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Text of Speech by Shri Shyam Saran, Special Envoy of PM at India Habitat Centre on 28 February, 2009

February 28, 2009

Geo – Political Consequences of Current Financial and Economic Crisis: Implications for India.

Shyam Saran,
Special Envoy of PM

India Habitat Centre
28 February, 2009

Dr. Shankar Acharya,

Thank you for chairing this Session. I am deeply honoured by your presence. I would also like to express my appreciation to the India Habitat Centre and Mr. Raj Lieberhan for providing a forum for this interaction on a subject that has so far been off the radar in this country. It is my firm belief that even while we learn to cope with the more immediate impact of the ongoing financial and economic crisis, we should look more closely at the manner in which the crisis may be changing, in a fundamental manner, the global geopolitical landscape as well as the dominant ideologies which were accepted wisdom in most parts of our world.

Let us first look at the nature of the financial and economic crisis itself. It is a crisis that originated in the US and has now spread over the entire global economy. The Western dominance of the global financial markets and the global economy as a whole has been shaken to the core. It is possible that New York and London may no longer regain their undisputed status as the central financial markets of the world. With this has come an intellectual crisis engendering an open questioning of the western espousal of the magic of the market place, the belief in selfregulating market mechanisms and the relentless retreat of the state from virtually all key areas of economic life. These twin crises are beginning to spawn significant and farreaching political consequences. One relates to the redistribution of political power based on real economic strength. The other relates to perceptions, which are equally important, shaking confidence in market based liberalism that has been the dominant dogma for the past two centuries and more.

First, let us examine the chief characteristics of the crisis.

In essence, it is the consequence of unsustainable imbalances in the global economy i.e. prolonged fiscal and trade deficits in the U.S. matched by fiscal surpluses and astronomical foreign exchange reserves in China, but also smaller surpluses in other economies such as the oil exporting Gulf and Japan.

These imbalances will need correction through a sizeable increase in saving and decrease in consumption in the U.S. and associated Western economies, while China will need to save less and consume more – China today saves over 40% of its GDP . It seems to us that neither is likely to happen in the near future. In order to avoid a recession and promote the recovery of its economy, the U.S. has deployed and may continue to deploy progressively larger monetary and fiscal stimulus packages. The same is being witnessed in the market economies of Europe. This will push their economies in a direction opposite of the basic adjustment required, and can only be justified as a temporary palliative. The subsequent adjustments will have to be that much more significant and farreaching, the larger the deficits are today. On the other hand, China’s saving rate is likely to remain high. Asians, including Chinese, respond to difficult times, by saving more not less, particularly, where social security safety nets are absent. China has announced a large spending package for infrastructure, but this will only increase the significant excess capacity that already exists in infrastructure, whether these are highways, ports or building construction.

The US and China have become joined at the hip over the past couple of decades. This is what Kissinger said in a recent article:

"China made possible the American consumption splurge by buying American debt; America helped the modernization and reform of the Chinese economy by opening its markets to Chinese goods. Both sides overestimated the durability of this arrangement.”

If this arrangement has to be progressively adjusted towards a new balance without risking economic collapse, an extraordinary and unprecedented level of consultation, coordination and understanding would be required between the two countries.

Let us consider what is required.

The US will need to reduce its trade deficit through a deliberate and graduated decline in the value of the US dollar. As this will lead to the progressive decline in the value of China’s vast dollar holdings – China currently holds US $ 1.1 trillion in US debt including US $ 652 billion in US Treasury debt it will have to acquiesce in this erosion of wealth rather than seek to significantly diversify its reserves. Will China play ball?

China will need to resist the temptation to save its vast export industry from rapid decline and ruin, by devaluing its currency visàvis the U.S. dollar, or at least keep the current parity level. The U.S. interest, on the other hand, will be to persuade the Chinese not merely to maintain the current value of the Yuan, but to revalue significantly. Can these two contrary interests be reconciled? It is estimated that closure of export factories has already led to 20 million workers in China becoming unemployed. Will the creation of new jobs in the infrastructure sector help mitigate the retrenchment in the export sector? The evidence is that the latter, for the moment, is outpacing the former. What is the scale of destruction of its industry and rising unemployment, which a Yuan revaluation would further exacerbate, that China would be willing to tolerate?

For its part, the US appears to be working on the assumption that dependent as China is on the health of the global and particularly the U.S. economy, it will, in fact, be persuaded to do the unprecedented things that may be required. For this persuasion to work, the U.S. is embarking on an equally unprecedented diplomatic offensive to coopt China in its economic recovery strategy.

For example:

There are increasing calls for a SinoUS global condominium, a socalled G2, which would shape a new world order. Some like former Secretary of State, Brzezinski, have gone much further than others, calling for a "comprehensive, global partnership, paralleling our relations with Europe and Japan.” Brzezinski elaborated this further by recommending a USChina peacekeeping force to deal with failed states and a strategic dialogue to cover IndiaPakistan, IsraelPalestine and the Iran issue.

Though somewhat less dramatic, even Kissinger has called for taking SinoUS relations to a new level, at par with transAtlantic relations forged in the postWorld War II period.

The new US Secretary of State, Hillary Clinton, has echoed these sentiments by describing SinoUS relations as the most important bilateral relationship for the incoming Administration.

This implies an apparent willingness on the part of the US to accommodate China’s regional and global interests as a price to be paid for China refraining from tipping the US into a full blown economic and financial crisis through its own policy interventions and, hopefully, supporting US economic recovery. China is being invited to participate in the fashioning of new global governance structures and have a major voice in the management, if not resolution, of major regional conflicts.

China has not revealed its hand so far. It has certainly encouraged thinking in the U.S. and the West that it is the key to their economic recovery. This provides it with a significant leverage for achieving its foreign policy objectives even though on the ground it may be able or willing to do much less.

A brief look at the structure of the Chinese economy may be useful in this context.

The Chinese economy continues to be dominated by Stateowned enterprises which are largely domestic marketoriented or are engaged in commodity production and trade. The country’s export economy, which is the most dynamic, is occupied by two categories of enterprises: These are either wholly owned subsidiaries of foreign companies or joint ventures between Stateowned enterprises and foreign companies. There is yet only a small percentage occupied by private enterprise, though this segment is growing. The high growth rates enjoyed by the Chinese economy has been, and continues to be, generated by these two categories of enterprises. The export economy today constitutes over 40% of the country’s GDP. If this segment of the economy continues to decline as rapidly as currently, China may not be able to sustain the 77.5% GDP growth that its leaders believe is required to avoid widespread financial and political unrest in the country due to growing unemployment. If such unrest indeed becomes widespread, China’s leadership will certainly wish to first address this threat with all the instruments available, including economic and trade policies designed to protect their industry and employment.

The above scenario suggests that China’s role in global economic recovery may be more limited than is being envisaged in some quarters, although it is likely that China will emerge from this crisis in a relatively stronger position than before.

I would not like to leave behind an impression that only China is likely to be threatened by political and social unrest as a result of the global economic crisis. This affliction may, in fact, be quite widespread, affecting even mature and politically stable societies. The most vulnerable will obviously be countries that are already at the margin of economic survival. There may be more failed and failing states, the possibility of more widespread radical movements and an expansion of zones of conflict in different parts of the world. It will require the major states of the world to demonstrate a very high degree of collaborative engagement to keep a handle on these multiple crises, precisely at a time when their attention may be inexorably drawn inwards towards domestic preoccupations. Depressing as this may sound, it is a scenario that we should be fully prepared to confront. What is happening today in India’s neighbourhood is a visible pointer.

This is, therefore, one of those rare occasions in history when predicting even the near future is fraught with deep uncertainty. The one certainty is that the economic and financial crisis is putting all major countries and economies, through a global shaker and it is not clear which way the dice will eventually fall. What can be predicted with some degree of confidence is that the global landscape which will eventually emerge when the dust finally settles down, will be vastly different from what it is today.

Its contours, however, are not yet clear.

What are the implications for India?

For India, this is not necessarily a negative. It creates for us, other things being equal, greater strategic space. We will have more room for manoeuvre in managing our relations with a more diverse set of powers, and do so with more flexibility.

It should be our objective to encourage the trend towards a more diffused and diversified international order. This fits in well with our own instinctive preference for a multipolar world, which includes a multipolar Asia. We will need to work with other powers who share this objective. Our effort should be to build coalitions on different issues of shared concern and not primarily rely on a more limited range of strategic relationships.

This will imply a more energetic pursuit of our relations with countries like Russia and middle powers like Brazil, South Africa and Mexico. The European Union and, in particular, some of its individual members like France, can be useful political and economic partners. Europe seems currently torn between a desire to salvage Western dominance, on the one hand, and to lead the way towards an ambitious restructuring of the global political and economic governance structures on the other. We should encourage the latter trend.

With the US, we have built an extraordinarily broadranging relationship, which is likely to endure a change of political guard in either country. We must remain fully invested in this critical relationship, even while remaining alert to the possible threat to India’s interests as the US pursues its larger goals especially in our region.

Closer home in Asia, we will need deeper engagement with Japan and Indonesia and of course, a more nuanced diplomacy towards China. We have several areas of convergent interest with China, quite apart from a rapidly expanding trade and economic relationship. Our positions on multilateral trade, climate change and several other global issues are similar. At the same time, we should acknowledge that there are competitive components in our relations, which will need to be managed with prudence but firmness.

In this context, the prospect of a SinoUS strategic convergence has caused some anxiety in India. The situation is more complicated than it appears. China itself is hedging its bets by pursuing a number of parallel bilateral and regional strategies.

For example, while consulting closely with the US, it has also worked together with Japan and South Korea to create a NorthEast Asian swap arrangement and promised to consider a regional economic recovery package. China is also interested in adding substance to BRIC (Brazil, Russia, India and China) and put security issues also on its agenda. It is promoting both the Shanghai Cooperation process as well as a closer and more comprehensive relationship with South East Asia. It would be prudent for India to follow a similar hedging strategy as well, in its relations with other major powers and groupings. This will include an intensified engagement and dialogue with China itself, including on its interest in promoting a grouping of major emerging economies or on a new security architecture in Asia. India’s approach should be to position itself innovatively in a manner that enables it not only to rideover this crisis with relatively less adverse impact but more importantly, to ensure a position of advantage for itself as a new international and geopolitical landscape begins to emerge.

Our political prospects will inevitably be determined not only by how we weather the current storm, but whether we have strategies that enable us to emerge from the crisis as among the foremost of the economies of the world, and as one of the key drivers of the global economy. We will need to go beyond the defensive and survivalfirst strategies which currently dominate our thinking. Instead, we need to carefully assess what our strengths and vulnerabilities are as a continentalsized emerging economy, and articulate a forwardlooking economic game plan on that basis.

What are our likely vulnerabilities?

At least for some time to come, the impact of the global crisis could well lead to diminished markets overseas and the revival of protectionist tendencies in those markets. There may be, similarly, diminished prospects for attracting inward investment from major capitalexporting countries. In short, the global economic environment may not be as supportive of India’s growth prospects as it has been during the past decade and a half. To the extent that our higher growth trajectory has been associated with the globalisation of the Indian economy, leveraging the liberal economic environment prevailing in major Western and other market economies, the downward pressure on our growth prospects may be unavoidable.

Secondly, all major economies will end up being more regulated than before. There will be more State intervention, initially by default and eventually by choice. There is a real possibility that a new economic orthodoxy will emerge where the state will, once again, become not only a regulator but a major economic actor. The tendency in countries like India would be to uncritically slip into a similar mode of thinking. Our statist legacy makes us particularly susceptible in this regard. We must guard against this.

What are the strengths we can leverage to position India as a leading economic and political power, postcrisis?

Some opportunities appear to be to be worth pursuing.

For example, we should use the opportunity created by the crisis to consolidate proactively our economic interaction with our neighbours including through unilateral and asymmetric steps, if necessary. Our current policy line is that without a politically stable and economically prosperous neighbourhood, India will find it difficult to pursue its regional and global interests. It is time to put substance into this approach, even though current preoccupations with developments in Pakistan, Bangladesh, Sri Lanka and Nepal do cause anxiety. As the economic crisis hits the economies of our more fragile neighbours, we should accelerate regional economic integration through a series of economic support measures. An Indiainitiated South Asia Economic Recovery Initiative could be explored.

We could use the opportunity of depressed commodity and other prices to acquire productive assets abroad while they are cheap, buying energy and rawmaterial sources, for instance, and making strategic investments abroad. The political obverse of this would be a strong outreach in Africa and West Asia and other developing countries, revitalising our developing country constituency through targeted initiatives.

The Indian IT industry is likely to be significantly impacted due to loss of overseas markets as well as protectionist trends. So far the IT industry has been focused on the export market. It has not looked at the domestic market as a significant business opportunity. Now could be the time to do this. More competitive conditions in both domestic as well as external markets require Indian industry to be more efficient and productive. This is where our IT industry can play a significant role, but this will require the dynamic sectors of the economy, the service sector and the manufacturing sector, to come together to deliver a major punch, once the global economy settles down into a new and altered landscape. There should be a willingness in business and industry to think through and come up with an ambitious and potentially winning strategy. They should seek government support for delivering on such a strategy rather than looking only for shortterm relief.

There is little doubt that for at least the next 3 to 5 years, if not more, we will find a buyer’s market in a wide range of sectors due to the global slowdown. There is already significant excess capacity in capital goods and infrastructure sectors. Not only are more economical prices on offer but probably better terms and conditions for technology transfer as well. There is a window of opportunity for government and business to take advantage of these favourable conditions, to accelerate the upgradation of our transport networks, build more state of the art airports and seaports, build ten instead of only one high speed rail freight corridors, extend mass public transportation networks to all major towns and cities, and most of all, solve the power problem once for all. The civil nuclear agreement is a timely instrument in our hands today. As investment in the nuclear renaissance in the developed world slows down, India could some source many more high capacity nuclear reactors on the most competitive terms, if it wishes to. The country can leverage its financial credibility in the global market, to raise the funds required. We have to package and project ourselves as part of the solution to the global economic recession and not as its tragic victim. As a sound, creditworthy and growing economy, with relatively less exposure to the buffeting of the global crisis, we are still a good bet, a lowrisk and potentially highreturn economy. But we will need to communicate these strengths more effectively to the rest of the world than we have so far.

The interrelated crisis of climate change and energy security has already triggered a wave of innovations in renewable energy, such as solar energy, biomass and wind energy. The United States and, to some extent, Europe are the chief repository of such innovations. We have several interesting initiatives being pursued in India as well, though these are scattered in different locations, both in the public and private sectors. It is inevitable that, for some time to come, many of the venture capital initiatives in the area of renewable energy in the US and Western Europe, may run out of steam as money flows dry up. The decrease in oil prices, even though temporary in nature, will further reinforce this trend. India must not lose its longterm perspective. Its energy security demands an accelerated and significant shift from dependence on fossil fuels, increasingly imported, to renewables especially solar energy. Here is an opportunity for Indian business and industry to plug into the innovation chains in U.S., Europe and Japan, to help us bring about that shift. Energy of every kind will always be a big and growing business in India. Renewable energy will be even bigger. We should have the wisdom and foresight to grasp the opportunity we have today, to emerge as leader of tomorrow. We should map our future as a modern, state of the art, carbon free economy and a renewable energy leader within the next couple of decades. A stimulus package that promotes these initiatives will create productive assets which will help overcome the deficits which will inevitably have to be bridged in the future.

What are the key messages for India in terms of the likely Geopolitical Consequences of the Global Financial and Economic Crisis?

Our diplomacy will need to gear up for a more diffused, decentralised and complex international landscape, populated by several major powers, with US enjoying a significantly diminished predominance. Though complex, the new international terrain will create more space for India to emerge as a key driver of global economics and politics. In the meantime, we will need to deal with the continuing uncertainty across the globe through hedging strategies, encompassing multiple and concurrent bilateral, regional and multilateral relationships.

In relative terms, India’s economy is likely to be less severely impacted than economies that are much more globalised and export and FDI driven. This gives the country an opportunity to expand its regional and global profile, but this may require a significant reorientation of our diplomatic assets towards promoting regional economic integration and political stability in our own periphery. Our aim should be to emerge from this crisis as an economy in which each of our neighbours have a significant stake. This must be paralleled by a political engagement strategy that is nuanced and goes beyond the statetostate level dynamics.

We will need to restructure our economy to play on our strengths such as in IT and reduce our vulnerabilities, for example, in infrastructure. There should be a strategy to take longterm advantage of the depressed global market conditions both for capital equipment and strategic commodities, including nuclear energy. This is an opportunity for acquiring strategic economic assets abroad as well as critical technologies on more favourable terms.

Finally, we should use the challenge of climate change to fundamentally shift the Indian economy from its reliance on depleting fossil fuels, to a significant use of renewable energy. This will promote India’s energy security and spur technological innovation and change, positioning India as a frontranking power once the current crisis begins to recede.

Let me conclude by saying that we need to think in very unconventional ways to deal with a very unconventional crisis. In the Global 2020 Document – Mapping the Global Future – it is stated and I quote:

"Linear analysis will get you a muchchanged caterpillar but it won’t get you a butterfly. For that you need a leap of imagination”. I am certain that imagination is one resource that is never in short supply in this country.

Thank you.

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