The Unassuming Economist

This post by Prakash Loungani and Karan Bhasin first appeared in Business Standard:

The India-US trade agreement should be seen as a win for consumers and producers, with debates on protectionism and strategic autonomy often missing the economic trade-offs involved

The recently announced India–US trade deal has led to much confusion regarding the terms of the agreement and its implications for both consumers and producers. In February 2020, one of the authors had termed this as an eventuality given the complementarities of the two economies. Little did we imagine that the deal would take six more years. 

But all is well that ends well. As proponents of this deal, there is little suspense regarding our views on it. The deal is good — for both countries. However, as often happens, many are questioning the agreement and invoking passionate phrases such as “strategic autonomy” to challenge it. In what follows, we provide some insights into how the deal would benefit Indian consumers and producers and strengthen the economy.

Lastly, we discuss the issue of oil purchases, since that has become the primary yardstick used to judge whether India enjoys strategic autonomy. The idea behind this piece is to carefully examine trade and explain why we are at a critical moment in history, and why vested interests should not contaminate the discourse.

How do Indian consumers gain from freer trade?

Let us begin with a simple comparison of India pre-1991 and post-1991. India historically followed a highly protectionist trade regime that restricted access to the domestic market. Ambassador and Fiat cars were the only options available to Indian consumers. Ambassadors truly served as brand ambassadors of stasis — no innovation, no progress, the same car delivered year after year. Gradually allowing more players expanded consumer choice and lowered the cost of car ownership. The same story holds true for virtually all major sectors of the Indian economy.

Young India is aspirational, and consumers demand the best possible products at a given price point. Some of these may be European, others American. Protectionism in the form of tariffs is nothing but a tax on aspirations. We welcome the fact that the government has concluded trade agreements with many countries and has either withdrawn tariffs or significantly reduced them. In that regard, if India does offer lower tariffs for American goods, it effectively delivers a consumption tax cut for Indian consumers, who ultimately bear the burden of tariffs. Greater choice and stronger competition will help reduce prices, benefiting aspirational India the most.

Dry fruits from the US, for instance, attract a hefty tariff even though the US is India’s primary supplier. Our grandmothers often recommend having five soaked almonds every morning. Reducing these tariffs would surely make them happier. 

For decades, the Indian consumer has lived behind a ‘glass wall’. We could see the innovation, safety standards and nutritional variety available elsewhere, but our own trade policies made them untouchable. Protectionism turned global staples into luxury icons. By lowering these barriers, India is not just signing a trade deal; it is finally shattering that glass wall, allowing aspirational Indians to participate in global standards of living rather than merely observe them.

What about Indian producers?

Some now ask what happens to Indian businesses that must compete with US firms. Here too, the evidence favours trade. Most Indian businesses, especially micro, small and medium enterprises, stand to benefit from new opportunities through improved access to US markets. A zero per cent tariff on Indian goods was never realistic, as no country receives such treatment. The lowest achievable rate was around 18 per cent, slightly below that faced by India’s competitors. The deal delivers precisely this, reaffirming commitments to supply-chain diversification. 

India offers scale, manufacturing capacity and a large workforce, allowing firms to relocate or expand production here. Preferential access to the US market will naturally benefit Indian producers. The additional growth momentum created will also support firms focused primarily on domestic demand.

For over a decade, India has grappled with weak private investment. Successive governments have tried various measures to encourage capital expenditure. Protectionism, however, allowed firms to operate outdated plants without pressure to invest. The renewed need to compete and improve efficiency could lift private investment, generate employment and expand India’s middle class over the coming decade.

What about India’s strategic autonomy?

Having established that the agreement benefits consumers and producers, we turn to the question of strategic autonomy. Many have erroneously linked it to the purchase of oil from one country. 

Before the war in Europe, India’s energy basket looked very different. By 2020, the US had emerged as an important energy supplier. When oil prices spiked, India understandably sought cheaper alternatives. Strategic autonomy is not about buying oil from a particular country, but about sourcing energy at the most attractive prices. Over the past year, energy prices have moderated significantly, and India’s energy mix should reflect that reality.

Moreover, trade deals are always part of a broader package. With lower energy prices and reduced discounts, diversifying India’s energy mix carries little cost while delivering preferential access to one of the world’s largest markets. The economic arithmetic, here too, clearly favours the deal. 

Economics is about trade-offs, and true win-win outcomes are rare. The complementarities between the Indian and US economies make this agreement possible. These same complementarities led us in 2020 to believe such a deal was inevitable — only the timing was uncertain. Now that it is in place, it is worth recognising that both economies stand to gain substantially from deeper trade ties linking the world’s oldest and largest democracies.

(Prakash Loungani is Programme Director in the Master’s in Applied Economics at Johns Hopkins University. Karan Bhasin is a New York-based economist and Non-Resident Fellow at ORF America. They co-teach a course on economic growth at Johns Hopkins University.)

From a paper by Surjit S. Bhalla, Karan Bhasin, and Prakash Loungani:

“There seems to be a consensus that the inflation targeting framework adopted in India in 2016 has been successful in taming inflation. A comprehensive analysis of inflation targeting should be based on the impact on inflation dynamics, expectations and implications for growth. We illustrate the strong downward time-trend in India’s inflation dynamics coinciding with the inflation targeting regime. Trend inflation levels in India and other emerging market economies also suggest a downward trajectory regardless of the adoption of inflation targeting. Thefore, it is difficult to conclusively establish that adoption of inflation targeting in India led to a moderation in inflation or anchoring of inflation expectations. On expectations, there is some evidence of anchored household expectations, however, this anchoring predates the formal adoption of inflation targeting. Long-term expectations in India have remained firmly anchored since early 2000s. In terms of growth, the high real interest rates policy followed during the initial years of inflation targeting to establish credibility of IT regime adversely affected India’s growth dynamics.”

From a chapter by Salil Seth, Mrinal Kanti Mahato, and Parveen Yadav:

“Confronted with proliferating geopolitical risks emanating from energy producers, the energy security of the European Union (EU) is surrounded by plethora of challenges. Amid high volatility in energy prices, political disruptions and energy supply constraints, myriad hurdles are in the offing for energy security in EU. The current energy policy of the EU, which emphasizes competition, sustainability, and a secure supply chain, requires revitalization. A roadmap should be established to develop energy security strategies. This work performs systematic data mining for drawing literature in line with the mentioned road map-based objectives.The intention of the work is to facilitate EU with conceptualized framework strategies pertaining to energy security. This is anticipated to act as a trailblazer for energy protagonists like sustainability engineers, energy policy drafters, energy supply chain intermediaries, and strategy makers and incubate the concept with reference to the EU. This will enable the EU to overcome challenges in the energy security and at the same time set a benchmark for other competing nations.”

From a paper by Panagiotis Delis, and Georgios Kontogeorgos:

“Evaluating macroeconomic forecasts for their unbiasedness and efficiency is essential for policymakers, economists, and investors. The degree to which these stakeholders incorporate expectations into their decision-making processes depends heavily on how these forecasts have been formed. Existing methodologies do not explicitly address critical dimensions, such as the variability of bias across target events and forecast horizons, the forecast errors’ heteroscedasticity, and the potential state-dependence in bias. More importantly, they encounter difficulties during high-uncertainty periods, which can lead to inaccurate inference due to the presence of outliers. Apart from generalising the unbiasedness tests, this study contributes to the literature on both strong and weak efficiency by incorporating these aspects. Finally, the proposed methods are applied to the expectations of a crucial survey of the US economy, namely, the Survey of Primary Dealers (SPD). The findings from this application indicated that interested parties should investigate unbiasedness and efficiency in an outlier-robust way, while also allowing for greater flexibility in the methods regarding the variables and periods examined.”

From a paper by Antoine Gaudin, Brendan Harnoys-Vannier, and Martin Kessler:

“In the context of the ongoing review of the Debt Sustainability Analysis (DSA) for Low-Income
Countries (LICs), this paper seeks to help shed light on IMF and World Bank macroeconomic
projections. DSAs are central to the financial architecture of developing countries. Yet, the ways the
projections are performed are rarely accessible to outside researchers.

The first contribution of this paper is to provide a newly constructed database of 605 DSAs
conducted from 2013 to 2024. It contains all the information of all published DSAs for LICs in Tables 1
(macro-economic and fiscal) and 2 (external debt dynamics), as well as the shock scenarios. It will be
updated regularly.

The second contribution of the paper is to analyze forecast errors concerning public and external
debt, as well as the main macroeconomic components. It highlights results on large optimistic biases,
with a 10 percentage point underestimation of the trajectory of the debt-to-GDP ratio on average after
5 years. Decomposing this result, it finds that:

1. Larger countries tend to be more affected by significant positive biases. Small Island
   Developing States (SIDS) and vulnerable countries tend to be more accurately forecasted. We
   interpret this finding as showing the integration of past shocks in the baseline.
   
2. It’s mostly fiscal: The main driver of forecast errors is the underestimation of primary deficits, followed by overestimated GDP growth. In particular, forecasting errors on primary deficits stem from overestimated fiscal revenues.
   
3. Mixed results post-2017 reform: While the 2017 reform introduced tools aimed at enhancing forecast realism, biases have persisted. This is evidence of some limited (non-statistically significant) improvements by reducing the optimism bias. This pleads for further disclosure of assumptions. However, given that they were rolled out in 2018, and that COVID-19 made projections difficult, we also caution against too broad interpretation of those results.
   
4. DSAs designed in the context of programs perform better on public debt, but worse on deficits: This tends to show that the IMF tends to overestimate the political feasibility of a program. We find some support for the idea that in LICs, the multipliers are still underestimated.
   
5. Influence of country-specific factors: The study identifies institutional, structural, and cyclical factors influencing these biases, including governance quality, economic diversification, and global economic conditions. Countries reliant on commodity exports tend to have significant forecast biases, particularly optimistic projections for both public and external debt ratios. Countries with fragile governance or in conflict display more pessimistic forecasts for primary deficits and external debt, but overly optimistic growth projections. Countries that have had market access and have build-up debt stocks toward defending market access.
   
6. Recession conditions: DSAs conducted during recessions are associated with strong optimism in public and external debt ratios as well as real GDP growth. This suggests both a tendency to overplay rebound effects and a misconception of the way macroeconomic effects transmit over various phases of the business cycle.
   
   
   Optimism bias is very hard to control, but it can have large policy consequences on the IMF and its members. By publishing more information on its DSAs, the IMF and the World Bank have allowed outside scrutiny. The database we are publishing hopefully provides the tools to outside researchers to help this scrutiny, and we hope that this paper is a first example of such exploration.