Macroeconomics in an Open and Integrated World: Avoiding the Extremes

A number of important things distinguish India from other emerging economies. In terms of population, with 1252 MM (2013) people, it ranks second behind China, but India has demography on its side as youth make up a majority. India, however, still ranks as a relatively poor country, although an active middle class has flourished in recent years. But if something differentiates this country from the rest of the countries being analysed in this book, it is the country's democratic performance, which has never been interrupted since it achieved independence from British rule on 15 August 1947. In this sense, as the world's largest elected democracy, public authorities receive constant scrutiny from its citizens, in contrast to China's autocratic government.

From an economic perspective, and after a brief period of FDI promotion on receiving independence, India established a relatively closed economy with considerable state intervention in industrial policy and multiple controls over private investment. Authorities were implementing a national development strategy characterized as a highly interventionist industrialization model, popularly known as the ‘licence raj’, which affects both local and foreign investors. The legal scheme introduced by the Foreign Exchange and Regulation Act (FERA) in 1947 (and reformed in 1957) imposed a 40 per cent ceiling on foreign investors’ participation in industrial projects, sometimes even preventing TNCs from using their own brands in India (Kumar, 1995). Development, in turn, is internally financed from resources mobilized domestically as the national economy remains inaccessible to capital from abroad (FERA legislation prohibits most FOREX transactions).

On the monetary side, authorities’ emphasis has been on generating resources for public investment, whereas a highly repressed model characterized the local financial sector. A close capital account granted enormous policy autonomy for those working at the Reserve Bank of India (RBI), which immunized them against the monetary trilemma. Finally, this highly centralized and substitutive setting installed a pegged exchange rate system that (initially) fixed the rupee value in tandem with the sterling pound.