perhaps more fundamental, challenge. The US, which built the old world order, is now in a period of self-doubt and retreat. There is no guarantee that a post-Trump environment will get the US back to its former normalcy as a champion of free trade. The protectionist genie is out of the bottle. Until the US finds its footing again, our primary strategy must be to embrace the OECD ex-US bloc. We should engage with China where it is rational, while recognising the sustained misbehaviour by China against India on numerous episodes before, and we should wait for the US to find its feet one day.

Conclusion

In summary:

1. India was a great beneficiary of globalisation
2. We must recognise that the nature of globalisation has changed, and that this is detrimental to India's interests
3. This is an important turning point in India's history; it is our duty to strategise a response.
4. India needs to be a prime mover of a new deep globalisation arrangement between the advanced economies -- excluding the US -- and India.
5. India needs deep trade agreements ("DTAs") with the advanced economies, excluding the US.
6. The competitiveness of producing in India needs to be addressed by domestic reforms: a globalisation-ready indirect tax system, regulatory reform, financial sector reform, legal system reforms, an environment of institutions for macroeconomic stability, making better cities, solving the policy stuck in agriculture, and shifting the communication strategy in favour of more truth.
7. We should engage with the highly flawed objectives of the US and China from such a vantage point of strength.

The era of India’s economic rise on the back of an indulgent, open global system is over. This is not a Balance of Payments crisis, where we have to mortgage RBI's gold in London, but it is an equally important moment. Our future depends on it. The leadership needs to take the opposition into confidence, as was done by A. B. Vajpayee in 1998 after the nuclear tests, and collaboratively lead this transformation. For all of us in India, for the people and the firms, this is a time to rise to our best and prove our mettle.

The authors are with the Pune International Centre and XDKR Forum.

Bibliography

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Chinoy, Sajjid Z., External pragmatism, internal reforms can turn US tariffs into opportunity, Business Standard, 14 August 2025.

Chitgupi, Aneesha, Ajay Shah, Manish K. Singh, Susan Thomas, Harsh Vardhan, Who lends to the Indian state? XKDR Forum Working Paper 34, August 2024.

Das, Soham, India’s choice after Washington’s shock, Financial Express, 20 August 2025.

Froman, Michael B. G., After the Trade War: Remaking Rules From the Ruins of the Rules-Based System, Foreign Affairs, September/October 2025.

Hinz, Julian, Moritz Schularick, Keith Head, Isabelle Mejean, Emanuel Ornelas, An alliance for open trade: How to counter Trump's tariffs, VoxEU, 27 Jul 2025.

Jaitly, Akshay and Ajay Shah, Exporting into a world that has carbon taxes , Business Standard, 1 May 2023.

Kelkar, Vijay, Arbind Modi and Ajay Shah, Steps towards the perfect GST, Business Standard, 18 August 2025.

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Ninan, T. N., India's problem isn't Trump -- underperforming economy made us easy to bully, The Print, 11 August 2025.

Patnaik, Ila and Ajay Shah, The case for trade barriers against Chinese imports, Business Standard, 24 June 2024.

Rao, M. Govinda, India can't beat Trump on tariffs, so it must drop its own trade walls, Business Standard, 13 August 2025.

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Be you ever so high, the markets are always above you

by Ajay Shah.

Purposive state action is fraught with error. Human and social systems are poorly understood and contain nonlinearities, so there is a law of unintended consequences. Grand schemes go wrong. What works well is a humble approach, of crossing the river by feeling the stones, in an environment of expertise. There are two rings of containment of power, that help address a regime which diverges from this approach.

Two rings of check-and-balance

The first ring of containment of power is the checks and balances of the political system. Liberal democracies work by dispersing power, by using ambition to counteract ambition. This curtails mistakes.

In some situations, these things break down. Power becomes concentrated, which induces mistakes. The second ring of containment is the financial markets.

1. When Liz Truss was Prime Minister in the UK, the markets pushed back. The 30-year yield went from 3.6% to 5.1%. The GBP dropped 7.6%. The FTSE fell 7%. Ultimately, this led to her being ousted in 44 days.
   
   
2. When Tony Blair and the labour party won the elections on 2 May 1997, the financial markets expressed skepticism. When a new government is greeted with a higher interest rate, this immediately curtails spending power. This pushed the new government to go through with a group of responsible decisions. On 6 May 1997 (i.e. 4 days after winning), they announced independence for the Bank of England coupled with the creation of an independent Debt Management Office so as to unburden monetary policy from the debt management conflict of interest. On 2 July, in the budget speech, they were cautious in their spending commitments. All these actions were crafted because the second ring of containment impinged upon the political leadership.
   
   
3. Vijay Kelkar has long argued that the stock market crash of 17 May 2004 helped encourage Sonia Gandhi to choose the team of Manmohan Singh, P. Chidambaram and Montek Ahluwalia as the UPA economic policy leadership, which delivered the economic successes of 2004-2011.
   
   
4. James Carville worked for Bill Clinton. A rough analogy into Indian politics would be Amar Singh. He once said: "I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." This awareness tempered and shaped the early actions of the Clinton presidency, which worked out as a successful period for the American economy. 
   
   
5. It is starting to work out similarly with the Trump Tariffs. The wheels of global general equilibrium started turning on 2 April, with forward looking forecasts embedded in financial market prices. Financial players everywhere asked: How well will the US economy work? Is the US the safe haven, with sound institutions, that we thought it was?
   
   The 10 year US Treasury went up from 3.9% to 4.5%. The 30 year bond briefly went up to 5%. The S&P 500 dropped 12.1%. Safe haven seekers turned to Germany, and yields on government bonds there fell. Larry Summers said on 9 April:  "We are being treated by global financial markets like a problematic emerging market".
   
   In my column in the Business Standard of 3 March, I had said that in the US, the first ring of containment has broken down --
   

   The US is in a constitutional crisis, with a failure of checks and balances, with the inability of the judiciary, the legislature, the electoral system, the agencies, the special counsel and the press to rein in a strongman.

   and that the second ring of containment would have to do its work --
   

   Market discipline will then impinge upon Trump and the MAGA world, and we hope, atleast partly kick them into shape. Be you ever so high, the markets are always above you.

Market discipline is not perfect. In the field of sovereign risk, we know well that the market tolerates a lot of fiscal misbehaviour for a long time, and then abruptly pulls access. Similarly, I have argued that the Indian equity market fares poorly on macro forecasting while it does well on micro-forecasting. The wrath of the market involves caprice. The key point here is that markets do speak truth to power, over and beyond the checks and balances of the political system.

A development perspective

The yearning for raw power is there in many people. On 9 April 2025, Donald Trump described his decision process: "Instinctively, more than anything else. I mean, you almost can’t take a pencil to paper. It’s really more of an instinct, I think, than anything else".  Montagu Norman, Governor of the Bank of England said in 1930: "I don't have reasons, I have instincts". For a country to have a high level of per capita GDP, this primeval yearning for power needs to be contained.

The first ring of containment is the checks and balances in the political system (e.g. converting the Bank of England into an inflation targeting central bank with dispersed power in the Monetary Policy Committee). A good financial system constitutes the second ring of containment that checks such impulses, that induces better decisions by the political masters.

From an Indian perspective, checks and balances are the essence of the growth journey. The first ring of containment is relatively well accepted (Kelkar & Shah 2022). More attention is required upon the second: a financial markets system that would induce checks and balances, that would matter enough to reduce the incidence of mistakes in public policy.

Consider government borrowing. When government borrowing takes place as a set of acts between consenting adults, where voluntary lenders negotiate a price on the bond market, this creates the checks and balances in the episodes narrated above. In India, about 95% of government borrowing is mobilised coercively (Chitgupi et. al., 2024), which limits the role that the financial markets play in reshaping the incentives of the state. 

Consider the exchange rate. The checks and balances in the episodes narrated above involved a starring role for the exchange rate. When poor countries run a government controlled exchange rate, this channel of influence is limited [EiE Ep67 Floating exchange rate], which sustains poverty.

In India, a disproportionate burden of adjustment falls upon the equity market as other markets adjust less.

In today's mainstream thinking, financial development is seen as integral to the journey of economic development through its allocative function.  `Finance is the brain of the economy', `Wall Street tells Main Street what to do'. The financial system should occupy `the commanding heights of the economy' and make all the detailed allocative decisions about firms, technologies or industries which receive investment [EiE Ep21 The beauty of finance]. A good financial system performs the allocative function better than `industrial policy' can [EiE Ep89 Industrial policy]. 

But finance plays another important function as well: that of reshaping the checks and balances of the state, or being the second ring of containment for power. The second ring of containment matters most when the first ring of containment -- checks and balances of the political system -- falters. These two lines of reasoning encourage us to place financial sector development at the centre of the growth journey [EiE Ep57 How to do development].

There was a time in India when we were making progress in building a financial system. This has faltered (Shah 2023;  EiE Ep71 The Journey of Finance). We need to get back to the knowledge building and community building that began in the early 1990s in this field.

Review of "The Rise of the BJP: The Making of the World's Largest Political Party" by Bhupender Yadav and Ila Patnaik

by Josh Felman.

In 2014, the BJP secured a remarkable victory. They won an absolute majority in the Lok Sabha elections, the first time any political party had done so in three decades. Then, five years later, they repeated this feat, increasing their majority. Now, they dominate the national landscape in a way not seen since the heyday of the Congress party, half a century ago.

How did this happen? Most analysts give a one-word answer: Modi. Others give a two-word answer: Modi-Shah. Without doubt, Narendra Modi and Amit Shah are exceptional politicians and strategists. But life is complicated, and great men cannot entirely determine the course of history.

One reason why the BJP won in a landslide in 2014 is that Congress completely mismanaged the economy. The party proved unable to deal with the fundamental problems that emerged after the Global Financial Crisis, such as the sizeable non-performing loans at the banks. Instead, they tried to resuscitate the economy through lax fiscal and monetary policy, a strategy which failed to revive growth, producing only double-digit inflation. Then came a spate of scandals, and the government became paralyzed, unable to do anything at all.

Even so, it is wrong think that the BJP was merely the accidental beneficiary of Congress' collapse. As this book stresses, the BJP has been rising for a long time.

Sometimes a picture is worth a thousand words. So consider the following chart. It shows that despite a notable dip in the 2000s, there has been a clear trend to the BJP's representation in the Lok Sabha. And that trend is upward. The BJP was formed in the 1980s, initially earning just a few seats. By the mid-1990s, it had become the largest party in Parliament.

How can we possibly explain this development? This book provides an answer. Not "the" answer, of course, but a particularly valuable answer, for the explanation comes from a BJP insider. Unlike most books written by politicians, this work avoids the intricacies of long-forgotten debates and refuses to engage in score-settling. Instead, this is a serious work, covering the entire sweep of independent India's history, documented with extensive footnotes -- exactly as one would expect from the co-author, who is a noted, non-political academic. (Full disclosure: I have also been a co-author with Ila Patnaik.)

The aim of the book is to explain how we have arrived at the current political pass. Of course, it does so from a BJP perspective. But that is exactly the need of the moment: we need to understand what the BJP believes, as these beliefs will translate into actions that affect all of us.

So, what explanation does the book provide? Essentially, it argues that the rise of the BJP stems from two factors: its organizational ability and its message. Of the first, the book makes a convincing case. Indeed, no reader – no matter what his or her political view – can finish this book without a sense of awe. It’s not just that the party has come up with one brilliant idea after another, such as "multiplying" their Prime Ministerial candidate by projecting 10-foot holograms of Modi in 200 cities across the country. Even more astounding is the BJP's ground game.

Consider the BJP's strategy for the 2014 election. The party developed a booth management strategy, under which leaders were assigned to every single one of the 1 million voting booths in the country. Each leader supervised around 50 individuals, whose job it was to meet with around 30 voters and convince 15 of them to vote for the BJP.

This arrangement required an incredible amount of effort, coordination – and manpower. Simple arithmetic shows that 50 leaders for 1 million booths required no less than 50 million party workers. For the 2019 election, the party mobilized 110 million members. How on earth did the BJP manage to convince so many people to work so hard for the party?

One strategy has been to convince members that they are part of a family. They even have a slogan for this: Mera Parivar, Bhajpa Parivar (My family is the BJP family.) In practice, this means that the life of a party worker is dominated by an endless calendar of events: campaigns, followed by political activities, interspersed with visits from seniors. Particularly strenuous efforts are made to nourish connexions amongst members from all strata of the party, with seniors being asked to share meals with workers on their visits to the regions.

Another strategy is to employ the highly motivated swayamsevaks (volunteers) of the RSS. The authors are unequivocal about the links between the RSS and the BJP. They emphasize that the predecessor of the BJP, the Jana Sangh, was founded with the explicit purpose of giving a political voice to the RSS' vision for India. And they note that the BJP was born when the leaders of the Jana Sangh were forced to choose between their commitment to the RSS philosophy and their political career in the Janata Party. They chose to stay true to their ideology.

The devotion to this ideology remains strong to this day. Prime Minister Modi has said, 'I am connected to the mission and not ambition. In my life, mission is everything, not ambition'.

So, what exactly is this mission? Put another way, if the second reason for the BJP’s success is that it has developed an attractive message, what exactly is that message?

In some areas, the book gives a clear answer. It says that right from the start the BJP has focused on the fight against corruption. Its first major success came in 1987 when it was able to pin the Bofors scandal on the Congress Party, accusing their senior officials of taking bribes in return for granting a large defence contract. In 2002, Venkaiah Naidu became BJP President partly on the strength of his credentials as convener of an anti-corruption movement in Andhra Pradesh. And of course corruption was a major theme of the 2014 election.

Another key element of the BJP mission, according to the book, is improving the standard of living of the poor, the people whom the Jana Sangh used to call the 'last man in line'. The Modi government came up with a particularly effective way of doing this, by providing the poor with tangible benefits such as LPG gas cylinders and toilets – and cash transfers, paid directly to newly created Jan Dhan bank accounts. These programs created a direct link between the party and the poor, earning in particular the loyalty of female voters.

In other areas, however, the book is much less precise. For example, we are told repeatedly that the BJP believes in "nationalism". But it is not clear what this means. After all, Congress is also a nationalist party; indeed, they led the independence movement against the British.

Some commentators claim that the BJP's nationalism is different because it is a communitarian vision, focusing on building a Hindu nation-state. The BJP strenuously denies this charge. Indeed, the word Hindutva is not to be found anywhere in this book. Instead, the BJP views itself as the party of true secularism, devoted to the principle that no group should be treated differently by the state. Accordingly, they oppose triple talak divorce and special status for Kashmir – because these policies treat different groups differently.

But this argument sits uneasily with the claim that the BJP believes in 'cultural nationalism'. The book takes great pains to stress that this phrase refers to an all-Indian culture, coming out of many traditions: Hindu, Muslim, even Western. But the only traditions the BJP has mobilized to defend – at least the only ones mentioned in the book are Hindu traditions.

Particularly striking is the framing of the dispute over whether to build a Ram temple on land where a mosque was standing. As the book puts it, for the BJP, Ayodhya was not a land dispute; "it was a mission to unite India with the thread of cultural nationalism". The argument seems to be that the country should have united behind this plan, since it honoured an important tradition, the place where Lord Ram was reputed to be born. But many people did not see things this way, and the dispute proved enormously divisive.

That said, the BJP's message of cultural nationalism does resonate with a significant section of the population, giving it a compelling message to go with its superb organization and millions of devoted members. That makes the BJP a formidable vote-getting machine. No wonder it has just risen and risen.

But history teaches that a relentless rise is often followed by a disastrous fall. Indeed, one doesn't have to look very far to see an example of this process at work. Right after independence the Congress Party bestrode the political landscape like a colossus, winning 364 out of the 489 contested seats in the first parliamentary election. But since the 1970s it has gradually decayed, to the point where it holds only 52 seats in the current Lok Sabha.

The BJP has thought long and hard about this example, concluding that Congress declined because it failed to nourish its roots during its long period in power. To make sure this doesn’t happen to them, the BJP not only pays considerable attention to sustaining morale amongst its party members (as already mentioned); it also takes great care to avoid the perils of dynastic leadership. The BJP offers a clear path for ambitious young supporters, who can start with party work, progress to a role in government, and then take up role of an elder statesman. To ensure that this career ladder is not blocked by elderly seniors, members are expected to step aside from active operational roles once they reach the age of 75. It will be interesting to see whether this practice continues, now that the party has a firm hold on power.

Beyond the constant need to replenish the party with new energy, the BJP faces another challenge, one that will be even more difficult to manage: it must meet the needs of the nation. Without doubt, the BJP has found a way to satisfy what we could call 'Cultural India'. But meeting the needs of Aspirational India, the hundreds of millions of young people looking to find good jobs and raise their living standards, will be a far more difficult task.

The current government is fully aware of this problem, having inherited an economy that was in shambles. Accordingly, it has implemented reform after reform, including Inflation Targeting, the Insolvency and Bankruptcy Code, and the Goods and Services Tax. But the economy has still failed to take off, as investment has remained stubbornly low.

So far, there have been no political consequences, as the public has accepted that it will take time to restore an economy that was in such bad shape when the current government arrived. But the BJP knows that at some point, the public will demand results.

Accordingly in 2020, the government decided to change tack, abandoning the post-1991 policy of opening up the economy in favour of a new approach, Atmanirbhar Bharat ('Self-Reliant India'), whereby tariffs are being increased to encourage import substitution while production subsidies are being given to firms selected by the government. It is still early days, but there is little in India’s history or that of Asia more generally that suggests this strategy is likely to work. In that case, trouble for the BJP may lie ahead.

For far too long, the nature of the BJP has remained a mystery to the English-reading public. Finally, we have an authoritative presentation of their point of view, one that allows us to understand better how the BJP has risen and what it believes. For anyone who wants to understand how India arrived at the current juncture – and where it is likely to go in the future – this book is a must read. Buy it and read it carefully.

 

Josh Felman is the principal at JH Consulting.

What year in the history of an advanced economy is like India today?

by Ananya Goyal, Renuka Sane and Ajay Shah.

India has been stepping out from poverty into middle income. It is estimated that the proportion of persons below the PPP$1.90 poverty line has dropped to 87 million in 2020. In thinking about India's journey, it is interesting to ask: In the historical journey of advanced economies, What year in the history of the US or UK roughly corresponds to India of 2021? This is a good way to obtain intuition on where India is, in the development journey.

GDP measurement is a daunting enterprise. GDP measurement is particularly weak when it concerns the deep past of the UK or the US, or the Indian present. Measuring asset ownership such as cars and other assets can induce valuable insights. For many products (e.g. cars, washing machines, mobile phones, denim) we should look at the extent to which the product has reached into the households of the country. In this article, we ask: What is a time point in the history of the US or the UK which is comparable with where India is today, in terms of household asset ownership?

This is connected with the question "How big is the Indian middle class?" when we apply certain thumb rules such as "to own a car is to be middle class".

While these are fascinating questions, such comparisons have to be undertaken with care. When the highways are weak or when the public transport is strong, households will find cars less attractive. Closer to the equator, cooling technologies will be more appealing. And, most important, technological progress across the years has resulted in a sharp decline in the prices of many of these assets, through the wonders of mass production of assets like cars, and through Moore's law for CPUs.

In the interpretation of asset ownership information, we should maintain a distinction between causes and consequences. The causes are the factors such as household prosperity or climate or cost reduction, which shape the decision of household purchase. The consequences are about how a given household asset reshapes the welfare and culture of the household. The consequences appear more similar across space and time. As an example, the impact of personal transportation upon an individual is similar across countries and decades, regardless of the the decline in the real price of an automobile and the expansion of household income.

GDP measurement is faulty, and asset ownership measures across space and time are clouded by differences in the climate and by technological progress. No one element of this article is the single truth. We should assemble an overall picture in our minds, pooling all these aspects of the truth.

Per capita GDP

In 2020, per capita GDP in India (in PPP terms at 2011 prices), is $6806. Looking back into the history of the US and the UK, we get the dates:

	Comparable year in US history	Comparable year in UK history
Per capita GDP	1896	1894

This places India of today as being roughly like these advanced economies at the dawn of the 20th century. By this measure, India is about 120 years behind the US or the UK in terms of economic development.

Women's labour force participation

Looking back into US history, the first measurement of women's LFP seems to be in 1890 and it shows a value of 18.2% (Smith & Ward, 1985). The women's LFP in India for 2020-21 is measured by CMIE at 9.2%. By this measure, India is at a state of maturity which is older than 1890 for the US.

Asset ownership

We use data from the September - December, 2019 Consumer Pyramids Household Survey to measure asset ownership in India. For each asset, we compute the fraction of households which own a stated asset.

Asset	Share in India today (%)	Comparable year in US history
Car	6	1915
Refrigerator	59	1945
Air conditioner	7	1955
Washing machine	25	1955
TV	95	2000
Computer	8	1985

Cars

In India today, 6% of households have a car. This value was obtained in the US in 1915.
The Ford Model T was introduced in 1908. Thus, the productivity gains associated with modern manufacturing have been in play for over a century before we get to the India of today. It was harder for a US household in 1915 to buy a car, as cars were then more expensive. Our measure (1915) is an over-estimate on account of improvements in mass production.
There are about 300 million households in India, so the installed base of cars used by households is about 18 million.

Cooling equipment

Demand for refrigerators and air conditioners in the US is likely to be lower than what we see in India owing to the climate. And, there have been great advances by way of cost reduction of refrigerators.
At present, 59% of Indian households have fridges, and the US was at such a value in 1945. Similarly, 7% of households in India have air conditioners, a value that was seen in the US in 1955. Both these values (1945 and 1955) are an over-estimate owing to (a) Differences in the climate and (b) Improvements in mass production.
With about 300 million households, these values map to about 20 million air conditioners and about 180 million refrigerators, in homes. The total Indian market size for these products is, of course, greater as there are also purchases by organisations like restaurants.

Washing machines

Washing machines are interesting in that there is no difficulty with the difference in climate, but there are cost reductions owing to improvements in mass production.
The US was at the present Indian value of 25% in 1955. This estimate (1955) is likely to be an over-estimate on account of improvements in mass production. An anonymous commentator points out that if clothes can be washed using cheap labour, the incentive to buy a washing machine is lower.
About a quarter of 300m households is about 75 million washing machines in existence in households in India today.

Electronics

The Indian value for television sets of 95% looks near-complete. This was only achieved in 2000 in the US.
With home computers, the Indian value of 8% is comparable to that seen in the US in 1985.
Both these values (2000 and 1985) are over-estimates owing to the dramatic decline of prices of electronic equipment.

Where is India when compared with the historical journey of the US or the UK? We have many answers. We have values of pre-1890 (women's LFP), 1896 (PPP per capita GDP), 1915 (cars), 1945 (fridges), 1955 (washing machines and air conditioners), 1985 (home computers) and 2000 (television sets). We think that overall, the asset-ownership based estimates are over-estimates on account of improvements in technology, and because households would value cooling equipment to a greater extent in the Indian warmth.

In terms of consequences, refrigerators and washing machines are both mechanisms to reduce household drudgery. When food can be stored in a refrigerator, the need to cook multiple times within the day is eliminated. The present Indian values are comparable with the US of 1945 (fridges) or 1955 (washing machines). India may then be at the cusp of change, with the emancipation of women that came in the US in the 1950s and the 1960s, when these appliances reduced the demands upon women for housework.

Economic development is hard to reduce into any single metric. As Yashwant Sinha once said, India lives in many different centuries at the same time. There are people and cultural traits in India today which are medieval, and there are pockets of India which are living at the global frontier of 2021. Each aspect of India is evolving through its own historical forces. We need to embrace and understand all aspects of this reality at once. In understanding India, we have to appreciate all these different clocks that are unfolding before us. The numbers discovered in this article help in building this intuition.

Sources

Nicholas Felton (2008), Consumption spreads faster today, The New York Times.

Homi Kharas, Laurence Chandy (2014) What Do New Price Data Mean for the Goal of Ending Extreme Poverty? , Brookings Institution

World Poverty Clock , World Data Lab. Retreived August 2021.

Maddison Project Database, version 2020. Bolt, Jutta and Jan Luiten van Zanden (2020), “Maddison style estimates of the evolution of the world economy. A new 2020 update ”.

Consumer Pyramids Household Survey (2019), Centre for Monitoring Indian Economy.

Historical Household Tables (1940-2020) Current Population Survey, US Census Bureau.

Smith, J., & Ward, M. (1985). Time-Series Growth in the Female Labor Force. Journal of Labor Economics, 3(1), S59-S90.

Why is India's business history important?

by Tirthankar Roy.

Remembering Dwijendra Tripathi

In September this year, Professor Dwijendra Tripathi passed away. Until recently, he was the only business historian of India whose works were internationally recognized and respected. In the last twenty years, he produced as author or co-author a set of books, the Oxford History of Indian Business. The deep knowledge of the facts, love of the field, and a direct writing style, for which Tripathi was known, are in full display in these books.

I had interacted with Professor Tripathi closely in the 1990s, reviewed his books, visited his home, and admired him for his warm personality, scholarship, and his distance from ideological camps. On the last occasion we were in touch (7th July 2017), I emailed him the draft of a paper where there was a reference to Tripathi and Jumani in a mildly critical fashion, asking him if he would think that my criticism was unfair. He wrote: “Please go ahead with your paper; criticism is the life blood of scholarship.” Few Indian scholars I know of are so sporting.

With Tripathi’s benchmark books in existence, why write another book called "business history of india"? For that is what I did earlier this year (Cambridge University Press, 2018).

What is the idea of this new book?

This book is different, because it asks two questions that I have not seen others ask before. The first question is, how does a study of history help us understand the resurgence of private enterprise in India in recent times? We can ask this question for all emerging economies, which have seen dramatic transformations led by private capital. What are the historical roots of this emergence? I will call this the emergence question and come back to it ahead.

The second question is this. In a Bengali essay from the 1980s, Ashin Dasgupta wrote, “the more I browse the history of the last 300 years, the more I believe that Indian business has certain Indian features.” Dasgupta was writing about the descendants of Akrur Datta, a Bengali merchant of the 18th century. If this is true, if capitalism – like human beings – have different personalities, we should ask, what is Indian about Indian capitalism?

When I was a student, we learnt a way to connect the present with the past, according to which India was a great place for business until the 18th century -- a dark age unfolded when the British made money exploiting Indian resources, and Indians struggled to get a share of it -- and after 1947, a new dawn broke out. Most professional historians do not believe in this epochal transition model, because its facts are mostly wrong. But what is the alternative model linking the present with the past?

Observe any emerging economy today, and what we should see are hubs of private enterprise that are wealthy, innovative, and institutionally advanced, against the backdrop of a poor countryside that is changing slowly, even regressing by some benchmarks. The past looked exactly like this. Hubs of dynamic, wealthy, innovative capitalists did business in the backdrop of a poor countryside. We find such hubs in the Mughal cities, in the 18th century textile trade, in 19th century port cities, and in the IT or garment clusters today. We can then connect the past with the present by asking, are these hubs similar or are they different? That is what the book does.

We see surprising parallels across time. The most dynamic business towns of the past and those in the present are cosmopolitan, outward-looking, globally connected places. They traded with the world. Whether they exported textiles, or raw cotton, or software is a matter of detail. The people whom trade made rich had access to state-of-the-art knowledge and technology of their times, and knew the value of such knowledge. As an example, without the rich Indian merchants of nineteenth century selling cotton or indigo, you would not get the Presidency College of Calcutta (Kolkata) or the Elphinstone College of Bombay (Mumbai).

But this isn’t a happy story. Making money was a struggle against enormous odds. Interest rates were high, institutions were undeveloped, politics often unfriendly. Have these obstacles disappeared today? Hardly. Capital is still costly in India, all global metrics measuring institutional quality still place India towards the bottom of the list, and politics is still unpredictable. Why does capitalism work at all in an environment of expensive capital and dangers of expropriation by State agencies? The book answers, cosmopolitanism helped. And so did some very Indian resources, such as the idiom of caste or community, if only in some situations. These obstacles and the resources used to overcome them make Indian business history Indian. This is my story.

Who am I writing it for?

Three types of audience: business historians, economic historians, and India-watchers.

Business history emerged in the US and until recently was North American in its choice of examples and theoretical frameworks. This is changing and there is a drive to include more emerging market examples. While the book was not written with that aim, it helps that project.

My own field, economic history, has been preoccupied with a different question. For us, the big question is, “why do some countries grow rich while others stay poor”? While the modern West forged ahead (from early-1800s), why did countries like India and China stagnate and fall behind? Writers like Daron Acemoglu and James Robinson call this one of the most important questions for the social scientists. I am not sure of that, but certainly divergence has been the only game in town for some time.

I think this is a bad question to ask, for many reasons. Let me show only one reason here: The question prejudges India to be a basket case. Those who think this is the greatest question are forced to ignore and overlook the hubs of enterprise that I talked about above.

Business history does not judge. It does not carry the burden on its shoulder as economists do, that we must answer the greatest question in social science. It treats individual business decisions as context-bound, which is a more flexible approach to doing history.

My third intended reader is anyone interested in the historical roots of economic emergence. Many people try to answer the emergence question, and the answers can be odd. Around 2007, a team of 11 people published an article in the IIMA house journal about India’s emergence. The authors were top professionals, and like many thinking people, they felt compelled to say something about history. This is what they said. We should not be surprised that Indians are so good at buying and selling things, they have been doing that for centuries. Still, until now they failed in their historic mission to create a world-class capitalism thanks to “foreign invasions”. The authors wisely left the identity of the invaders open, you can write your favourite invader (Turks, Europeans) in the blank space.

But this cannot be right. India has not had a foreign invasion in the last 70 years, and still scores poorly on Ease of Doing Business index. Indeed, India has not been a cradle of capitalism, not now, not in the past. Doing business has always been a struggle to overcome obstacles. Economic history tends to exaggerate the obstacles. Business history shows the struggle as it was, and helps us understand the struggle today. My book is about that endeavour.

 

Tirthankar Roy is an Economic Historian at the London School of Economics.

The measurement of Indian manufacturing GDP: problems and some solutions

by Amey Sapre and Pramod Sinha.

Since the release of the 2011-12 series, the reliability of Indian GDP data has been the subject of intense debate. In the case of manufacturing GDP, there were large upward revisions in growth rates from 1.1% to 6.2% in 2012-13 and –0.7% to 5.29% in 2013-14, which were inconsistent with trusted private databases about growth in manufacturing. The introduction of the new MCA-21 dataset has also raised questions, as the lack of release has made it impossible for independent researchers to cross-check the estimates.

GDP estimation is a remarkably complex process. It is built on several sub-processes, datasets, and methodologies at the sub-sector level. At every base year revision, we see changes in sources and methods of computation that aim to yield improved measurement of macro aggregates. Valuable insights that can be derived, through the study of measurement issues, for our interpretation of the resulting data and thus our reading of macroeconomic conditions.

In a recent paper, we address three questions about Indian manufacturing GDP estimation:

1. Are we correctly measuring output and intermediate consumption in the formula for Gross Value Added (GVA)?
2. How sound is the technique of imputing missing data based on blowing-up using Paid Up Capital (PUC)?
3. When the new MCA-21 dataset is used, are manufacturing firms being correctly identified?

Questions about measuring output and intermediate consumption in the formula for Gross Value Added (GVA)

There are many concerns about how GVA has been estimated using firm data. In the paper, we recreate the process of GVA estimation. We use the Goldar Committee report in letter and spirit, and use the production side approach to recreate the GVA for a set of firms that file in MCA-21. For this, we take the XBRL formatted data from MCA-21 and identify the data fields used to compute GVA.

We also do a mapping of the XBRL fields with fields in CMIE Prowess and estimate the GVA. A detailed mapping can be found here. These two strategies give us a unique vantage point from which to evaluate discrepancies in GVA estimation.

Conceptually, the use of the MCA-21 dataset involves a shift from the erstwhile Establishment to the new Enterprise approach of value addition. The establishment approach captured production based data from factories registered under the Factories Act. The enterprise approach captures financial data of firms, and goes beyond just manufacturing by capturing value addition from post-manufacturing, ancillary or related activities such as marketing, and operations of branch/head offices. How does this impact upon value addition? There are two parts to this answer.

The first is the extent to which measures of output change.

Under the establishment approach, “Sales” was a measure of output. In the current enterprise approach formula, several disaggregated components of revenue that include revenues from products, services, operating revenues, revenue from financial services, rental income, incomes from brokerage and commission and other non-operating incomes are part of output. In the Goldar Committee report, there is a limited discussion on the inclusion or exclusion of several revenue fields in GVA computation. Also, the data labels and tags of the XBRL fields are broadly based on items in Schedule-III of the Companies Act. The lack of proper definitions of the fields makes the identification process cumbersome and prone to errors. It is evident from the output composition that value addition is not solely accruing from manufacturing activities, but also from several related activities. This leads to inflated GVA levels as the component of output is now similar to the total income of the company, and not industrial sales.

In the paper, we show a comparison with the previous sales based method and argue that changes in output composition alone can lead to increased levels of GVA. This will eventually push the growth rates upwards.

Comparison of GVA based on old and new method (Figures in Rs. Crore)

Year	Based on Sales	Based on Disagg -regated revenue	Difference
2011-12	701896.6	767311.4	65414.8
2012-13	742237.2	819228.5	76991.3
2013-14	780371.1	872178.1	91807.0

We study the firms in the CMIE Prowess. Using the traditional sales-based measure, our manufacturing GVA estimate is Rs.780,371.1 crore for 2013-14. Using the disaggregated revenue, it appears that there is an over-estimation of manufacturing GVA of Rs.91,807 crore, by including revenue from non-manufacturing activities.

What is missing in the GVA formula is a clear rationale of including revenues from different non-manufacturing activities. If such activities form a part of the enterprise level activities, it also requires a clear segregation of costs, identifiable data fields, and a consistent treatment in the formula to identify value addition from core manufacturing and other activities.

The second issue is changes in measures of intermediate consumption.

Identifying components of intermediate consumption at the enterprise level is equally difficult. Conventionally, subtracting the cost items (related to production) from output provides a measure of value addition entirely from manufacturing activities. However, with large and diversified enterprises, identifying cost items from financial data fields can pose significant challenges. A close scrutiny of the XBRL fields shows omission of important cost components, such as; Power & Fuel expenses, Advertisement and marketing related expenses. These are sizeable components and their omission can underestimate costs, thereby overestimating GVA. Thus, two possible reasons that account for distortion in GVA are; increase in output due to addition of several revenue items, and omissions in the components of costs.

Questions on the blow-up methodology

Missing data imputation is done, in Indian GDP estimation, by assuming that GVA is proportional to Paid Up Capital (PUC). In the paper, we replicate the blow-up process by constructing an available and active set of companies based on random samples that give different Paid-up Capital coverage. The details of the procedure have not been clearly documented in official publications. Several variants of the method are possible, such as; blow-up for each range of Paid-up Capital, blow-up by industry group, by ownership type of company, among others.

PUC-based blowup assumes that PUC and GVA have a deterministic and linear relation. This is at best a weak assumption, as one cannot draw sufficient inference about a company’s manufacturing activities by looking at its Paid-up Capital value. In the paper, we show that the size distribution of PUC and GVA have no systematic relation, and thus PUC is not an appropriate method to scale up GVA. Since the GVA contribution of a firm can be negative, the PUC based blow-up shows a distorted picture as it always contributes positively.

Our analysis of the blow-up procedure reveals several shortcomings. First, the blow-up factor is sensitive to Paid-up Capital (PUC) coverage and can show a considerable increase as the number of non-reporting companies increases. Second, the variation in blown-up values is unpredictable as there is no systematic trend for different values of the PUC factor. This leads to an unknown degree of error as the addition due to blow-up can be significantly large as compared to the actual contribution of unavailable companies.

On this problem, we are also able to offer a solution. In the paper, we show that using industry level growth rates of GVA to scale up previous year’s GVA of unavailable companies is a feasible and superior method. We use a sample to first classify each missing company into its industry and based on growth rates of GVA for each industry, we scale up the last available GVA of the unavailable company. Using industry level growth rates of GVA has an advantage over the PUC based blow-up as it uses the previous year’s GVA of the company instead of scaling up GVA of available companies. Industry growth rates capture the economic conditions faced by firms in and also provide a sufficient clue about the state of business environment. Computationally, on average, the method gives a lower margin of error, lesser variability, better representation of firm’s conditions and provides a close approximation to the actual GVA contribution of the firm. CSO can potentially shift to using this method.

Are manufacturing companies being correctly identified?

The Goldar Committee report makes a mention of using the ITC-HS product codes for identification of manufacturing companies. In absence of such codes, the Company Identification Number (CIN), which contains the NIC code, can be used to identify the nature of business activity of the company. The problems with using these two options are known. What is unknown is the extent of misclassification of companies and the error in the GVA estimate.

The reliance on ITC-HS code has several problems. Only 59% of the 30,006 companies filing in XBRL across all industries had reported the ITC-HS for products and NPCSS for services. However, even having the codes does not solve the problem. The codes only identify a product and do not distinguish between its trading and manufacturing. Thus, using such codes does not provide an assurance that value addition is being correctly captured for manufacturing products.

The problem is compounded in cases where the codes are unavailable. At present, a company’s CIN and the details on its website are used to identify its business activity. This yields misclassification.  For a company, its 21 digit CIN does not change once it has been created at the time of registration. Over time, a company may change the nature of its business activity or diversify into any other sector. This change of business activity is not reflected in the CIN code of the company. Using CIN can be potentially misleading since the top revenue generating activity of the company might be different from the one mentioned in its CIN code.

The NIC classification also changes from time to time. This adds to the complexity of identification in two ways; first, changes in business activities of companies are independent of changes in NIC codes, and second, a particular NIC code may not reflect the same business activity over time.

In the paper, we analyse this problem by studying two groups, (i) companies that operate as non-manufacturing entities, but have their NIC codes registered in a manufacturing activity and (ii) companies that are into manufacturing, but have their NIC code registered in any other economic activity. We show that there are a large number of companies in both categories and can create a significant distortion in the GVA estimate. We argue that any classification method for companies based on either ITC-HS or CIN code or hand mapping based on clues gathered from the name of the companies  or details from their website is likely to be incorrect. This process requires careful hand-analysis of each firm, to classify the firm correctly.

Conclusion

Sound computation of GDP is essential to decision making by the government and by the private sector. With imperfect observation of GDP, on many questions, we are flying blind. There has been a great amount of criticism of the Indian GDP data in recent years, as the high growth rates seen in the official data are inconsistent with trusted private databases. Our paper contributes three new blocks of knowledge to one component of the problem, i.e. measurement of manufacturing GDP.


Amey Sapre is an Economics Ph.D. student at IIT, Kanpur and Pramod Sinha is a researcher at NIPFP.

The gains to US GDP from a Doing Business score of 100

by Dhananjay Ghei and Nikita Singh.

Can a country achieve growth by implementing large pro-business reforms? If yes, then how much growth is really possible from such reforms? In a recent WSJ op-ed, Cochrane takes a stab at this question for the United States. Using data from the World Bank's ease of doing business index, Cochrane claims there is a log-linear relationship between GDP per person and business climate. By extrapolating this relationship out of sample, he predicts that the US would register a 209% improvement in per capita income (or, 6% additional annual growth if the required reforms are implemented over the next 20 years) by achieving the ease of doing business index value of 100.

Brad Delong disagrees. He fits a fourth-degree polynomial on the same data. He justifies this on the grounds that the third degree coefficient is negative and statistically significant. His forecast shows that an increase in the index value beyond 90 would actually lead to a lower GDP per person. Figure 1 juxtaposes the log-linear and polynomial regression fit, and we can see how the two views are sharply different. The straight line yields higher and higher GDP as you go to 100; the polynomial droops off at the end.

Figure 1: The analysis of John Cochrane and Brad DeLong

Areas of concern

There are many areas of concern with this analysis:

1. Assuming linearity is surely a stretch. But polynomial regressions are a bad way to deal with nonlinearity. In particular, polynomial regressions are very fragile at the end points. This can be easily seen in Figure 2 as the prediction interval increases at edges of the data. In addition, extrapolation using a polynomial is almost always sure to give a wrong answer as the curvature of the polynomial is unidentified outside the sample.
2. Using a cross-sectional regression with one variable is a poor guide to the causal relationships. Labour and capital matter to GDP per capita. There are stark differences in law and governance, institutions and culture across countries; it is unlikely that the doing business score is a sufficient statistic.
3. Hallward-Driemeier and Pritchett (2015) show that the "doing business index" is not a good reflection of how the laws on paper are implemented in reality. The main point of their argument is that better de jure regulations do not necessarily imply improved de facto outcomes specially when a country has weak governmental capabilities for implementation and enforcement. Even if the US does well on the rule of law, and this gap between rules and deals is absent, this is a serious issue for many (most?) observations in the dataset.

Figure 2: The 95% prediction interval for the polynomial regression

Can we do better?

Criticisms 2 and 3 are hard to handle. But a little bit of statistics helps us do better on the first. We use non-parametric regression as a way to have nonlinearity in the relationship between business climate and GDP per person without having to take a stand on a particular functional form. This involves three steps:

1. Selecting an optimum bandwidth using cross-validation
2. Estimating a nonparametric model using the chosen bandwidth
3. Tests of statistical significance and specification

We use a second order Gaussian kernel and fit a local linear estimator to identify the functional form in sample. Business climate is significant at 1% level in the local linear non-parametric model. Moreover, based on a lower cross validation score, the non-parametric regression is favoured.  In addition, we do a bunch of robustness tests by changing the type of kernel and regression. The results do not change much in either of the cases. These calculations were done in  R using the np package.

Figure 3: Non-parametric regression gives us the best of both worlds

The results, shown above, show that there is nonlinearity in the data. The linear model used by Cochrane is not appropriate. But we're better off as compared with using a polynomial regression; the confidence interval is tighter at the edges.

Figure 4 superposes the three models. The coloured dots show the predicted value of GDP per person using the three different specifications when the doing business index takes the value of 100.

Figure 4: Comparing the three predictions

Our nonparametric estimate shows that gains from achieving a score beyond 90 are increasing and somewhere in between Cochrane and DeLong's numbers. Cochrane predicts that the US would achieve 6% additional annual growth for 20 years by moving to a score of 100. If we go out of sample to estimate using the nonparametric fit, this shows an annual growth of 2.22% for the next 20 years. This is not something to laugh at, but it's a smaller, and we think a more plausible estimate.

References

Hallward-Driemeier, Mary and Lant Pritchett. 2015. "How Business Is Done in the Developing World: Deals versus Rules." Journal of Economic Perspectives, 29(3): 121-40.

Tristen Hayfield and Jeffrey S. Racine (2008). Nonparametric Econometrics: The np Package. Journal of Statistical Software 27(5). URL http://www.jstatsoft.org/v27/i05/.


Dhananjay Ghei is a researcher at the National Institute of Public Finance and Policy. Nikita Singh is a MRes. student at London School of Economics and Political Science. The authors thank Ajay Shah for valuable discussions and feedback.

Understanding the Indian financial environment

by Ajay Shah. 

The big facts about the US financial environment

 

Using very long time series in the US, three important facts are : (a) An inflation target of 2%, which is successfully delivered by the US Fed; (b) Bond return of 2.7% and (c) Equity premium of 3 percentage points.

In the US, there is a fair understanding about these three numbers and confidence that these values will hold in the coming decades.

The fact that these three things are known in the US with fair precision generates an environment of confidence. In the US, we know the probability distribution; the only thing not known is how future draws from the distribution will work out. All economic agents -- households and firms -- are able to look into the future and make plans knowing these foundations. This ability to make plans at long time horizons generates good outcomes for all economic agents and for society at large.

How might we think about the Indian economic environment?

 

In India, we don't know the probability distribution governing these three things (inflation, bond returns, equity returns). This generates a qualitatively higher level of uncertainty. Every financial or real sector investor faces bigger difficulties owing to this lack of knowledge. Many investments don't get made, many financial strategies (e.g. retirement planning) are not undertaken owing to the inability to peer into the future and figure out what will happen. The phrases `ambiguity' or `Knightian uncertainty' are used when describing an environment where we don't know the probability distribution of the shocks that we face.

It is interesting and important for us to understand the fundamental facts about the Indian economic environment. When institutional reforms generate enhanced clarity, and take us into the world of shocks from a known distribution, this will give a qualitative reduction in uncertainty and a better climate for all economic agents.

This is partly about better understanding the past, and partly about envisioning the new institutional machinery which is coming together. Let's start at the past.

Long-run equity returns and returns to equity investment in India

 

India is an equity market dominated financial system. The failures of public policy have hampered the working of the bond market and the banking system. On 20 May 2015 the market capitalisation of the CMIE Cospi index was Rs.101 trillion, and it had 2318 firms. On 17 April 2015, the stock of `non food credit' of banks, to all firms and individuals in India (and not just 2318 big firms) was Rs.65 trillion. The equity market is the dominant and market-based foundation of the financial system.

An array of interesting questions swirl around equity investment in India:

1. Do equities in India deliver a strong equity premium, in the long run?
2. How well does `dumb' investment in index funds perform? Is the market so inefficient that active management beats the index funds?
3. There are over 4000 listed firms with a very great heterogeneity within them. Should one just focus on the top 50, or are there interesting investment strategies by delving into smaller and/or less liquid firms? If so, what's the appropriate investment technology to use when going there?

The long run performance of the stock market indexes with the biggest stocks

The graph above starts with the oldest time-series of equity index returns -- the 

BSE Sensex. My data here starts from 3 April 1979. This is a 30-stock index which had idiosyncratic rules about modification of the index set. From 3 July 1990 onwards, we switch over to Nifty, where the rules about changes in the index set are systematic and sensible. The black line above is the long time series obtained by pasting the two.

Over a span of 36.17 years, the black line has compound nominal INR returns of 15.91%. On average, this is a doubling every 4 years. Of course, a part of this is inflation. We don't have sound inflation data for 36.17 years so it's not possible to compute the average real INR returns on the Indian stock market index.

Nifty is the 50 biggest firms in India who have adequate stock market liquidity. Nifty Junior delves one notch below them to the next 50 big firms who have high stock market liquidity. You may think it's only a small step away from Nifty firms in terms of the large-cap high-liquidity character. Data for Nifty Junior starts from 1 January 1997. This is superposed in the graph above as the red line.

Over this span of the most recent 18.41 years, Nifty gave compound returns of 12.62%. In this period, Nifty Junior gave compound returns of 17.17%. This was a premium of 455 basis points per year.

The graph above can be interpreted as follows. Suppose you invested Rs.100 in the BSE Sensex index fund on 17 July 1979, then switched to a Nifty index fund on 3 July 1990, and 100% switched to a Nifty Junior index fund on 1 January 1997. In this case, over the 36.17 years in the graph, you'd have got a 400x return, from 100 to 40,000.

These are eye-popping numbers, but they are all in nominal INR. When expressed as USD or when expressed in real terms, the picture becomes good, but not eye-popping.

While these sample means are computed over long time horizons, it's important to keep the uncertainty of these estimates in mind. As an example, consider the estimate for BSE Sensex + Nifty above: a mean return of 15.91% over a time horizon of 36.17 years. The annualised standard deviation of this market index works out to 24.9%. This gives a distribution of the mean that has a standard deviation of $\sigma/\sqrt{N}$ of 4.14. A 95% confidence interval would be 8.11 percentage points on each side of the point estimate of 15.91 per cent. Hence, even though 36.17 years seems like a lot of data, it isn't enough to be really confident about the numerical estimate for the average equity returns in the historical data.

All this information does not take us all the way to an estimate of the equity premium, as we don't know much about the riskless rate of return in this period. See this article by Suyash Rai on alternative methods for estimating the equity risk premium. 

Interpretation and speculation

 

1. These are strong rates of return over long time periods. The BSE Sensex / Nifty index had long run average returns of 15.91% and the Nifty Junior fared significantly better.
2. These returns were achievable by index funds. There is no slip between cup and lip when going from this evidence to realised investment performance.
3. The sharp difference between returns on Nifty and returns on Nifty Junior (455 basis points of a difference in returns per year, over 18.41 years) suggests that there may be many interesting subsets within the 4000+ listed firms in India with heterogeneity in returns. We shouldn't paint the entire Indian equity market with the Nifty brush.
4. Can active management do better? Three factors are at work. Is the market inefficient? Does the fund manager know how to beat the market? Do you trust the fund manager to work for you? There is ground for concern about all three checkpoints.
5. We have evidence, in mid cap stocks, that foreign institutional investors do much worse in security selection when compared with domestic institutional investors. This evidence suggests that foreign investors should sub-contract to domestic money managers or buy index funds. From the viewpoint of foreign investors, there are three issues. First, there is high home bias against India; global portfolios are systematically underweighted against Indian equities and fixed income. Second, one chunk of that investment problem (the Nifty / Nifty Junior asset class) can be done well using index funds. Third, they need to explore smaller firms and figure out answers to the three factors of market inefficiency, fund manager capability and the principal-agent problem of the manager.
6. I am not aware of sound studies of mutual fund performance. I am not aware of sound databases about mutual fund returns. It would be interesting to look at how mutual funds are faring, to subject them to benchmark risk based on mixing Nifty and Nifty Junior, and see the extent to which there is outperformance.
7. The case for private investment in public equities (PIPE) or hedge fund structures, which charge 2+20, would lie in three claims: (a) The market is inefficient (b) The manager understands these inefficiencies and is able to exploit them (c) The 2+20 structure aligns the incentives of the manager. At the same time, 2+20 is a very large tax; you'd need very large market inefficiencies to make it work.
8. It's time to look behind Nifty Junior in the construction of index funds. 

 

A speculative view about the big facts about the future Indian investment environment

 

If we peer into the future, we can get an outline of the big numbers in macro/finance in India:

1. There is some slow progress in Indian financial policy. RBI now has an objective -- CPI inflation of 4%. In time, the conflicts of interest at RBI will be removed. In time, the Bond-Currency-Derivatives Nexus will get built, which will give RBI the ability to deliver on the inflation target. In time, RBI will become a sound institution. Once all this happens, CPI inflation in India would become stable with a tight distribution around the mean of 4%.
2. Sound practices in monetary policy and sound practices in public debt management will give a government bond yield curve with perhaps 6% on average at the short end and 9% at the long end. Perhaps the average nominal return for government bonds will be 7%, as most EMs tend to finance a lot at short maturities.
3. Equity returns in the past came from (a) India's one-time abandonment of socialism and (b) High returns for extremely high risk given the bad macro/finance institutional environment. I think the equity premium in the future will be lower; it will be 5 to 6 percentage points. This will be higher than what's seen in the US (where risk is very low) but lower than what we've enjoyed in India in the past. This will give nominal INR returns on the Indian equity index of 11 to 12 per cent.
4. I think that when the US inflation target is 2% and the Indian inflation target is 4%, we will get a long-run average USD/INR exchange rate depreciation of 0% to 1% per year with a volatility of 13% per year. The latter number is typical of floating exchange rates from inflation targeting EMs. It will make sense for most global investors to invest in Indian fixed income and equity without needing to fully hedge USD/INR fluctuations.

In summary, I think that in a few years, the Indian financial reforms will be completed. After that, when we peer into coming decades, there may be an internally consistent picture around five numbers:

1. An inflation target of 4%;
2. A short rate of 6% on average;
3. Average nominal return for government bonds of 7%;
4. An equity premium of 5 to 6 percentage points and
5. Mean USD-INR returns of depreciation of 0 to 1 percent per year with a volatility of 13%. 

Clarity on these foundations, supported and made possible by the financial reforms, will make a difference to the lives of all economic agents in the country.

This is, of course, all speculative. I am surely off track on many elements of this story. For everyone working with Indian macro and finance, however, it is an interesting exercise to arrive at an opinion on the five numbers above, which are the skeleton frame of Indian finance. It would be interesting to think about the internal consistency of this picture, and chip away in finding flaws and fixing them.