Rapporteur, Satu Limaye

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ECONOMICS

In the early 1990s South Asian governments began implementing reforms to accelerate economic growth. Throughout the region steps have been taken to deregulate industry and commerce, liberalize trade, reform financial markets and tax systems, and increase foreign investment and technology transfer. These initial reforms have yielded positive results, including increased foreign exchange reserves, growing exports, and rising foreign investment. The region and the world have an important stake in the extension of these policies.

Accelerated and equitable economic growth resulting from further reforms will improve the lives of millions of people. By creating new commercial opportunities, rapid economic development could shift the region's prevailing focus from long-standing regional hostilities to greater regional cooperation. Dynamic, open economies will facilitate the subcontinent's integration with the world economy and diminish its political isolation. Already, investors from the United States, Europe, and Asia have increased their investment, trade, and joint ventures in the region. If current trends are bolstered, India and its neighbors might emulate the economic dynamism of the wider Asia-Pacific region. Over time, accelerated economic development in South Asia, if well distributed among social classes and regions, will also help to contain population growth, reduce social unrest, and enhance political stability.

U. S. INTERESTS

South Asia's huge emerging market represents one of the last untapped economic frontiers in the world. India's middle class alone has nearly 200 million people and is growing by 5 percent per year. This rivals the total population of the United States. Strong institutional and legal frameworks, an English-speaking professional and entrepreneurial class, and impressive scientific and technical skills are additional advantages for Americans doing business in the region.

The United States is well positioned to benefit from the region's economic opening. A long-standing economic presence in the region and heightened activity in the wake of recent reforms have given the United States a competitive advantage vis-à-vis European countries and Japan. American companies–and therefore American shareholders and workers–stand to gain from increased exports to and profitable joint ventures in South Asia. American direct investment in India rose from less than $20 million in 1990 to over $1 billion in 1993. Bilateral trade in 1993 amounted to $7.3 billion, representing a 44 percent increase for U.S. exports and a 20 percent increase in Indian exports. In addition to providing commercial benefits, stronger economic ties will help moderate U.S.—South Asian discord on other issues and create a deeper American private and public engagement with the region.

NEW ECONOMIC POLICIES IN SOUTH ASIA

Although new economic policies in South Asia are still evolving, the general elements of reform are now clear. In discussions with South Asian colleagues, we found grounds for both optimism and concern about the extent and pace of further reforms.

Trade Liberalization

Many tariffs have been lowered, and import restrictions and licensing requirements have been either relaxed or removed. In India, the peak tariff has dropped from 400 percent in 1990 to 65 percent in mid-1994, and the average tariff has dropped from 87 percent in 1990 to 33 percent in mid-1994. India has also reduced the number of items that require an import license. Bangladesh has reduced tariff rates as well as the number of goods under quantitative restrictions from 33 percent of imports in 1988/89 to 10 percent in 1992/93. Pakistan has cut import duties and average tariff rates (from 92 percent to 70 percent) as well as canceled import-license fees.

Compared to liberalizing economies of Latin America and East Asia, South Asian countries still maintain high tariffs and many quantitative restrictions on imports. In Mexico, for example, tariffs have been reduced to a high of 20 percent and an average of 10 percent, whereas in South Asia they range from 40 percent to 110 percent. South Asian governments' plans to further reduce tariffs are encountering opposition from protected industries. Aside from preserving inefficiencies and elevating consumer costs, high tariffs inhibit export growth, the start of new industries, and foreign investment because they make the imports required for production too costly.

Investment

Reforms aimed at expanding domestic and foreign investment are an important part of South Asian countries' evolving economic policies. Regulations that have in the past constrained domestic investment (for example, limits on capacity expansion) are being relaxed or eliminated. This has had some positive impact. For instance, there has been a rise in Indian domestic investment during the past two years. However, domestic investment could be expanded further throughout the region.

South Asian countries have more successfully moved to attract greater foreign investment by offering tax holidays and exemptions, permitting higher equity participation, and streamlining the investment approval process, among other measures. As a result, capital inflows to some countries of the region have increased during the past two to three years. India has benefited the most. Actual foreign direct investment flows into India jumped from $128 million in 1991 to $544 million in 1993. Foreign portfolio investment has risen from a very small amount to about $3.5 billion in 1993. In Sri Lanka, foreign investment (portfolio and direct) increased from $56 million in 1990 to $362 million in 1991, the most recent year for which figures are available. Pakistan has also seen an increase in foreign investment, though smaller than in India and Sri Lanka. Direct foreign investment in Pakistan increased from $242 million in 1991 to $261 million in 1992, and portfolio investment increased from $87 million in 1991 to $92 million in 1992. With further reforms, domestic and foreign investment are expected to rise in all the countries over the next five years.

In the near term, however, some caution about the rise in investment is warranted. While many South Asians view the inflow of capital as testimony to the attractiveness of their economies, much of it has come in the form of portfolio investment rather than direct investment, reflecting fund managers' interest in spreading risks as much as their high confidence in the region's economic reform. While purchasing equity or debt in companies that are traded may in fact make them quite productive, South Asian countries can do more to attract investment that will create jobs and improve the competitiveness of industry by further easing licensing procedures, improving infrastructure, relaxing regulations on repatriation of funds, and increasing protection for intellectual property.

Privatization

Privatization of government-owned enterprises and financial institutions has been cautiously and selectively pursued. But there is ample scope–and a compelling need–for further action. India has sold only about $1.6 billion of equity in 32 out of almost 200 central government—owned companies. An estimated one-half of India's public enterprises lose money, a total of some $1.3 billion per year. India's finance minister recently announced that the government would seek to halt further subsidies to loss-making industries, but the ruling Congress Party has stopped short of supporting outright privatization.

Movement toward privatization has been hesitant elsewhere in South Asia too. Pakistan has privatized 35 government-owned corporations but has been slow to act in the critical power-generation and distribution sectors. Although Sri Lanka's privatization program began in 1987, only 12 of 49 public enterprises have been at least 51 percent privatized.

The cautious approach to privatization in the five countries reflects an unwillingness to confront powerful labor and political interests that benefit from jobs and patronage in government-owned industries. Nonetheless, we believe that steady progress toward privatization or at least greater cost control and enhanced efficiency in public-sector enterprises are important to the success of the overall reform efforts.

Infrastructure

The entire region, with the possible exception of parts of India and Sri Lanka, currently has inadequate physical infrastructure. Energy shortages, both at the industrial and household levels, are a particular problem. Transport and telecommunications also need improvement. To sustain faster economic development and attract investment it will be necessary to increase the quantity of infrastructure and the quality of services derived from it.

Steps taken to attract investment in infrastructure have had limited success. In India's power sector, for example, low electricity rates, uncertainty over future financial returns, and losses at government-owned electric companies inhibit private investment. Still, efforts to attract private investment in the power and other sectors continue. India recently announced incentives to private foreign and domestic companies to invest nearly $5 billion in the construction of highways and bridges. Pakistan has recently approved seven proposals for private power generation. International infrastructure funds to finance projects in some of the South Asian countries have been established and could lead to further improvements of the region's ports, roads, and power plants.

Tax Revenues

Tax revenues in the subcontinent are extremely low. In both India and Pakistan, only 1 percent of the population pays income taxes. Wealthy agriculturists in all the countries pay little or no taxes while benefiting from government subsidies such as low-cost water for irrigation. Low tax revenues exacerbate already high fiscal deficits and force the governments to rely upon economically unsound trade taxes (i.e., tariffs) as well as consumption taxes. Pakistan gets a very high percentage of its revenues from import and excise duties. But it is seeking new revenue sources. In the latest budget, the government imposed a 15 percent sales tax and announced measures to tighten tax collection. To broaden tax revenues, other regional governments have expressed an interest in introducing a value-added tax, with India indicating that it will introduce a full-fledged value-added tax by 1997.

Labor Policy

Rigid laws protecting workers' rights and jobs inhibit growth and new investment in productive ventures. South Asian governments are wary of easing restrictions on laying off workers, given the inadequacy of social safety nets and the power of organized labor. They contend that they cannot risk large-scale lay-offs until a rapidly growing economy produces alternative employment for displaced workers. Investors, both domestic and foreign, respond that relaxing labor laws will stimulate investment and thus create new job opportunities.

Some South Asian businesses are not waiting for legal changes but are negotiating labor-shedding through private voluntary retirement schemes and other incentives. In India's communist-led West Bengal state, where labor unions exercise an especially powerful influence, the government has approved the highest number of such agreements. More may come about as private and public industries go to private-sector financial markets for funding and are required to cut costs in return for loans. Nevertheless, we believe that there is a need for formal legal changes to relax present labor restrictions in order to attract greater investment and promote growth in the long run.

Banking

Banking remains tightly controlled by South Asian governments. Though reforms have been announced, much remains to be accomplished. India has liberalized the banking sector by establishing private banks and diluting government ownership in nationalized banks. It has lowered the high statutory liquidity ratio and taken steps to reduce administrative control of interest rates, address the problem of nonperforming assets, and impose discipline and improve efficiency through the adoption of international accounting standards. However, governments in the region and even private bankers see a need for continuing state involvement, even dominance, in banking to address social concerns.

Agriculture

In every South Asian country, agriculture is still the predominant sector in the national economy as well as the principal source of employment. For example, rural Nepal accounts for 99 percent of the country's land, 90 percent of its population, and 60 percent of its gross national product. The figures are less dramatic in other South Asian countries, but the rural sector remains critical throughout the region.

Widespread adoption of Green Revolution technologies has increased South Asian agricultural productivity. Much of the Punjab, in both India and Pakistan, is fertile and irrigated, and the state has long been the locus of some of Asia's most productive agriculture. Increasing production in these key areas will be vital to future food security. In India, which over the past two years has achieved near self-sufficiency in food production, we were told of a growing middle class and consumerism in the rural sector. Bangladesh has made progress toward self-sufficiency in rice production despite a series of devastating natural disasters and relatively rapid population growth. The reform of its fertilizer distribution system is regarded as a model for developing countries.

Still, high levels of population growth might surpass recent growth in agricultural production in South Asia, as they have in the past. Serious food shortages could occur in the first decades of the next century unless decisive steps are taken soon. There is no more arable land. An increasing amount of the land now cultivated is going out of production–or threatens to do so–because of soil erosion, salinization, and waterlogging. There are also serious water-supply problems, particularly in the Indian and Pakistani Punjab where water tables are being seriously depleted. Overcoming these obstacles will depend on scientific breakthroughs by now inadequately financed international and national research institutions. Finally, in Pakistan and parts of eastern and central India where feudal practices remain strong, governments still tend to underinvest in education, health, and population programs–the very programs necessary to create a viable agricultural policy.

IMPEDIMENTS TO ECONOMIC REFORM

The commitment to further economic reforms varies in each South Asian country. On the whole, we believe that the economic reforms already accepted in South Asian countries are highly significant and unlikely to be reversed, but the danger remains that they will not be pushed to their logical conclusion. If South Asian countries shirk the next, more difficult steps of reform, the momentum of the process could be lost and might be hard to retrieve. So far, the reforms have been relatively painless for South Asia's populace and therefore politically neutral. The next steps will affect entrenched interests and arouse greater political opposition. But they will also stimulate more rapid growth and eventually benefit a much wider group of South Asians.

Nonetheless, public attitudes toward reform remain ambiguous. Because there is little popular support for fundamental change, reform has had to be pursued cautiously and quietly. South Asian colleagues attributed public attitudes to cultural as well as pragmatic factors. Many spoke of the patience of their citizens while others pointed out that the region's economies, while falling far short of their potential, had not approached collapse as had economies in the former Soviet Union and Eastern Europe. More recently, however, South Asian public opinion, or at least some sections of it, has begun to show a greater interest in the fate of economic reform.

For their part, business, bureaucratic, labor, and agricultural interests that prospered under the old economic order resist fundamental reforms. Past policies have made such vested interests particularly powerful. Potential challengers to the status quo, such as a new class of young entrepreneurs, intellectuals, and even officials, have just begun to gain the authority and positions from which they can bring change.

POLITICS OF ECONOMIC REFORM

So far economic reform has been good politics in South Asia. India's new policies have not yet encountered mass opposition, even from the influential leftist parties. The government of Prime Minister Narasimha Rao strengthened its hold on power after three years of reform. The bold measures advanced by Pakistan's interim prime minister, Moeen Qureshi, were widely hailed. Bangladesh's leaders were able to foster economic reform despite the absence of any strong pro-reform constituency within the country. However, given South Asia's raucous politics, future reforms will face a number of barriers, especially as the process creates, or is perceived to create, clear winners and losers.

Ideological resistance to reform exists on both the left and right of the political spectrum. In India the left parties are already mounting challenges to reforms affecting labor and the privatization of public-sector enterprises. In Sri Lanka the August 1994 electoral victory of the leftist Freedom Party may endanger elements of the country's economic reforms.

Opposition from the right is limited and arises from a mix of nationalism, social conservatism, and political opportunism. In India the main opposition party, the Bharatiya Janata Party, has sought electoral advantage by challenging foreign involvement in the economy even though it has been historically committed to the free market. In both India and Pakistan religious conservatives and cultural nationalists express concern that open economies will permit foreign influences to undermine distinctive, traditional values in their societies.

Relatively weak parties, frequent changes of government, rule by coalition, and civil strife in the region make steady, coherent economic reform difficult. Ongoing confrontation in Bangladesh between the government and opposition, often expressed through strikes and violence, has undermined efforts to attract foreign investment. The conflict in northern Sri Lanka has distracted the government from its economic reform efforts. In India the destruction of a mosque at Ayodhya and subsequent unrest slowed the reform process for almost a year.

DEMOCRACY AND REFORM

Many South Asians regard their democratic systems as constraints to speedy or radical economic reform. Indians in particular compare the limits they encounter to the relatively free hand of governments in authoritarian societies such as China. Indians may misrepresent their case. The fact is that their government has a pervasive role in the economy, especially through its public enterprises and restrictions on the private sector. Unfortunately, this involvement in the economy is inefficient.

However, South Asians also contend that over time democratic politics will provide an enduring foundation for economic reform. The consensus-building process required by democracy will help ensure that reforms are broadly based and will survive changes of government leadership. The results of well-designed reform will in turn help strengthen democracy.

We believe that South Asian countries can and will surmount these obstacles to reform if their leaders and citizens see that the alternatives to doing so are even more painful.

RECOMMENDATIONS

Americans have much to gain–and to contribute–by participating in South Asia's economic opening. While U.S. businesses will have to assess for themselves the prospective benefits of involvement in South Asian economies, the U.S. government can take a number of steps to assist South Asian economic reforms. Many of the recommendations that follow were suggested by South Asians as ways for the United States to provide tangible support to their reform efforts. Hence, we recommend that the United States:

• Open U.S. markets further to South Asian exports through early approval of the Uruguay Round of the General Agreement on Tariffs and Trade (GATT) and through other multilateral and bilateral or regional trade liberalization efforts. South Asians express concern that the United States will restrict market access just when they are beginning to focus on export-led economic growth.

• Avoid linking human rights issues to trade or attaching environmental and labor conditions to bilateral and multilateral trade agreements, beyond what is now legally provided for in GATT and the North American Free Trade Agreement(NAFTA). The United States should pursue its concerns in these areas through recognized multilateral channels.

• Make South Asia a major focus of U.S. government trade and investment promotion activities. The naming of India in 1993 as one of the world's "major emerging markets" by the U.S. Department of Commerce is an example of a low-cost way to highlight opportunities in South Asia. We urge a sustained "South Asian Market Initiative" to bring the region's opportunities to the attention of U.S. companies. Visits by U.S. cabinet-level economic officials such as those planned by Commerce Secretary Ron Brown and Treasury Secretary Lloyd Bentsen in 1994 are key. U.S. institutions such as the Export-Import Bank, the Department of Commerce, and embassies in the region should expand their efforts to link American business people to opportunities in South Asia.

• Review and revise cold war—era export controls to ensure that sales of U.S. technology and know-how to South Asian countries are not unnecessarily restricted. While observing U.S. legal and internationally agreed limits, the United States can substantially ease the flow of commercially available technology.

• Actively promote assistance to South Asian economies through international financial institutions such as the Asian Development Bank (ADB) and the World Bank. In the past the United States has been largely supportive of such lending to South Asia, and it should continue to be so.

• Expand scientific and technical cooperation with South Asia. Some of the South Asian countries, particularly India, have impressive scientific and technical establishments with which the United States already pursues collaborative projects of mutual benefit and potential commercial as well as societal significance. Such cooperation should continue and, as appropriate, expand into areas such as health, population, medical sciences, environment, basic and applied sciences, agriculture, and natural resources.

• Assist South Asian governments in developing the technologies and strategies necessary to feed their rapidly growing populations. This year the U.S. Agency for International Development (AID) should increase support for the international agricultural research centers operating under the aegis of the Consultative Group for International Agricultural Research (CGIAR) and expand collaborative research between South Asian national agricultural research systems and U.S. universities.