How India and U.S. Relations Affect Their Economies

Opportunities and Challenges for Growth

Newly elected Prime Minister Narendra Modi (L) has a 10-year plan to open up India to FDI. Photo by Kevin Frayer/Getty Images

On June 26, President Trump is meeting with Indian prime minister Narendra Modi. They will discuss increasing the number of H1B visas for Indian immigrants and the number of U.S. arms. U.S. business leaders want India to reduce protectionist policies that give domestic companies an unfair advantage. This would specifically help U.S. companies compete in the sectors of pharmaceutical, entertainment, and consumer electronics.

 The Trump Organization wants to double its real estate holdings in India. (Source: "Trump and Modi Set for First High Stakes Meeting," CNBC, June 26, 2017.)

Modi must streamline the government bureaucracy that has so far raised the cost of foreign direct investment.  For example, he has talked about ending “tax terrorism.” He has promised to rationalize India’s complicated tax regimes and support the introduction of a Goods and Services Tax, which would bring greater predictability to India’s business climate.  

Opportunities for U.S. Businesses

There are many opportunities for foreign direct investment by American businesses. They are attracted by the growing Indian middle class, which is almost 250 million people  - bigger than the middle class in the U.S. This will continue to drive India's expanded consumer spending and economic growth. 

Businesses take advantage of India's rich talent pool of researchers, scientists, and engineers, as well as a large, well-educated English-speaking workforce and the democratic way of life, make it an attractive destination for manufacturers.

India has seen more than 100 initial public offerings in the last 18 months, with nearly 50% from small and medium enterprises. Private equity funding has been steadily growing in 2012-13 and the same trend is expected to continue. Energy, Healthcare, Industrial, and Materials have been the top four sectors.

While inbound M&A deals have declined in the last year, outbound deals have increased substantially in the emerging markets in the Middle East, Asia, Africa and South America, driven by depressed valuations due to the recent recession. There are very deep pockets of funds awaiting new sustainable venture/product, franchise. The potentially big challenge, therefore, will be to researching, sourcing, costing and securing funds globally or what is termed as seeking borderless venture capital infusion.

In the next decade, India will see substantial investment flowing into energy (generation, distribution, and transmission), mining, water, waste treatment and ports infrastructure. In technology, India’s software sector has evolved from the low-cost, “back office” operations set up to an integral part of corporations' global manufacturing enterprise.  FDI will flow into advanced communication, visuals, automobile, biotechnology, and healthcare. Small to medium sized technology company will especially benefit from business/deal size of between $1- $10 million from North America, North Africa, and the Middle East.

Modi's 10 Step Plan

India's President Pranab Mukherjee outlined 10 steps the Modi government plans to take: 

  1. Food inflation: Increase the supply of food to lower costs. Prepare to help farmers during a possible subnormal monsoon.
  2. Economy: Usher the economy into a high growth path, rein in inflation, reignite the investment cycle and restore the confidence of the domestic as well as international community.
  3. Jobs: Strategically promote labor-intensive manufacturing. Promote tourism and farming.
  4. Taxes: Retrospective tax laws, introduced in 2012-13, have been described as the single biggest impediment to foreign investment into the country. The Modi government will embark on rationalization and simplification of the tax regime to make it non-adversarial and conducive to investment, enterprise, and growth. The government will make every effort to introduce the GST while addressing the concerns of states.
  1. Reforms: Reform regulations to encourage investments, especially in sectors that create jobs.
  2. Agriculture: Increase investment in agri-infrastructure. Address issues pertaining to pricing and procurement of agricultural produce, crop insurance, and post-harvest management. Incentivize the setting up of food processing industries.
  3. Reviving manufacturing: Set up world class investment and industrial regions, particularly along the Dedicated Freight Corridors and Industrial Corridors. Create a single-window system of clearances both at the center and at the states through a hub-spoke model.
  4. Infrastructure: A new 10-year plan will modernize railways, including the Diamond Quadrilateral project of high-speed trains. Execute the National Highways program. Build more low-cost airports in smaller towns. Develop inland and coastal waterways as major transport routes.
  5. Energy security: Augment electricity generation capacity through both conventional and non-conventional sources. Reform the coal sector to attract private investment.
  6. Urbanization: Build 100 cities focused on specialized domains and equipped with world class amenities. By the time the nation completes 75 years of its Independence, every family will have a pucca house with water connection, toilet facilities, 24x7 electricity supply and access. (Source: Ramesh Kumar Nanjundaiya, Triniti Solutions).

Understand India's Economy

India's economy has three comparative advantages. First, its cost of living is lower than the U.S. Its GDP per capita is half that of other poor countries like Iraq or Ukraine. This is an advantage because Indian workers don't need as much in wages, since everything costs less.

India's second advantage is its well-educated technology workers. Its third advantage is its English-speaking population. This combination attracts U.S. technology and call centers to India, resulting in job outsourcing. For example, an Indian call center employee only costs $12 per hour, almost half the American counterpart of $20 an hour (including all costs, not just salary). As a result, more than 250,000 call center jobs were outsourced to India and the Philippines between 2001-2003. (Source: Technology Manufacturing Corp.)

India's economy has suffered from U.S. monetary policy. When the Federal Reserve began its quantitative easing program, it lowered U.S. interest rates which strengthened the value of the dollar. This caused the value of India's rupee to fall relative to the dollar, which forced India's central bank to raise its interest rates to stem 9.6% inflation. This action slowed India's economic growth, resulting in mild stagflation. For more see, What You Need to Know About the Emerging Market Crisis.

India and the U.S. Are Allies in Defense

In 2006, the U.S. agreed to overturn decades of American law and defy the Nuclear Non-Proliferation Treaty by allowing full civil nuclear cooperation with India. This is despite the fact that India had violated the treaty by exploding nuclear devices and not putting their program under the IAEA’s safeguards.

India wants to be treated like the official five nuclear powers: U.S., Russia, Britain, France and China. The U.S. wants India to cap its production of fissile material (highly-enriched uranium and plutonium), but India refused. India plans to increase its warheads from 50 to 300 by 2010.

This winking at the rules for India looks bad to ally countries that the U.S. has convinced to refrain from building nuclear capacity: South Korea, Taiwan, Brazil, Argentina, South Africa, Ukraine, Kazakhstan and Japan. The agreement was part of an overall increase in the business relationship between American companies and India. ​ The U.S. and India should place greater importance on military cooperation, including joint defense exercises, and counter-terrorism efforts.