Engaging India and the Emerging Powers – the UK Growth Imperative

Jo Johnson MP

Achieving Export-led Growth

Globalisation is bringing about a profound transformation in the world’s political and economic structures. As one of the Atlantic powers that has seen its power and influence dwindle, the UK must either adapt to the new world order or see its relevance continue to decline, with all that that means for its role in international affairs, for national security and for the British economy.

What is true for the UK is also true on a larger scale of Europe as a whole, which as a ‘legacy’ continent has to choose between either looking outward and trying to compete with global rising economic powers, or accepting an increasingly diminished role in world affairs.

The UK government has put a high priority on forming closer relationships with the newly powerful actors, the BRICs in particular, and announced a target of doubling exports to £1tn by the end of the decade. Given trends in the Eurozone and other developed markets, there is no way such a target could be met without a dramatic transformation of trade with the BRICs and the intense engagement with New Delhi has been emblematic of this ambition. More government ministers have visited India since May 2010 than any other country (excluding Belgium).

For a country banking on exports (and business investment) to speed recovery, it is encouraging that recent trade figures suggest the UK’s external sector could be weathering the euro-zone crisis. UK exports in goods and services increased in 2011 and 2010 after a sharp fall in 2009. By the end of last year, the trade deficit had shrunk to its smallest level since 2003. With the fiscal squeeze still underway and credit conditions tight for many businesses, however, the onus remains on the UK’s external sector to help drive economic recovery in 2012.

In a two-speed world, there is no nothing to dictate that Britain must stay in the slow lane of economic recovery, but it must better position itself to take full advantage of the booming emerging markets that will account for the bulk of global growth over the next few years. The crisis in the eurozone, the weak performance of the US economy and sluggish growth in the domestic economy should encourage UK firms to broaden their horizons from traditional trade partners in Europe and North America to tap growth in new markets.

Since arriving in Downing Street in May 2010, David Cameron has repeatedly urged British business to take advantage of growth in the world economy that was “not in the eurozone, but in huge modern cities from Bogotá to Istanbul”, where “people [were] hungry for the skills and services Britain is best at”. George Osborne has said that “an enterprising Britain is one that sees a world with a resurgent China, a booming India, a thriving Brazil and understands that it is an opportunity not a threat.’

Although by instinct suspicious of the Heseltinian tradition of herding businessmen onto aeroplanes bound for faraway countries, Messrs Cameron and Osborne have consistently led from the front what has been a concerted cross-government effort to boost Britain’s commercial diplomacy. The creation of a new Trade and Investment cabinet subcommittee for Economic Affairs, chaired by Lord Green, previously Group Chairman of HSBC, was an early and welcome indication of resolve in this respect.

The urgency of this reorientation has if anything increased over the last two years. With the eurozone struggling, UK exporters will find little growth in a market that accounts for half of all external trade. Some economists believe that exports to the euro-zone could soon be falling at double-digit annual rates. Meanwhile, growth of exports to countries outside Europe has picked up. But because these increases are building on such a small base, the big picture is that UK exporters are still heavily reliant on what happens in the Eurozone.

This is of course not a zero-sum game. No one is suggesting UK businesses should seek to export less to the rich European countries that form the world’s most important trading area, with a GDP of about €12,000bn and a population of 500 million. Indeed, the UK has to continue pushing for the completion for the single market. Eliminating significant non-tariff trade barriers could increase our trade with other EU members by up to 45 per cent, according to the Department for Business, Innovation and Skills, and boost per capita incomes by seven per cent.

The UK and Europe have to work on boosting internal and external trade in tandem. In order to re-invigorate domestic European demand, countries such as Spain and Italy will have to continue in their efforts to reform their public and private sectors, and members will have to genuinely commit to liberalising the single market. In order to take full advantage of growth in developing countries, the EU has to push the FTAs that will unlock their markets to European firms. Ultimately, however, demand in emerging countries, not Europe, has the greatest potential to drive forward UK, European, and global growth.

Whilst more trade is what the UK needs, it is not going to be easy. There are plenty of reasons to wonder whether exports can really be a growth panacea for the UK and other European countries at a time when nearly every country in the OECD and many beyond are looking to international trade as a way out of recession or stagnation. Not every country can run a current account surplus.

Focusing on the UK, it is also worth remembering that the UK’s track record of achieving export-led growth is strikingly poor.

Trade over the past 30 years has been a consistent drag on growth. The Pink Book, which charts the UK’s balance of payments, shows that the value of imports has exceeded the value of exports in all but six years since 1900, none of them recent. The UK has recorded a current account deficit in every year since 1984.

On the positive side, the UK has run a surplus in its trade in services in every year since 1966. This has failed, however, to compensate for the deficit shown in its trade in goods. The last time the UK registered a fleeting surplus on its trade in goods was in 1982, but only thanks to North Sea oil. In 2010, the current account deficit was £48.6 billion, equivalent to -3.3 per cent of GDP, not far off the 1989 record of -4.9 per cent. In 2011, it shrank a little, to £29 billion, or 1.9 per cent of GDP.

The attempt by the UK, as a country with a substantial external deficit, to promote export-led growth, with the assistance of exchange-rate depreciation, is not a beggar-my-neighbour policy, as some have suggested, but a defensible and sensible policy aimed at returning the current account to balance.

Over the past 60 years, the UK has steadily lost share in global exports. This is partly due to the emergence of competitive low-cost exporters from the developing world, epitomised by China, which has been pursuing an aggressively mercantilist approach and keeping its exchange rate down through huge foreign currency intervention. But it is also due to the ferocious competition from developed world structural surplus countries, such as Germany and Japan.

While the share of global exports accounted for by developed economies as a group has fallen from 73 per cent in 1950 to 59 per cent in 2009, the UK’s decline has been sharper, from 10 per cent of global exports in 1950 to under 3 per cent in 2011. The same trend is manifesting itself in the post-recession recovery. The fall in the external value of sterling has had less of a positive impact on exports in the last few quarters than anticipated.

UK trade is also facing the wrong way. The UK needs to export more to developing economies, but re-orienting existing UK trade towards higher growth markets will take longer than a political cycle. Our trading relationships have been shaped by distance, market size and cultural, linguistic and historical ties. The EU remains the UK’s most important market, as the destination for 45 per cent of exports in 2011, and will continue to be so for at least a decade. But it is likely to be a relatively slow growth region. A further 27 per cent of the UK’s trade is with developed countries outside the EU: the US, Canada, Japan, EFTA (including Switzerland) Australia, New Zealand and Israel.

Nothing is forever, however, and Britain’s trade patterns have demonstrated remarkable adaptability in recent years, due in part to the post-war winding down of Commonwealth preference and membership of the European Economic Community. In 1973, the year Britain joined the EEC, just 36 per cent of UK trade was with other Common Market states. By 2000, this figure had risen to 58 per cent.

Over the last decade, the rate of growth of exports to EU countries has been roughly half that to non-EU countries over the last decade. A breakdown of goods exports by destination shows that the fastest growth has been to Australasia and parts of South East Asia, such as South Korea and Indonesia. Even though annual growth in exports to some countries has at times exceeded 100 per cent, the fact that the export share was initially so low means that many countries remain relatively trivial trade partners in absolute terms.

There are some striking figures which illustrate this point. India’s share of UK exports, for example, remains well under 2 per cent, notwithstanding volume growth of around 40 per cent in 2011. These new emerging markets are therefore unlikely to be any quick fix for growth within the term of this parliament because the base of our economic engagement is still too small to make any noticeable difference to the overall picture.

In total, the four BRICs accounted for current account credits worth £31.3 billion in 2010 or 5.1 per cent of the £615 billion total, compared to £25.7 billion and 4.4 per cent in 2009. (China accounted for about 1.9 per cent of total UK current account credits in 2010, India and Russia for between 1.2-1.3 per cent each, and Brazil for 0.75 per cent.)

Exports to Ireland of £20 billion in 2010 exceeded the combined value of exports to India and China (£19.4 billion). That is an improvement on the previous year, when the UK notched up more credits on the current account with Ireland (£28.7 billion) than it did with the four BRICs, Indonesia and Mexico combined.

It is noteworthy that other developed countries have re-oriented their export profiles more effectively than Britain has done, raising doubts about whether we are keeping pace with our EU partners in promoting British commercial interests in the emerging economies.

The proportion of Germany’s goods exports going to the BRIC countries, which are showing strong demand for its capital goods at this stage in their development, is more than twice ours, having more than doubled from 4.5 per cent in 2000 to 10.6 per cent in 2009, while the share of Japan’s goods exports to the BRICs, at 21 per cent, is more than four times greater than Britain’s.

Furthermore, it is worth noting that the UK ran a big current account deficit with the BRICs of about £21 billion in 2010 (up from £17 billion in 2009), which represents an increasing drag on UK growth.

This is principally because of the UK’s current account deficit with China, which, at £20.9 billion (up from £17 billion in 2009), is the largest of any individual country. The UK ran a small current account deficit of £1.3 billion with India (down from £1.5 billion in 2009), and modest surpluses with Brazil and Russia. It is of course essential that the UK becomes more engaged with these markets, as they will be the principal sources of global growth over the next five years, with China and India likely, given their current growth rates, to develop into economies that are the size of the US and EU today. But it will also be important to change the terms of trade, so that the UK over time reduces its substantial current account deficits with China and India.

This will not be easy. Penetrating difficult and distant markets will be a marathon, not a sprint. But government can have an important part to play in encouraging new firms to export, in facilitating the re-orientation of existing exporters towards emerging markets, and in breaking down non-tariff barriers and other regulatory hurdles to trade.

The organisational overhaul of UKTI and the Foreign and Commonwealth Office’s decision to create 30 new posts in India and 50 new positions in China, roughly a 7 per cent increase in each mission’s manpower, at a time of severe budgetary restraint, underline the seriousness of the Coalition’s intent to boost its commercial diplomacy in BRIC countries. Such steps will help UK businesses find the support they need to capitalise on the great transformation in the world’s political and economic structures unleashed by globalisation.

India as a Case Study of UK Engagement with the Brics

India and the UK are re-connecting at an unprecedented rate, forging a partnership of equals that is no longer overshadowed by their colonial history. The Coalition has stated its determination to forge a ‘new special relationship’, an ambition that is finding an echo in India as it prepares to play a bigger role on the global stage.

Key figures in the British Government have made a personal investment in the relationship. In opposition, David Cameron, accompanied by George Osborne, made India his first major foreign port of call in 2006. Post-May 2010, planning for a visit started the day the new team took office. There is a contrast in approach here that reflects the new urgency attached to developing closer relations with the big powers of the future: David Cameron and George Osborne visited India within 10 weeks of taking power.

With respect to India, the urgency underlying the new approach is more than justified. The UK has been rapidly slipping down the rankings of India’s trading partners over the last decade. In 1999, Britain was India’s fourth most important source of imports. By 2011, it was its 21st.

Germany, by contrast, has made phenomenal progress in penetrating the Indian market and is now easily the largest goods exporter to India among the EU27. It is meeting a massive demand for the capital goods needed to plug India’s various infrastructural deficits. It is not alone in outstripping the UK: even Belgium exported more goods to India than Britain in 2011.

That is not to say the absolute growth in UK-India trade is unimpressive: UK goods exports jumped 40 per cent and services exports by 8 per cent in 2011, taking the total value of UK exports in goods and services to £8.06 billion, up from £6.25 billion in 2010.

At this rate of growth, Britain is on track to meet its target of doubling trade by 2015, a significant achievement. But there is no doubt that other countries are out-trading the UK and that we are losing market share in many sectors.

Part of the explanation for this relative underperformance vis-à-vis Germany and others is that the Indian market is relatively closed in the areas where the UK economy is competitive and open in others where Britain is weaker. Britain’s services exporters have historically encountered major obstacles to effective market entry in India. Retail, for example, is completely shut to multi-brand retailers in the FDI channel, even though allowing in the likes of Tesco and Sainsbury’s would simultaneously raise farmer incomes and lower food prices for consumers. Food price inflation has been running at high levels for many years to the extent that a kilo of onions in Tesco is now cheaper than a kilo of onions in Bombay.

Financial services liberalization is also proceeding at a glacial pace. Banks continue to find it difficult to open up branches in any meaningful scale across India. Insurance FDI is capped at 26 per cent, for example, even though the Indian Government first promised nearly a decade ago to lift the cap. The legislative logjam in the Indian parliament, which has been paralysed by a spate of corruption scandals, is holding up passage of a key measure that would hike upwards the foreign direct investment cap in the insurance sector. The financial crisis has also reinforced what was already a very conservative mindset at the Reserve Bank of India. UK hopes of achieving its market access goals in financial services have suffered.

The Indian economy is much more open in sectors where the UK’s competitive advantage is less obvious, notably in infrastructure, capital goods, project engineering and manufactured products. This pattern has played particularly favourably to the strengths of countries such as Germany that have larger and more competitive manufacturing sectors. Machinery and vehicles and other manufactured goods account for almost 80 per cent of EU27 exports to India.

That said, the UK has also let some opportunities to increase its market share of Indian merchandise goods imports slip. Potentially game changing deals have been lost, with the Eurofighter consortium’s failure to secure the Indian Ministry of Defence order for 126 multi-role combat aircraft the most noteworthy recent example. Valued at over $10 billion, this would at a stroke have embedded British firms in key supply chains in India.

Getting the EU-India Free Trade Agreement Right

The Eurofighter example shows the tension between the EU as a union of competitors on the one hand and as a union of countries with a common interest in gaining more favourable market access to rapidly developing markets on the other. It is in the latter capacity that the EU launched FTA negotiations with India in June 2007.

After 11 full rounds, they are now in a phase where negotiators meet in smaller more targeted clusters rather than full rounds. This entails expert level intercessionals, chief negotiator meetings and exchanges at Director General level. Following the EU-India Summit on 10 February in Delhi negotiations are in an intense phase but there is a limited political window of opportunity and a formidable amount of work still to be done on important issues, particularly with respect to the overall ambition of the services package.

If agreement can be reached, the prize is great. An extended FTA, according to an analysis conducted for the European Commission in May 2009, could see India gain €4.9 billion in the short run and €17.7 billion in the long run and the EU gain €4.4 billion in the short run and €1.6 billion in the long run.4 It would therefore bolster further what is an already strong EU-India trade relationship.

The EU is already India's largest trading partner accounting for just over €100 billion in trade in goods and services in 2011, up sharply from approximately €86 billion in 2010. The EU accounted for 19 per cent of India's total exports and 14 per cent of India's total imports in 2010. Although the EU is still a more important trading partner for India than India is for the EU, that is changing.

India ranked 8th in the list of the EU's main trading partners in 2010, up from 15th in 2002. India accounts for 2.6 per cent of EU's total exports and 2.2 per cent of the EU's total imports. There is still much potential for trade growth on both sides and the completion of an ambitious FTA – rather than a modest and unambitious FTA of the type Japan concluded with India in February 2011 – would be a significant enabling factor.

Estimates vary as to the value potentially to be created from such an FTA. Britain alone believes the UK could see a trade boost of upwards of £300m a year, and potentially more, depending on how ambitious the deal is and on the timeframe adopted for the phasing in of the most important liberalising measures. But the overall picture is that an FTA would help underpin the EU’s position as the number one supplier of goods and services to India at a time when it is under considerable competitive pressure from countries such as China, South Korea and the UAE.

The FTA is a way to give the EU an advantage against the competition by providing its businesses with access to the important Indian market on a preferential basis (as WTO rules provide for a carve-out from requirements to multilateralise for bilateral FTAs that cover substantially all trade).

The EU-India Summit on February 10, 2012 reaffirmed both sides’ commitment to the early conclusion of an “ambitious and balanced package”. From the UK perspective, negotiations for an FTA are an ideal opportunity for Britain to improve the terms of its trade relations with the subcontinent. The UK remains committed to the multilateral trading system, but in the absence of progress on Doha is also supportive of broad and ambitious Free Trade Agreements that open markets and boost trade and jobs.

Concluding the EU-India FTA is a priority for Britain, but not at any price. While it is helpful to aim to have a final text ready for ratification (which will itself take at least a further 15-18 months) by the end of 2012, it is essential that the opportunity for an ambitious agreement, covering not just goods, but also services and investment, is not wasted.

The leverage that the negotiation of an FTA provides offers the best chance that the UK will have for some time to make progress towards longstanding goals of British commercial diplomacy.

The difficulty is that progress on the aspects of the FTA that are of most interest to the UK has been extremely slow. On the goods side of the negotiation, most of the pieces are now in place, even if the EU still expects India to show some movement on cars and wines and spirits, which attract import duties of 150 per cent, in return for concessions on the export of garments and textiles from India to the EU.

On the services side, however, there is little to show for six years of talks. The EU only received an Indian offer of any sort on March 19, 2012. This exchange of offers on services was of course a welcome development in itself, as it was a sign of progress and gives member states a chance to comment for the first time. As much of the services offer fell so woefully short of UK expectations, however, it in fact raised many more questions than it answered, not least as to the likelihood of an ambitious agreement being achievable by the end of the year.

It is unlikely that the negotiation will succeed in meeting the timetable envisaged as, in a number of important specific respects, the UK, and it is far from alone in this respect, clearly needs India needs to move much further than will be politically deliverable in New Delhi.

A central problem is that the government has failed to secure broad buy-in for reform, as the proceeds of growth have so far been unevenly shared. Systemic corruption, which hits the poor hardest and fuels their sense of unfairness, has worsened this problem and strengthened the hand of those opposed to reform.

A sense of complacency in New Delhi has also contributed to a failure to press ahead with a second wave of reforms that are needed to sustain the near double digit growth rates of the 2005-2008 period. Notwithstanding the risk that India could lose the confidence of international investors, demonstrated by Standard & Poor’s decision on in April 2012 to announce a ‘negative outlook’ on the country’s BBB- investment rating, New Delhi is failing to move decisively and rapidly across a range of fronts.

Unsettled by disappointing setbacks in battleground state elections in Uttar Pradesh in March 2012, the Indian government now has little political space for manoeuvre ahead of elections in 2014. Few commentators still harbour hopes that the present government will unleash the reforms for which economists and investors have now been calling for several years.

Some influential analysts are warning of the risks that India will fall into a ‘middle income trap’ of the kind that has beset any number of other former emerging market darlings that have failed to sustain turbo-charged growth-rates for more than a few years.

This is, for now, an exaggerated fear. The consensus among economists today is that India’s growth slowdown is in the process of bottoming out, rather than accelerating, with expectations for growth in 2012 of 6.5-7.0 per cent, rather than the 8-8.5 per cent average of 2000-10.

The failure to enact structural reforms and to develop infrastructure means that India’s non-inflationary growth rate is not as high as it could be, but growth of 6.5-7 per cent still compares favourably to the sluggish “Hindu rate of growth” that crimped opportunities for economic development in the pre-reform India.

That said, the EU-India FTA is held hostage by domestic Indian coalition politics and in danger, like the Doha Round of multilateral trade talks, of dying a lingering death.

Seven Crucial Issues in the EU-India FTA Negotiations

There are seven areas in the EU-India FTA negotiation which will decide its future. These are set out below.

5.1 Mode 4

London is reluctant to make further concessions in relation to India’s most important request in the services negotiation, which relates to the ‘temporary movement’ of services professionals under the so-called Mode 4 provisions of the General Agreement on Trade in Services, which covers the movement of natural persons. The size of the UK’s services sector means that London’s stance in relation to Mode 4 is of critical importance and will be a key factor in whether an ambitious trade deal can be concluded this year.

Given the need to balance Mode 4 offers with the annual limit on non-EU immigration sought by the Coalition government, however, the UK is expected to be unlikely to offer a more generous settlement in any bilateral trade negotiation than it has already made as part of the Doha negotiations. It will not be possible for the UK to make commitments in the FTA which are not compatible with the government’s efforts to reform the immigration system. The first major change to reduce immigration into the UK took effect in April 2012, when the UK government's new annual immigration limit came into force.

This, along with radical changes introduced to the student route and plans to tackle permanent settlement, is intended to cause net migration fall back down to the tens of thousands. Under the annual limit, employers will be able to bring only 20,700 people from outside the EU to work in skilled professions under Tier 2 (General) of the points-based system. A further 1,000 visas will be made available to people of 'exceptional talent', to ensure that Britain remains open to the brightest and the best. Those earning a salary of £150,000 or more will not be subject to the limit.

The Intra Company Transfer route (ICT), which is not part of the annual limit and is of particular importance to Indian information technology service providers, will also be changed in 3 ways:

The job will have to be in an occupation on the graduate occupation list;
only those paid £40,000 or more will be able to stay for more than a year - they will be given permission to stay for 3 years, with the possibility of extending for a further 2 years; and
those paid between £24,000 and £40,000 will be allowed to come to the UK for no longer than 12 months, at which point they must leave the UK and will not be able to re-apply for 12 months.

5.2 Banking

Little progress has been made on the Reserve Bank of India’s roadmap for liberalisation since the onset of the financial crisis. This undoubtedly made financial sector reform less easy to achieve politically, strengthened the hand of conservatives within the Indian regulatory establishment and provided a pretext for a continuation of a variety of protectionist practices.

There is, in particular, an urgent need for clarity over the RBI’s subsidiarisation plans for foreign banks. UK banks such as Standard Chartered, HSBC, Barclays and RBS need to have it confirmed that foreign banks converting to subsidiaries will receive ‘national treatment’, just as Indian banks such as ICICI do in the UK, which is now home to nearly 30 Indian financial services firms.

Branch licensing restrictions prevent UK and other foreign banks from expanding in wealthier areas unless they meet quotas for lending to priority sectors and open branches in rural areas. The UK is pushing for these lending restrictions to be eased as and when banks convert to subsidiaries (at present they operate as branches of their UK operations).

The UK accounts for half of all foreign bank branches in India, but that is in large part because British banks have been in the country longer than many others and have in some cases stuck with a difficult market through thick and thin. For example, the Chartered Bank, a forerunner of what would become Standard Chartered, opened its first overseas branch in India, at Kolkata, on 12 April 1858.

A financial sector which is dominated by state-owned banks and Indian private sector banks - foreign banks account for about 2 per cent of the Indian market - is struggling to provide the capital required to meet India’s massive infrastructure requirements. Poor physical infrastructure – particularly in roads, ports, and power – is one of the principal bottlenecks for continued Indian growth.

Financial liberalisation would significantly help India meet its infrastructure needs, which exceed the capacity of the domestic banking system. The government estimates a financing gap of over $310 billion over the next five years alone. India’s savings rate is high, at over 30 per cent of GDP, but is not harnessed effectively into productive investments because the banking system is repressed and capital markets are under-developed.

5.3 Pensions and insurance

Lifting of the caps on foreign direct investment in the insurance sector would provide a further source of funds for investment in Indian infrastructure. British institutions such as the Prudential and Standard Life, which are minority partners in market-leading private sector insurers, are potential sources of long-term funds for investment in infrastructure.

The UK, along with a number of other countries, notably the US, has been pushing successive Indian governments to honour a commitment made to lift the FDI cap in the insurance sector to 49 per cent from the present level of 26 per cent. Progress with the Pensions Bill is similarly slow-moving as these liberalising steps are dependent on legislative changes that are controversial in India.

Although the government said last month that it would move the Insurance Laws (Amendment) Bill 2008 and The Pension Fund Regulatory and Development Authority (PFRDA) Bill 2011 during the budget session, few are betting on rapid progress in a political environment in which the Indian government is hunkering down ahead of a general election in 2014 and unlikely to expend political capital on liberalising reforms.

5.4 Legal and Professional Services

Foreign lawyers in India are banned outright from setting up offices in India, and even domestic firms are heavily restricted. They cannot grow in size to beyond 20 partners each and they cannot incorporate, advertise or tie up with companies outside their profession.

Numerous studies have recommended that India's legal profession be opened if only to rebalance the market, which derives 90 per cent of its revenue from litigation and is small compared with the size of the economy. But many Indian lawyers, a good number of whom also sit in parliament, have fiercely opposed the entry of their foreign rivals, arguing they are not prepared for competition from global firms and that corporatisation will destroy the values of the local industry.

Britain is the EU country keenest on deregulation, although it is certainly not alone, because London is home to some of the world's largest and most international law firms, including Clifford Chance, Linklaters, Freshfields Bruckhaus Deringer and Allen & Overy.

The passage of the Limited Liabilities Partnership (LLP) Act should make it easier to pass the legislation needed to open up the sector. It is estimated that liberalisation of the sector could boost the Indian economy by $2-3 billion a year.

The LLP Act also marked an important step forward for the international accountancy profession, which has faced similar obstacles in opening up the Indian market. Firms such as KPMG are not allowed to use their own brands in the Indian market. There is a need also for independent regulation of the sector. Indian chartered accountant (CA) firms are regulated by the Institute of Chartered Accountants of India (ICAI) under provisions of the Chartered Accountants Act (1949). The requirement for the rotation of corporate auditors in the Companies Act (2011) and pressure from international investors for higher standards of corporate governance and for the adoption of international accounting standards have reinforced pressure from the EU for the liberalisation of the accountancy industry in India.

5.5 Retail

Failure to open up the retail sector to multi-brand retailers such as Tesco, Wal-Mart and Carrefour has been emblematic of the government’s waning energy. Prime Minister Manmohan Singh had seen the opening of the retail sector as a continuation of the economic reforms he supervised as finance minister in the 1990s.

A more efficient retail sector would generate a boost in employment and better connect farmers to urban markets. Indian critics of FDI, however, fear the loss of neighbourhood stores and a restriction in consumer choice. The opposition BJP party’s position is partly explained by its pro-small trader Poujadiste tradition and the fact that such small traders have provided a useful bank of votes.

The government has liberalised FDI in single-brand retail, where 100 per cent foreign ownership is now allowed, but has announced a “pause” in its plans to allow foreign capital into the supermarket sector 12 days after proposing the move, amid great fanfare, in November 2011. It is highly unlikely this will be revisited ahead of the election in 2014.

5.6 Investor protection

The investment chapter of the EU-India FTA negotiations has barely been opened. The delay reflects in part the fact that the European Commission only in January 2011 requested the expansion of its negotiating mandate to include investor protections. EU Member States have Bilateral Investment Treaties (BITs) with very high levels of investor protection, which India wants to repeal in the event that there is an over-arching investment chapter in the FTA.

This reflects less a desire to avoid duplication than the wish to tighten up bilateral treaties that India regards as excessively open-ended. India is concerned by the trend for companies to have recourse to international arbitration under these bilateral treaties, which were signed in the 1980s and 1990s at a time when India was a largely closed economy and attracted little foreign direct investment. The UK-India Agreement for the Promotion and Protection of Investments, for example, dates to March 1994. BITs contain important protections against state interference with investments of investors from the other state. These include the obligation to provide full compensation in the event of expropriation, but also other protections, including protection against arbitrary, discriminatory and unfair treatment.

The retrospective changes to Indian tax law announced in the March 2012 Budget, which affect Vodafone and many other companies, makes it likely that the investment chapter of the negotiation will be one of the hardest to close as such arbitrary action reinforces the demand for strong investor protection. There would appear to be good grounds for arguing that the imposition of a retrospective tax would constitute unfair treatment in breach of a BIT. Given that work has not even started, this is a considerable hurdle to the signature of an FTA by the end of the year.

Clearly, there must be a balance between not exposing a resource-constrained Indian state to costly arbitration and India’s need, as a country running a substantial and widening current account deficit, now equal to around 4 per cent of GDP, to attract healthy flows of foreign direct investment. The two-way flow of investment between India and the UK has been strong. There have been some sizeable mergers and acquisitions, notably the Tata Group’s acquisitions of Corus and Jaguar Land Rover, which, strikingly, has made Tata the largest single employer in the UK manufacturing sector.

There is more Indian investment in the UK than in all other EU countries combined. In the other direction, Vodafone’s purchase of Hutch Essar, the mobile operator, and BP’s partnership with Reliance Industries, India’s foremost oil, gas and petrochemicals group, were major ventures in the other direction. But, in general, notwithstanding the significance of these big tie-ups, both countries acknowledge that the potential for more intensive economic cooperation remains to a great extent untapped and will remain so until key liberalising reforms are undertaken by the Indian government.

5.7 Human Rights and Democracy

Indian objections to the inclusion of a standard “human rights and democracy” clause in the proposed FTA have the potential to re-emerge as a serious stumbling block. This clause, which is likely to be discussed in the end-game of the negotiations, could be a deal-breaker for India.

Making human rights observance an “essential element” and a condition of trade terms and development aid gives the EU the ultimate right to suspend all or part of an agreement if a partner country does not fulfill its human rights obligations. New Delhi argues that the “essential elements” clause conflicts with India’s longstanding position that economic agreements should not be “contaminated” by political riders. It suspects that such clauses provide protectionist cover and is unlikely to give ground.

Since a decision by the EU Council in 1995, which was re-affirmed in 2008, the European Commission has systematically included this “essential elements” clause in bilateral trade and co-operation agreements. It now applies to agreements with more than 120 countries. The FTA is therefore caught between an irresistible force and an immoveable object.

The Commission has triggered an intense debate among the EU’s member states by pushing for an apparent exception for India, on the grounds that a 1994 EU-India co-operation agreement covers human rights questions.5

Given how much both countries can potentially gain from the FTA, the Commission argues that the FTA should leave more political considerations for other agreements. Feeling is equally strong in sections of the European Parliament on the need for consistency across FTAs. India is a member of the United Nations Human Rights Council, but ranks low, according to the Asian Human Rights Commission, among the international community in terms of the ratification of international conventions and covenants.

The Benefits to India

For all India’s bubbling self-confidence, the reality is that it is barely a lower-middle income economy, with a nominal per capita income little above a thousand dollars and with more than 300 million Indians living in absolute poverty. It faces a huge challenge in generating the jobs necessary to absorb the rising numbers of entrants to the country’s workforce. To meet global expectations and to achieve its development targets, India will have to focus on a few critical drivers, with which the EU and key member states such as the UK, France and Germany can collectively and individually help in material ways.

The first is to abandon the notion that a demographic dividend will materialise mechanically from its vast young population and accept the hard reality that it will have to be earned, via a human resources and skills revolution. The second is to jettison the myth that the economy and the private sector can continue to grow ‘despite the government’. The third is to overcome energy shortages and to provide sufficient capacity, preferably from renewable sources, to meet the needs of its fast-growing economy. The fourth is to make agricultural modernisation and the boosting of income levels of those engaged in agriculture a priority. Fifth, and last, India should recognise that its breakneck urbanisation has hitherto been largely unplanned and that this has to be urgently rectified.

India is making often astonishing progress, but its rise is not yet a done deal. It faces many potential futures, not all of them rosy, and cannot be complacent. As the authors of an influential recent essay on New Delhi’s strategic policy have noted, India has a “limited window of opportunity in which to seize [its] chances” and “to avoid the ‘middle income trap’ that has afflicted many other societies where growth rates experienced rapid acceleration only to peter out, then it will have to move decisively and rapidly across a range of fronts”.6

As the UK is still the seventh-largest economy in the world and one of the most open, it should be an attractive partner to India.

Its capabilities in education and skills development; in farm-to-fork cold chain management and retailing; in banking, infrastructure finance and insurance; in pharmaceuticals and life sciences; and in urban planning, architecture and design, to name just a few promising sectors, are directly relevant to India’s most pressing needs. It is in India’s interests, as much as Britain’s, for the two countries to engage more intensively and to become more interdependent than they are at present.

Six Ways To Expand Uk / India Trade And Investment

The UK can strengthen an already strong economic relationship by focusing on a few core areas where it needs revitalising.

7.1 Push UK interests up agenda in EU

First, as trade is an exclusive EU competence, the Coalition must push Britain’s interests in Brussels so that the Commission reflects UK demands to the greatest extent possible in the negotiations over the long-awaited EU India Free Trade Agreement (FTA). A comprehensive FTA that addresses considerable remaining tariff and non-tariff barriers, particularly on the services side, could deliver significant economic benefits as well as helping to reduce poverty in India. The Coalition, on a bilateral basis, through the ongoing Economic and Financial Dialogue and other mechanisms, must also continue to encourage further liberalisation of Indian markets, particularly for financial and professional services and for goods, including wines and spirits, defence, chemicals and automotive parts. The conclusion of an ambitious FTA (and, of course, of the Doha Round, in which India is a key player) would make it more likely that the UK will achieve its objective of doubling trade with India by 2015.

7.2 Business First

Second, the Coalition must encourage businesses to rise to the challenge of exporting to a country rightly seen as ‘difficult’. India never scores highly in surveys measuring the ease of doing business. In the World Bank’s 2011 survey of 183 countries, India ranked 134th, behind Brazil (127th), Russia (123rd) and China (79th).

In terms of enforcing contracts through the court system, a critical attribute of any market economy, India scores appallingly, coming 182nd. The World Bank estimates going to court to enforce a contract involves 46 procedures, takes an average of 1,420 days and consumes 40 per cent of the value of any claim. Obstacles such as this explain why surveys consistently show that UK firms are wary of proactively seeking out business opportunities in these priority markets.

Smaller and innovative firms have in the past experienced disproportionate barriers to exporting to India. Recent surveys show that only 23 per cent of UK SMEs export, compared to an EU average of 25 per cent, a shortfall of 100,000 firms that could deliver a potential £30 billion to the UK economy if they rise to the challenge. This is a legitimate area for vigorous government intervention, and the drive to reform both UKTI and the Export Credits Guarantee Department (ECGD), is welcome.

Take up of ECGD products aimed at SMEs has been disappointing, with the UK’s official export financing arm underperforming comparable bodies such as France’s Coface and Germany’s Hermes. The ECGD’s chief executive, Patrick Crawford, is now explicitly targeting “the many small exporters who have never heard of us” and it will be important for that organisation to be held to account for its progress in this respect.

7.3 Connectivity

Third, we must overhaul connectivity to the big emerging markets. While London has excellent direct connections to its traditional business partners, it lags behind European competitors in serving the BRICs.

It has 215 departures a week to New York, for example, but only 31 a week to two destinations in mainland China (compared to 64 to three such cities from Paris Charles de Gaulle and 56 to four such cities from Frankfurt). UK-India air traffic has trebled in the last five years, due to the liberalisation of the UK-India market, but this rate of growth will be hard to sustain given the UK’s historic failure to make long-term provision for runway capacity in the south-east. This will be a major brake on our ability to capitalize on the commercial opportunities presented by growth in India, as well as other fast-growing emerging markets, and is expected to cost the UK economy up to £14 billion over the next decade.

Runway utilisation at Heathrow is operating at 98.5 per cent, compared to 70 per cent to 75 per cent at other big European airports, such as Paris Charles de Gaulle, Amsterdam and Frankfurt. This is causing delays and reliability problems that are damaging Britain’s attractiveness, and restricts London’s ability to expand to new markets without sacrificing existing ones. Jakarta, Osaka, Caracas and Bogotá have all been removed from Heathrow’s destination boards in recent years, while Lima, Manila, Panama City and Guangzhou have never been available. They are all served by London’s three main rivals. They are all served by London’s three main rivals. All options for expanding hub capacity for London are controversial but all options need to be urgently considered, including the construction of a new hub airport in the Thames Estuary.

7.4 Aid

Fourth, we need to overhaul an anachronistic donor-recipient aid relationship, which risks traps Britain in some outdated attitudes towards its former colony. After a decade in which the UK sharply increased its aid to India to make it DfID’s single largest country programme, the tide is now turning. DfID is effectively freezing aid to India, while shifting resources in the existing programme towards investment in private enterprise, focusing funding on states that need it most and measuring its impact more systematically.

A new era of partnership in international development is emerging and Britain and India have an opportunity to be in the vanguard of this process.

India is now emerging as an aid power in its own right, as demonstrated in July 2011 by New Delhi’s announcement that it intended to set up its own $11 billion development agency. This has yet to materialise, however. As and when it does, it will find DfID to be a willing potential partner. In February 2011, Andrew Mitchell, Secretary of State for International Development, described a future in which the UK and India could work together, as equal partners, to reduce poverty in other developing countries.

7.5 Talent

Fifth, we must embrace global talent, which is in superabundance in India, not put up bureaucratic barriers to it. Britain has a strong base on which to build. It is the preferred launch-pad for Indian firms hoping to conquer European markets, with more companies headquartered here than in all other EU member states combined. London has an unrivalled place in the hearts of the Indian wealth-generating class. Le tout Delhi is in London in June, drawn by the mild climate, Wimbledon and the cultural activities the British capital has to offer. It still remains the preferred place for the affluent to buy their first home outside India.

These ties form a powerful emotional connection between the two countries that should not be underestimated. Of the roughly 29 million people in the UK labour force, 2.5 million were born overseas. Of that figure, more than 600,000 originate from the Indian subcontinent. That is almost as many as both the 631,000 from the 14 pre-enlargement members of the European Union and the 625,000 from the enlarged EU-10 that began to arrive after 2004.

But links between students, especially through universities, are not as strong as they could be. Indeed, British universities attract more people from China than they do from India, despite our stronger historical and cultural links with the subcontinent. A 2010 British Council report based on market research confirmed a widely-held belief that “students tend to choose a country first before choosing a university, meaning that it is crucial to build a national brand showing the UK as a safe and exciting place to study, offering a rich life experience and enhanced career prospects.”

Students invest in British education both to improve their job prospects back in their home country and to find post-study work in the UK. If the UK signals that it is no longer ‘open for business’, students will quickly choose countries they think are, such as Australia, Canada and the US. Australia is especially keen to earn its slice of the market: in October 2011, its Government announced sweeping reforms to liberalise its student visa system. Britain in April 2012 moved in the opposite direction.

Policy-makers in the UK should recognise that students prize the option value of post-study work in the UK even though the great majority will have no intention to stay in the UK permanently. If we no longer provide the option, they will tend to favour other countries that do. Of course, bogus colleges must be closed down. But waging war on legitimate students is nonsensical at a time when universities can play a valuable role in generating export earnings.

In practical terms, this means we need to take students out of the annual cap on non-EU net immigration or, alternatively, target only permanent migration. At present, the UK, unlike many other countries, makes no distinction between temporary and permanent migration. This is a problem as students are not the sources of long-term immigration that the government is really seeking to control, as most of them go home after a couple of years, and surveys show they are not what constituents are worried about either.

Tapping top-flight student talent globally will not just mean the UK gains in terms of innovation, research and a broader science and skills base. Greater exchange of students now will mean stronger relationships later. The UK cannot afford to lose touch with the next generation of opinion-formers, let ‘Britishness’ become a currency of depreciating value for a more Americanised elite or allow Britain to recede further as a cultural reference point.

The launch of the British Council’s Re-Imagine UK-India Relations project, the announcement of a new Chevening Science and Innovation Leadership Programme and plans to help top UK universities partner with the new Innovation universities that India plans to create are all steps in the right direction, but no substitute for bold action to take students out of the cap on non-EU immigration and to liberalise restrictions on post-study work.

7.6 Support for India’s anti-corruption movement

Lastly, the UK needs to have more confidence in itself. We self-deprecate too much. The Indian strategic élite is not as confident in itself and in the idea of the country’s “inevitable rise” as appearances suggest. Even if Anglophilia is waning in India, there is still enormous respect for British institutions, which, in relative terms, are bastions of incorruptibility. India has been beset by corruption scandals – 2G, the Commonwealth Games, land sales, coal industry profiteering – and the prime minister, Manmohan Singh, openly refers to concerns that his government is seen as the “most corrupt” in Indian history.

It is in the UK’s interests to support the ongoing middle class-led anti-corruption movement. Crony capitalism is not yet reaching Russian levels, but with many commercial decisions taken for political reasons, there is often no level playing field on offer for foreign firms. At the same time, while virtue is its own reward, it will also be important for the UK government to undertake an assessment of the impact of the Bribery Act on appetite among UK firms for engaging with India, as well as of any evidence that law-abiding UK companies are systematically losing out to bribe-paying competitors from other countries.

Conclusion

The emergence of new powers in the east and south has led to a sensible shift in the UK’s focus from the Euro-Atlantic world towards a more multipolar world. Progress in forging an “enhanced partnership” with India over the last two years has been significant and welcome. The 40 per cent growth in trade in 2011 emblematic of this renewed vigour in the relationship, but there is much more to be done. It is a concern that the UK is in some quarters seen as a country of diminishing relevance in India, as indicated by a leading research institute in Delhi recently ranking India’s strategic partnership with Britain as less significant than the one with France in terms of its historical significance and potential for the future.7

This reflects a worrying disconnect between perceptions of what Britain offers and the reality of the UK as a friendly country with relevant capabilities, not just in financial services, but across a wide spectrum of India’s needs as a developing economy and emerging global power. It also mirrors a broader disenchantment in New Delhi with the idea that the EU, as a plural, composite and democratic polity of 27 nations and 500 million people, can provide any kind of positive reference point for India as it builds up its own national power as a huge multi-lingual, multicultural state with a federal form of government and constructs its own continent-sized internal market. Mired in the Eurozone crisis, the EU as a whole is at risk of being seen as an agglomeration of declining countries rendered rudderless by baroque decision-making processes, a deepening democratic deficit and lack of political solidarity between member states.

Unless Europe puts itself back on a growth path, by undertaking structural reform and completing the single market, it will lose its appeal as a strategic partner for India and the UK will lose its value as a bridgehead to Europe. Equally, there is awareness among reformers in New Delhi that India still faces a broad range of potential futures, not all of them happy, and that further economic reform is the key to prosperity for many tens of millions. Over the 20 years since the onset of the reform era, India has benefited hugely from liberalisation, but a second wave of reforms, whether linked to an EU-India FTA or not, is long overdue. The choices India makes in the coming years, while it still has a chance of reaping a demographic dividend from its young and growing workforce, will set the parameters of its potential for decades to come.