India in the Global Economy

November 1996 India still is not attracting attention from foreign investors commensurate with its size and economic potential, nor is its engagement in world trade keeping pace with that of the more dynamic developing countries - especially comparable countries in East Asia. Despite considerable improvement in policies and performance in recent years, India's progress toward integration in the global economy has been modest. The four chief areas of weakness seem to be: ° Inadequate macroeconomic policies - notably a large fiscal deficit that crowds out private investment essential for export success and reduces the confidence of foreign investors. ° Higher levels of protection than in other developing countries. ° Inefficient transportation and communications infrastructure. ° Poorly equipped sections of the labor force and inflexible labor markets. In the presence of these policy weaknesses, India's large domestic market, which could be a strength, discourages Indian firms and foreign direct investors from focusing enough on export markets. Even with a favorable external environment, under current policies India is unlikely to achieve the medium-term targets for growth and exports spelled out in government plans. The country is also vulnerable to external and internal shocks. Reforms should contribute to increasing foreign direct investment and its benefits. Foreign direct investment can help raise the private investment rate without incurring additional debt and can help relax key infrastructure constraints. But its greatest long-run benefit may come from its direct and indirect effects in improving productivity. Foreign direct investment has long been opposed because of fears that it will have ill effects. But such effects are likely to result from policy-induced distortions, and it is those distortions that should be addressed. This paper - a product ...