Richard Melson

December 2005

India

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Deutsche Bank Research:

India Special

Authors

Teresita C. Schaffer*

Pramit Mitra

CSIS, Washington

Editors

Maria L. Lanzeni

Jennifer Asuncion-Mund

+49 69 910-31714

jennifer.mund@db.com

Technical Assistant

Bettina Giesel

Deutsche Bank Research

Frankfurt am Main

Germany

Internet: www.dbresearch.com

E-mail: marketing.dbr@db.com

Fax: +49 69 910-31877

Managing Director

Norbert Walter

December 16, 2005

India as a global power?

India is a potential world power.

India’s stable democratic political system,

huge middle-class population, immense military clout in South Asia, rising

economic fortunes and global ambitions make it a potential power that could play

a very important role in world affairs.

But it still must address numerous challenges. In order to become an

economic powerhouse, India must tackle several structural issues, such as reining

in the runaway fiscal deficit, freeing its manufacturing sector from antiquated

labour laws, selling state-owned assets and using the freed-up cash for investments

in physical infrastructure.

India’s relations with Pakistan, the US and China will be crucial. Peace

and stability will be critical in attracting and keeping foreign investment. If India

follows a pragmatic foreign policy and lets its economic priorities dictate foreign

policies, it will reap the dividends of peace.

India’s policies embody a blend of pragmatism and nationalism, and

its goals include both close relations with the US and recognition as one of the

leaders in a more multipolar world. India’s economic growth and ability to manage

its key diplomatic relationships will determine the size of the international role it

crafts over the next fifteen years. Its leaders’ skill in balancing the competing

objectives of its foreign policy will help shape the direction taken by both India

and the world.

India as a global power?

December 16, 2005 3

Economic growth among India’s

states has been uneven

India is going through a series of remarkable transformations.

Economically, its growth rate has accelerated. Politically, an era of

single-party dominance has given way to a roughly two-party

system, but one where both national parties require large coalitions

to form a government. India’s security policy has been transformed

by its own needs and Pakistan’s nuclear tests of 1998, as well as by

major changes, both past and prospective, in Asian power relationships.

These transformations began in about 1980, when economic

growth started to accelerate, and were well in place by the time of

President Clinton’s signature visit to India in 2000.

India’s changing geopolitical role grows out of these domestic

changes. The end of the Cold War devalued India’s long-standing

relations with Russia and reoriented India’s foreign relations around

a much broader network of global friendships, with the United States

emerging as India’s most important extra-regional relationship. India

today is increasingly integrated with the world economy, especially

compared to its own previous record. Its foreign policy is built on the

pursuit of security and preponderance of power in its broader

neighbourhood, and of substantial influence in global governance.

India’s policy makers, fundamentally pragmatic, recognise that

India’s continued economic growth is the essential foundation for

accomplishing these goals, and that energy supply will be critical to

achieving a satisfactory level of growth.

India’s foreign policy goals require much more sophisticated and

substantive relations with the United States, and strong security as

well as economic ties with Southeast Asia and Japan. Developments

in Asia and globally have led the United States and key Asian

countries to reciprocate India’s interest for reasons of their own, and

this growing convergence of interests has given a further boost to

India’s geopolitical reach. Two factors could retard or reverse this

process: a renewal of active India-Pakistan hostility and a reversal of

India’s economic progress.

I. Domestic transformations

A. A closer look at India’s economic growth

India’s first two transformations are domestic in character and

started with the economy. Deutsche Bank Research1 has examined

India’s economic record and prospects in some detail, forecasting

average real GDP growth of 6 per cent between 2006 and 2020,

expanding manufacturing and knowledge-based industries, and

population growth tapering to 1.3 per cent. Three other features of

India’s economic record in the past two decades are also important.

Differences among states: Growth in the states of India’s South

and West has decisively outstripped that in the North and East. In

Gujarat, the fastest growing state in India, the gross state product

(GSP) more than doubled between 1993 and 2003, and per capita

product increased by 73 per cent. In Uttar Pradesh, at the other end

of the spectrum, the increase in per capita product was only 13 per

cent during those same ten years. In India’s poorest state, Bihar, it

was "only" 22 per cent. In fiscal year 2001/2002, per capita product

in Gujarat was 3.8 times that in Bihar.2

1 Asuncion-Mund (2005).

2 Indian Ministry of Finance. Economic Survey 2005. Table 1.8.

Current Issues

4 December 16, 2005

The dynamic states are conscious of their success, and reluctant to

be held down by the rest of the country. In several of them, state

governments are asserting, and being allowed, to exercise greater

policy autonomy with respect to investment and other economic

issues. On the other hand, the lagging states include two of the

country’s largest, which together account for 120 of the 543 seats in

the lower house of parliament. They will fight hard to maintain or

expand their share of central government resources, and to avoid

cutting subsidies that benefit their impoverished population.

Human development strengthening: Poverty has steadily

decreased nationwide since 1990 although big disparities among

states remain (chart 1). The Planning Commission’s figures show a

decline of ten percentage points in both rural and urban poverty

between 1990 and 2000, with the rural poverty rate dropping from

37 to 27 per cent and the urban rate from 33 to 23 per cent. The

states that have experienced the highest economic growth have

also enjoyed the sharpest decreases in rural poverty.

Urbanisation and literacy have increased especially in the states

with lower poverty levels (charts 1 and 2). Indeed, if one examines

the record state by state, those with the most rapid growth in

urbanisation are close to eliminating illiteracy, especially for males.

In the rapidly growing states there is a striking difference between

the growth of rural and urban populations. Promisingly, the social

indicators suggest that some of the states that have lagged in

economic growth may be about to catch up. Rajasthan, for example,

has experienced the fastest growth in female literacy of any state,

and has also seen a sharp reduction in both rural and urban poverty.

Recent developments suggest India’s society is in rapid evolution.

By 2020, the impact of increased urbanisation and literacy should be

clearly visible in the labour force, and the expansion of infrastructure

will be a powerful spur towards both modernisation of the economy

and involvement in international affairs. The increasing presence of

Indians overseas will accentuate these trends. Especially in the

cities, globalisation is a fact of life for more and more ordinary

Indians.

One of the factors that differentiate the fast-moving states from the

laggards is the quality and effectiveness of state and local government.

This is apparent in the improving track record of two states

normally considered far from the cutting edge: Rajasthan, as

mentioned above, and Madhya Pradesh. Both have had strong

political leadership; both have invested in schools and infrastructure.

One of the biggest question marks about India’s future relates to the

HIV/AIDS epidemic. The Indian government’s figures released in

May 2005 estimated that there were 5.2 m people suffering from

HIV/AIDS in India, or 0.9 per cent of the population between 15 and

49 years of age. The first AIDS case was identified in Tamil Nadu,

and the four largest high-prevalence states are all progressive and

fast-growing southern states. Lively economies draw in transient

labour and trucking, both of them vectors for infection. Success in

mounting an effective counter-attack partly depends on an efficient

state government that is aware of the problem and capable of

working in sophisticated partnership across bureaucratic lines and

with non-governmental organisations. Aside from its inherent

importance, the HIV/AIDS issue serves as a good indicator of how

effectively India and its various states are providing needed public

services.

0 20 40 60

Punjab

Himachal

Pr.

Delhi

Haryana

Kerala

Gujarat

Rajasthan

Andhra Pr.

Karnataka

Tamil Nadu

Maharashtra

West

Bengal

Uttar Pr.

Madhya Pr.

Orissa

Bihar

% of population below poverty line

1999-2000

Source: Statistical Outline of India 2004-05,

Tata Services Limited

Large disparities in poverty

levels...

1

0 50 100

Bihar

Uttar Pr.

Rajasthan

Andhra Pr.

Orissa

Madhya Pr.

Karnataka

Harayana

West

Bengal

Gujarat

Punjab

Tamil Nadu

Himachal

Pr.

Maharashtra

Delhi

Kerala

... and in literacy rates

Literacy rates in 2001

(ages seven years & above), %

Source: Statistical Outline of India 2004-2005,

Tata Services Limited 2

India as a global power?

December 16, 2005 5

FDI flows to India remain below those

of its neighbours…

…but Indian businesses are

becoming global players

Politics have evolved from being

effectively a one-party system to a

contest between two and sometimes

three coalitions

Global investment: India has a large continental economy in which

foreign trade, aid and investment have historically played a relatively

small part. India’s imports and exports of goods as a share of the

economy have risen from 13 to 23 per cent since 1993, but these

are far below the levels of China or its Southeast Asian neighbours.

Even more significant is the impact of the information technology

(IT) sector, which accounts for only 3 per cent of GDP but fully half

of services exports, with both numbers rising rapidly.

Although foreign investment is increasing, it is likely to remain a

smaller part of the economy than is true for many emerging markets.

Foreign direct investment (FDI) in India has gone up by stair-steps in

the past two decades, but remains well below the rate in China,

Southeast Asia, or other countries in the immediate neighbourhood.

But India is well ahead of these same countries when it comes to

investment abroad by its companies.

What this means is that the impact of globalisation is already

apparent, and likely to become stronger before 2020. The removal

of many import restrictions has brought foreign goods within reach

of urban India. Business process outsourcing (BPO) has given the

middle class in many parts of India new job opportunities, at wages

that are significantly better than traditional ones. The largest Indian

businesses are becoming world players, putting their capital at risk,

forging alliances, finding joint ventures and, most importantly,

operating with the disciplines of the marketplace. This will over time

affect the way the Indian market works, both for domestic and for

foreign investors. It has also made India’s political decision-makers

conscious as never before of the importance of the country’s

economic ties in a global economy.

B. Political changes

The elections of May 2004 brought the Indian National Congress

back to power. The Congress Prime Minister relies on the support of

19 parties, drawn both from the ideological left and from a growing

array of single-state parties. The opposition, the Bharatiya Janata

Party (BJP), known for its strong nationalism, had led the two

preceding governments, a far cry from the meagre parliamentary

representation their predecessor parties enjoyed in the early years.

In the past 20 years, what had effectively been a one-party system

has become a complex contest between two and sometimes three

coalitions. The political parties that have steadily gained through the

past two decades are the single-state parties, taken together. They

have by definition no basis for unity, but their members have

become key coalition partners for both Congress and the BJP. The

BJP remains dedicated to its ideological core, especially when in

opposition, and the "left parties" remain dedicated to a broadly

Marxist approach, though their performance as the leaders of state

governments often pays little more than lip service to this ideology.

For the other parties, apart from a loose adherence to populism and

dedication to local causes, ideology has become largely irrelevant.

The BJP-led coalition that governed India from 1998-2004 proved

quite stable, and the same is likely to be true of the present one, led

by the Congress. The expense and complexity of elections are such

that if a coalition can arrive at a reasonable division of portfolios and

can create a consensus programme, its members will be reluctant to

bring down the government for fear of having to face the voters

ahead of schedule. A stable coalition, one that expects to survive for

most of parliament’s full five-year term, is able to make policy based on the country’s medium to long-term interests.

Political staying

power has a greater impact on policy-making than party ideology.

 

Current Issues

6 December 16, 2005

India’s military position was based on

"no first use"…

…while its foreign policy looks upon

its economic interests and its greater

role in the world

The end of the Cold War has brought

India closer ties with the United

States…

on the country’s medium to long-term interests. Political staying

power has a greater impact on policy-making than party ideology.

C. Military expansion

India changed from implicit to explicit nuclear weapons status with

its nuclear tests in 1998. The tests and the sanctions India faced

from most of the world’s industrialised countries had a modest effect

on India’s economy. They temporarily chilled India’s political

relations with much of the world, but in time most countries came to

accept that India would not relinquish its nuclear arsenal. Within

three weeks after India’s tests, Pakistan had tested as well.

In considering India’s domestic transformation, we also need to look

at the changes in India’s military posture. India’s nuclear doctrine

was based on "no first use", and envisaged treating its nuclear

arsenal as a deterrent to nuclear threats. Its aim was to maintain a

"minimum credible deterrent".

At the same time, the period since 1998 has been a time of major

investment in the Indian military. Defence budgets rose by 13 to 25

per cent per year, and the Indian military planned major acquisitions

of new equipment and technology. These were intended not only to

deal with immediate issues of infiltration from Pakistan-controlled

territory, but also for broad-based modernisation, including enhanced

power projection capability. India’s military strengthening

has been an important element in shaping a foreign policy that

places greater emphasis on India’s economic interests, but that

also assumes that India will be taking on a greater role in Asian and

global affairs.

II. The geopolitical impact of India’s

domestic change

While these political and economic changes were taking place, India

was re-tooling its foreign and security policies to take account of the

end of the Cold War. India’s foreign policy, traditionally built on nonalignment

and on a strong security and diplomatic relationship with

the Soviet Union, now treats the United States as its most important

friend outside the region. India’s economic interests have assumed

a higher priority in defining India’s foreign policy and security goals.

India’s security posture and its status in the world are based on its

continuing possession of a nuclear deterrent. India’s quest for a

special role in the world remains a strong feature of its foreign policy,

but the character of that role has become more India-specific and

less visionary than during the years of Nehruvian foreign policy, and

the tools India uses to pursue it have broadened.

A. De facto strategic alliance with the US

Indian Prime Minister Manmohan Singh’s visit to Washington in July

2005 put the new India-US relationship on display. Its most noteworthy

accomplishment was an agreement between India and the

United States on civilian nuclear cooperation that could transform

the strategic partnership that is emerging between the two democracies.

But the broad outlines of cooperation that were sketched

out in the two leaders’ joint statement were the culmination of a

decade of steady intensification of Indo-US relations, based on a

growing awareness of common interests.

India as a global power?

December 16, 2005 7

…as India’s economy "globalised"

over a decade ago

Indo-US trade ties are strengthening…

…but security remains central to

Indo-US relations

Defence trade and cooperation are

gradually being built…

The Indo-US rapprochement started with expanding economic ties

over the preceding 15 years, as India’s economy "globalised".

India’s software exports are growing at a rate of 50 per cent per

year, with about two-thirds going to the United States. Indians on

temporary work visas also make up a good chunk of the information

technology workforce in Silicon Valley; India receives nearly a third

of these work permits. Indian-Americans, an increasingly rich and

influential community, are lobbying on behalf of India in Washington

and investing in their native land. Despite the economic upswing,

however, issues connected with the outsourcing of business

functions by US companies generate periodic controversy, with

domestic forces discontent about US jobs being relocated to cheap

overseas labour markets like India.

US-India trade pales in comparison with Sino-US trade, but it is

growing rapidly. According to Indian trade statistics, bilateral trade in

merchandise goods and commodities has increased from a paltry

USD 5.6 bn in 1990 to approximately USD 18 bn in 2003, a jump of

more than 221 per cent. India still does not attract anything close to

the amount of US investment going to China, but there are still

plenty of opportunities. The pace of India’s economic reforms has

slowed since last year, but even with a modest pace, the country is

regarded as one of the most attractive destinations for foreign

investors.

Government-to-government economic dealings have not led to

changes as dramatic as the surge in private trade and investment

might suggest, but there have been notable accomplishments. In

January 2005, for example, the United States and India signed an

"Open Skies Agreement" that will facilitate greater trade and

economic cooperation between the two countries. Before the

agreement, Indian airlines were limited to a few major US cities:

Chicago, Los Angeles and New York. Now they can fly directly to

these cities as well as to other regional hubs like Houston and

Minneapolis. US airlines, meanwhile, are permitted to fly non-stop to

Indian cities. The agreement also removes restrictive requirements

on cargo flights between the two countries.

The biggest change in India-US relations compared with the Cold

War era, however, lies in the security relationship. Today’s Indo-US

security ties are based on a growing harmony between US and

Indian interests, especially those relating to the region from the

Middle East through Southeast Asia. India’s accelerating economic

growth has made its leaders conscious of their need for energy

imports, and has propelled energy security and the safety of sea

lanes of communication in the Indian Ocean to near the top of

India’s security agenda. This has been a strong basis for creating a

new security relationship, one that involves regular joint military

exercises and periodic joint operations. Recent examples include

Indo-US cooperation in post-tsunami relief operations as far afield

as Indonesia and an Indian offer to escort sensitive US naval

cargoes through the Straits of Malacca. These represent a major

change from the traditional Indian discomfort with non-regional

countries’ presence in the Indian Ocean. The framework for the new

Indo-US defence relationship was spelled out in an agreement

initialled during the visit of the Indian defence minister to

Washington in June 2005.

Since 2003, India and the United States have also gone a long way

toward removing the restrictions the US had placed on defence

trade and cooperation. Under the Next Steps in Strategic

Current Issues

8 December 16, 2005

…although nuclear cooperation and

sensitive technology remain elusive

India-China relations have also

transformed…

…with trade being the driving force

Partnership agreement (NSSP), announced in January 2004 and

completed in 2005, India tightened up its legal and administrative

framework for controlling the export and use of sensitive

technologies, making it possible for the United States to remove

many of the controls that had prevented export to India of these

technologies. In March 2005, the United States announced that it

would permit US corporations to bid on a major contract for the

supply of advanced fighter aircraft to the Indian air force, including

US willingness to license co-production of the aircraft in India. This

was a major breakthrough in US licensing policy, and for the first

time made it possible for US companies to be serious contenders for

a major Indian military procurement contract.

The agreement on nuclear cooperation, the final element in this new

structure of security relations and trade in sensitive technology, will

be more controversial. The United States undertook to work toward

changes in its laws and in international agreements to make

possible civilian nuclear cooperation with India, including sales of

civilian nuclear equipment. India, on a reciprocal basis, agreed to a

package of measures which it described as assuming "the same

responsibilities and practices and acquir[ing] the same benefits and

advantages as leading countries with advanced nuclear technology

such as the United States". These included most prominently placing

their civilian nuclear facilities voluntarily under safeguards, working

toward a multilateral Fissile Material Cut-Off Treaty, and participating

in the full range of arrangements for control of international trade in

nuclear and related technology, including the Missile Technology

Control Regime and the Nuclear Suppliers Group. Implementing this

agreement will be complex, and will face domestic criticism in India

and the United States as well as international questions. But once

implemented, the agreement will remove the burden of sanctions

from India arising out of its nuclear status and position the country

as one of the guardians of the world’s security against nuclear trade.

There has been much speculation about whether Washington’s

friendship with India is predicated on US hostility toward China. This

notion is exaggerated. At present, both India and the US are actively

engaging with China, as further discussed in the next section.

However, the fact that India’s rise to greater economic and military

power coincides with China’s, coupled with the great potential for

clashes some years hence between Chinese and US interests,

certainly increases US interest in a strategic partnership with India.

B. India looking east

The China connection: The change in India’s relations with China

is nearly as dramatic. For years, Indian security thinkers have

spoken of China as their main strategic challenge, and consciousness

of the war India lost to China in 1962 is still vivid. Chinese

policymakers have looked at India with a mix of apathy and suspicion,

and reacted angrily when India justified its 1998 nuclear tests

on the basis of the threat from China.

In the past five years, with India opening up its economy and beefing

up its armed forces, Beijing has begun to take notice. Trade is the

driving force. Bilateral trade was about USD 2.5 bn in 1999; five

years later, it stood at USD 13 bn. Although India represents only

1 per cent of China's global trade, China has emerged as India’s

second largest trading partner after the United States. Indian

companies look with envy at China’s manufacturing prowess, while

Chinese IT companies want to learn from India’s success in the

services sector. Bilateral investment flows are small but growing.

India as a global power?

December 16, 2005 9

Political relations are also

transforming into friendlier terms…

…but rivalry and competition appear

set to stay…

…with energy security being an issue

Indian software and services companies, like Tata Consultancy

Services, have set up a base in China not just to cater to Chinese

firms but, more importantly, to the multinationals doing business

there. For Chinese firms, India’s huge middle class obviously looks

very attractive. Most interestingly, the biggest Indian technology

companies are actively seeking out joint ventures with their Chinese

counterparts.

There has been significant progress on the political side of the

relationship as well. Border talks, desultory for most of the last forty

years, have become more serious. During Chinese Premier Wen

Jiabao’s visit to New Delhi in March 2005, the two governments

formally declared their intention to move toward settling their dispute.

More importantly, the Chinese have now accepted Indian

sovereignty in the small Himalayan territory of Sikkim, and the two

countries have established a system for local trade in part of the

disputed border areas. Both these decisions signal their intent to

move forward.

This does not end the traditional Sino-Indian rivalry, which is still felt

more keenly in India than in China. Their size, geographic proximity

and contemporaneous rise to greater political and economic power

ensure that competition will remain a feature of their relationship.

China, increasingly, is a benchmark against which Indians judge

their own economic performance and political status.

Two more concrete issues are likely to ensure that Sino-Indian

friendship remains laced with competition. One is energy, with the

two countries increasingly locked in a race to secure resources

globally, especially oil and gas, to fuel their expanding economies.

The other is Indian concern about China’s apparent long-term

moves into the Indian Ocean. China has a long-standing friendship

with Pakistan and played a major role in Pakistan’s nuclear programme.

In addition, China now has a significant presence in

Myanmar (Burma) and an expanding relationship with Iran. China’s

plans to build submarines, in the view of many Indian security

analysts, make little sense unless one assumes that they would be

deployed to the Indian Ocean. These moves are a direct challenge

to India’s increasing focus on the Indian Ocean as a vital element of

its security.

India’s major trading partners, 2000-2004

Percentage share in total trade (exports+imports)

Country 2000-01 2001-02 2002-03 2003-04 2003-04 2004-05

1 USA 13.3 12.2 13.4 11.6 12.2 11.1

2 UK 5.7 5.0 4.6 4.4 4.4 3.7

3 Belgium 4.6 4.4 4.7 4.1 4.1 3.8

4 Germany 3.9 4.0 4.0 3.9 3.8 3.5

5 Japan 3.8 3.8 3.2 3.1 3.2 2.6

6 Switzerland 3.8 3.4 2.4 2.7 3.3 3.0

7 Hong Kong 3.7 3.2 3.1 3.4 3.6 2.8

8 UAE 3.4 3.6 3.8 5.1 4.2 5.5

9 China 2.5 3.1 4.2 5.0 4.3 5.6

10 Singapore 2.5 2.4 2.5 3.0 2.5 3.3

Total (1 to 10) 46.7 45.2 46.0 46.1 45.5 44.9

April - October

Source: Statistical Outline of India 2004-2005,

Tata Services Limited 3

Current Issues

10 December 16, 2005

I

ndia’s rise in the world economy has

been a magnet to Japanese

companies

Relations with the ASEAN countries

are being enhanced by trade

The lead countries in India’s East

Asian strategy are Japan and

Singapore

Engaging Southeast Asia and Japan: India is also broadening its

profile in the Far East, where it had minimum influence during the

Cold War years. India’s "Look East" policy is a tacit acknowledgement

that India needs to learn from the record of its eastern

neighbours. The "Look East" policy reflects, once again, India’s

interest in protecting its broader economic and political interests

throughout Asia.

Bilateral relations with Japan soured when India tested its nuclear

weapons in 1998. However, they have improved greatly in the past 3

to 4 years. The fillip to Indo-Japanese relations was provided by the

August 2000 visit of prime minister Yoshiro Mori, the first by a

Japanese Prime Minister to South Asia in a decade.

The April 2005 visit of Prime Minister Junichiro Koizumi to New Delhi

provided momentum to this relationship. Japan and India have a

number of mutual interests: preventing incidents of piracy and

terrorism in the sea lanes through the Malacca Straits, improving

bilateral trade relations, and promoting peace in Sri Lanka. There

have also been occasional joint military exercises, although India is

also careful in not portraying its relationship with Japan in a too

militaristic tone. Giving higher importance to security-related Indian

cooperation with Japan is likely to be inhibited by concerns over its

likely negative impact on the developing Sino-Indian relations, which

are more multi-dimensional than the Indo-Japanese relations.

On the economic front, Japanese investments in India have been

sluggish. Japan is currently the seventh largest trading partner of

India with a share of 3.1% in India’s total exports and imports in

2003. Before the Indian economy began to open up in 1990, the

Indian market held little interest for Japan. As India opens up, reforms

its capital markets and makes it easier for foreign companies

to do business, and as the Indian middle-class population gets

wealthier, Japanese companies are beginning to pay more attention.

Japanese firms have an advantage over their rivals: brand recognition.

Sony, Toyota, and Panasonic are household names and

Indians admire Japan for its economic and engineering prowess.

In a similar fashion, India’s relations with the ASEAN countries have

seen a spurt in high-level visits and expanding trade and investment

in the past decade. India has become a formal dialogue partner of

ASEAN, and would like to expand its participation in Southeast

Asian and Asia-wide institutions. Here too, there has been a modest

but increasing programme of joint military exercises and port visits.

For India, the big attraction is a more stable set of political and

economic relations to the east, as well as the possibility of joint

operations in the energy field. India shares with the ASEAN

countries an interest in not having China become by default the

primary outside power. This has been of particular interest to

Singapore, which has taken the lead in encouraging India to play a

larger role in the region, and which has supplemented its official

interest in India with a growing array of academic programmes

focusing on India and on Indian Ocean security issues.

India’s greater interest in East Asia ties in with its desire to expand

the blue-water capability of its navy. The Indian Navy seems keen to

play an active role in Southeast Asia. India’s relief operations in the

wake of the tsunami disaster last year earned its navy the admiration

of many countries in Southeast Asia. Opportunities for such

a role in the Persian Gulf are limited because of the heavy US

presence there and the likely objections of Pakistan.

India as a global power?

December 16, 2005 11

India’s relations with Israel have

steadily improved

India’s growing energy requirements

are compelling it to strengthen its ties

with the world’s oil producers

C. Competing interests in the Middle East and Central

Asia

Before 1990, India’s Middle East policy was largely determined by

its stance on the Arab-Israeli issue. India voted at the United Nations

against the creation of Israel, opposing the concept that religion

should be the basis for a nation and wanting to express solidarity

with the Arab world and with India’s large domestic Muslim

population. But since 1992, when the two countries established

diplomatic relations, relations have steadily improved. The two most

talked about areas of cooperation are defence and intelligence.

India has signed, or has in the pipeline, defence agreements with

Israel worth USD 3 bn, making Israel the second largest supplier of

arms to India after Russia.

At the same time, steady economic growth over the past decade

has caused a sharp spike in India's energy requirements. Already

ranking sixth in global petroleum demand, India meets 70 per cent

of its needs through crude oil imports. By 2010, India is projected to

replace South Korea and emerge as the fourth-largest consumer of

energy, after the United States, China, and Japan. As a result, Indian

diplomats are also looking beyond the Middle East, to places like

Venezuela and Sudan, to diversify oil supplies. This quest for

securing energy could re-shape South Asia's geopolitical landscape

and affect India's diplomatic relations, particularly with the United

States. India imports 70 per cent of its crude oil requirement from the

Middle East, and its dependence on foreign supplies is set to rise in

step with its rapidly growing economy. Saudi Arabia is India’s

biggest supplier of crude oil, accounting for almost a quarter of

India’s total imports of 1.9 m barrels per day, while Nigeria accounts

for 15 per cent.

India’s energy needs are a major factor in India’s deepening ties

with Iran. In January 2005, the Gas Authority of India Ltd. (GAIL)

signed a 30-year deal with the National Iranian Gas Export Corp. for

the transfer of as much as 7.5 m tons of liquefied natural gas (LNG)

to India per year. The deal, worth an estimated USD 50 bn, will also

entail Indian involvement in the development of Iranian gas fields. A

breakthrough moment in India-Iran relations came on January 26,

2003, when President Mohammed Khatami took the podium as the

chief guest at India’s Republic Day parade, an honour reserved for

New Delhi’s most trusted friends. Both countries signed the "New

Delhi Declaration" promising to expand trade. Since then, bilateral

relations have progressed gradually, driven by a mutual desire to

expand trade links, India’s growing appetite for oil and natural gas,

and a common strategic outlook in Afghanistan and Central Asia.

The growing economic ties between India and Iran are moving in the

opposite direction from Washington's continuing efforts to isolate the

Tehran regime. India and the United States have agreed to identify

ways to cooperate in preventing the further spread of nuclear

technology. But signing long-term deals with Iran would make it hard

for India to oppose Iran if it came before the United Nations for

sanctions.

Energy and geopolitics both drive India’s interest in Central Asia.

India’s strong interest in Afghanistan goes back to pre-independence

days, with Afghanistan seen as India’s geographic security frontier.

The difficult relations between Afghanistan and Pakistan, and India’s

desire to maintain close ties with a few well-placed Muslim

countries, kept this relationship important after independence.

Following September 11 and the collapse of the Taliban government,

Current Issues

12 December 16, 2005

Indo-Pakistan relations remain central

to India’s geopolitical position…

Relations between India and Pakistan

are in fairly good shape at present

Kashmir remains the disputed issue

between India and Pakistan…

…with a settlement nowhere near

the Karzai government came to power with close ties in New Delhi,

and India has continued to tend these carefully, much to Pakistan’s

discomfiture.

The Central Asian countries north and west of Afghanistan, recently

separated from the Soviet Union, held many of the same attractions

for Indian policymakers and strategic thinkers, but several of them

also have oil and gas and hence great interest for India’s future

energy supplies. India has been eager to expand its influence in

these countries for reasons of geopolitics, rivalry with Pakistan, and

energy supply. Indeed, India’s growing relationship with Iran is

based in part on Iran’s willingness to give India land access to

Central Asia, which Pakistan has thus far refused.

D. The South Asian neighbourhood: India-Pakistan

tensions ease for the moment

One of the hallmarks of India’s new foreign policy is that it extends

well beyond the traditional boundaries of the South Asian region.

Nonetheless, the continuing dispute between India and Pakistan

remains central to India’s geopolitical position. India’s approach to

relations with Pakistan and its other South Asian neighbours has not

undergone the kind of fundamental change that characterises India’s

approach to the United States, Asia and the Middle East. The key

question is whether India will decide at some point that it needs to

push more aggressively for a settlement with Pakistan in order to

take full advantage of its new international position.

The ceasefire agreed in November 2003 remains in place at this

writing, and officials and leaders from the two countries continue to

pursue the complex peace dialogue they inaugurated in January

2004. The best-known and most difficult issue dividing them, the

dispute over Kashmir, is the subject of one working group; a second

deals with nuclear risk reduction; and others address six clusters of

bilateral issues.

India is not only the larger and more powerful country: it also holds

the parts of Kashmir that both countries care most about. In a formal

sense, India claims all of Kashmir, including the parts now held by

Pakistan and China. Pakistan claims that sovereignty over the parts

of the state held by India and Pakistan must be decided by a

plebiscite in which the inhabitants choose between India and

Pakistan, in accordance with UN resolutions from 1949. If one steps

back from these formal positions, which many would argue do not

represent serious expectations in either country, the two countries

have contrasting views of what kind of settlement they could accept.

They also differ on how to get there. Pakistan has traditionally

wanted to deal with Kashmir first. India has generally sought to

address the other, less emotive bilateral issues first, saving for last

the Kashmir issue.

The two countries have engaged in unsuccessful settlement efforts

several times in the past. But the two leaders’ continuing commitment

to the current peace dialogue, and their willingness to reassert

it even after flare-ups of violence, makes this an important moment

for potential progress. The two governments have exchanged highlevel

visits, expanded people-to-people ties, simplified some visa

rules and inaugurated a bus service between the two sides of

Kashmir. They have expanded modestly the level of bilateral trade,

including resuming direct trade by road, and have spoken about

permitting direct trade between the Indian- and Pakistani-controlled

parts of Kashmir. Both countries say they are determined to move

India as a global power?

December 16, 2005 13

India’s policy in the rest of the region

being transformed toward economics

Again, strategic positioning in view of

energy needs and trade ties

forward with discussions on a natural gas pipeline from Iran across

Pakistan to India. The hope is that these steps will generate the

goodwill to permit resolution of the harder issues and eventually a

lasting peace.

India’s relations with its other South Asian neighbours have always

been asymmetrical, reflecting the unequal size and power of the

countries involved. India’s position of primacy in the region was

always an important element in India’s approach to the region,

together with its expectation that this would translate into a degree

of foreign policy deference from the other regional countries. But

India is now dealing with a more troublesome security situation in

the rest of the region, and as with India’s approach beyond the

region, its priorities in the rest of South Asia are beginning to shift

toward economics.

The ethnic conflict in Sri Lanka has been under way for over two

decades. In addition, a ruthless Maoist insurgency has raged for

nearly a decade in Nepal, where an ineffective elected government

has been pushed aside by a new monarch determined to reverse

the democratic changes of the past 15 years. Declining governance

in Bangladesh is made more dangerous by the new presence there

of a small but vocal Islamic extremist element. India’s response to all

these security problems has involved a much higher level of international

consultation than in the past.

In the past ten years, India has also become more interested in

expanding regional trade and investment. India’s agreement in

principle with Bangladesh and Myanmar to establish a gas pipeline

linking the three countries is one example, and represents a creative

way to try to deal with Bangladesh’s political anxieties about energy

trade with India. In addition, the South Asian Association for

Regional Cooperation (SAARC)3 has agreed in principle to move

toward a South Asian Free Trade Area, and has taken the first steps

in that direction, in the form of a bilateral trade agreement between

India and Sri Lanka. At the same time, some of India’s major

corporations are dramatically expanding their investments in other

regional countries. Tata Inc., for example, is working on a USD 2 bnplus

investment package for Bangladesh, and one of its subsidiaries

is planning to invest in an IT training institution in Pakistan.

E. Europe, Russia, and the Developing World

Two pillars of India’s Cold War foreign policy have become markedly

less important. Russia had been India’s steadiest diplomatic

supporter, major trading partner, and principal military supplier for

four decades. Its trade significance has all but disappeared. It

remains India’s largest supplier of imported military equipment.

Russian diplomatic support does not have the significance it once

did, but Russia shares India’s interest in shaping a more multipolar

world. Russia is not currently a significant energy supplier to India,

but could become one as energy markets change in the next two

decades.

India continues to attach importance to its role as a leader among

developing countries, but this has become a much less prominent

feature of a foreign policy that today revolves more around relations

with the United States and the major Asian countries.

Europe figures in India’s geopolitical vision in two principal respects.

First, it is a strong trade and investment partner (see table 3), and a

3 Consisting of India, Pakistan, Nepal, Bhutan, Bangladesh, Sri Lanka and Maldives.

Current Issues

14 December 16, 2005

India’s most recent role in global

governance has centred on

multilateral trade negotiations…

…while aspiring for a permanent seat

on the UN Security Council

…and using other platforms for

participation in global governance

critical part of the economic success India is trying to achieve.

Second, its political dialogue with the major European countries is

essential to the global role India is constructing.

India enjoys good relations with all the nations in the European

Community. India has signed Bilateral Investment Protection

Agreements (BIPAs) with 16 of the 25 EU member states. The EU

(as a bloc of 25 nations) is India’s largest export destination and has

a share of over 24% in its total exports. In the year 2003, India was

19th largest exporter to the EU and absorbed 1.35% of total EU

imports. On the other hand, India was 16th largest importer of the

EU’s products and had a share of 1.46% in its global exports. The

last major summit between the EU and India was held in The Hague

on November 8, 2004. India and the EU states are working closely

on terrorism, UN reforms, non-proliferation and other strategic

issues.

III. India’s rise as a strategic power

India’s foreign policy during the early decades after independence

was based on a global role centred on non-alignment and leadership

in the developing world. It relied heavily on India’s standing as

the largest democracy in the world, and on articulate Indian leaders

who appealed to justice and idealism. Its hallmarks included resistance

to the then prevailing division of the world into East and

West and a push for economic aid and redistribution.

During the 1990s, India had a relatively low profile in global

governance. It last served on the UN Security Council from 1990 to

1992, a term largely shaped by the conduct and aftermath of the first

Iraq/Persian Gulf war, at a time when India was only beginning to

come to terms with the collapse of the Soviet Union. More recently,

India’s most active role in global governance has been its

participation in multilateral trade negotiations. At Cancun in

September 2003, India emerged as one of the main opponents of

the agricultural trade agreement sought by the developed countries.

Its hard line played well to important political constituencies at home.

As the world and India’s role in it evolve, India’s military power and

economic success are key building blocks for the role it aspires to.

India seeks greater standing in global affairs and institutions as they

are now organised, but it also would like to see a different global

organisation emerge, one in which power is distributed more evenly,

among a larger number of important powers, including itself.

The big prize in India’s quest for a larger role in global governance is

a permanent seat on the UN Security Council. India has worked with

four aspirants to permanent seats (Germany, Japan and Brazil) to

craft an approach that can command substantial global support, and

has made this an important element in its global diplomacy. Whether

or not it succeeds in the current round of UN reforms, India will

continue to work on this as a long-term effort.

India will also be looking for additional platforms for participation in

global governance. Prime Minister Singh’s attendance at the

Gleneagles meeting at the invitation of the G8 is one example. At

the regional level, India’s involvement in ASEAN forums is intended

to raise its profile globally as well as regionally. In the next decade,

one can expect to see India more actively involved in Asia-wide

organisations and possibly seeking entry into the International

Energy Agency (IEA). India will also make greater use of its

India as a global power?

December 16, 2005 15

Many structural factors have been

constraining India’s impressive

growth in recent years

India’s relations with the US, China

and Pakistan are critical to its growth

and stability

leadership position in the Global Fund to fight AIDS, tuberculosis

and malaria. In the WTO, India’s perspective is likely to continue to

evolve, reflecting the shift in India’s exports toward more

sophisticated goods that can benefit by some measures India has

traditionally opposed. And Indian participation in the organisations

dedicated to preventing nuclear transfer, should it come about in the

wake of India’s recent nuclear agreement with the US, would be an

important indication of its "coming of age" in global governance.

India’s concern until now has primarily been to secure a seat at the

table. How India would use these platforms, should they become

available, is less clear. It would certainly wish to protect its strong

interest in retaining foreign policy autonomy, and would probably

oppose interventionist approaches to political, human rights and

security problems in developing countries. On the nuclear front,

India would want to protect its own freedom of action as much as

possible, while preventing Pakistan from joining the non-proliferation

organisations.

IV. Conclusion: India as a global power?

At this point, however, it is too early to call India a global power. Its

stable democratic political system, huge middle-class population,

immense military clout in South Asia, rising economic fortunes and

global ambitions make it a potential power that could (if things go

well) play a very important role in world affairs.

But India’s impressive growth in recent years is still held back by

structural factors. The economic reforms enacted thus far enjoy a

broad political consensus, but this government, like its predecessor,

is proceeding cautiously with new ones. Its major achievement since

coming to power in May 2004 is the introduction of India’s first valueadded

tax.

To become an economic powerhouse and catch up with its bigger

rival, India will have to sustain at least 8% growth, over a long period

of time. Its first challenge will be to address some structural issues in

the economy. These include reining in the runaway fiscal deficit,

freeing its manufacturing sector from antiquated labour laws, selling

state-owned assets and using the freed-up cash for investments in

physical infrastructure. These are tough choices under the best of

circumstances, but India’s complicated coalition politics make these

decisions even harder.

Second, India’s growing HIV/AIDS epidemic could seriously slow

down its economic growth and threaten the country’s public health

structure. Ironically, AIDS has had its most severe effect on some of

the most prosperous parts of the country. Unless they take vigorous

action soon, it could erode a major economic advantage: a large

pool of inexpensive and skilled labour.

Third, India’s relations with Pakistan, the US and China will be

crucial. Peace and stability will be critical in attracting and keeping

foreign investment. If India follows a pragmatic foreign policy and

lets its economic priorities dictate foreign policies, it will reap the

dividends of peace. Continued tensions with Pakistan might prevent

India from realising its full economic potential. India’s economic

fortune will also depend on how it manages its relations with the US:

India’s growing ties with states like Iran, Sudan and Venezuela to secure energy resources could create speed-bumps in the bilateral

relations of the two countries. This could in turn slow down or disrupt

US investment and technology transfers to India.

Bilateral relations with China are perhaps not as important for India

as its relations with the US or Pakistan. For the moment, both

countries have entered into a pragmatic dialogue that puts more

emphasis on trade and commerce than political differences. But as

both China and India race to secure energy sources around the

globe and flex their naval muscles in the Indian Ocean region, their

rivalry could intensify. China has been careful in managing its

strategic ties with Pakistan in the last couple of years in order to

push its own relations with India.

India’s strategic approach enjoys a broad domestic political

consensus. It first took shape when the BJP was in power, and has

continued with remarkably little change since the Congress took

over. The BJP expresses its international security goals in starker

terms and takes a somewhat more nationalistic approach to the

immediate neighbourhood. Within the Congress coalition, the parties

of the political left are sceptical of the emerging relationship with the

US. But in practice, major decisions, including those on sensitive

issues of relations with Pakistan, have become part of the national

consensus.

India’s policies embody a blend of pragmatism and nationalism, and

its goals include both close relations with the US and recognition as

one of the leaders in a more multipolar world. India’s economic

growth and ability to manage its key diplomatic relationships will

determine the size of the international role it crafts over the next

fifteen years. Its leaders’ skill in balancing the competing objectives

of its foreign policy will help shape the direction taken by both India

and the world.

December 16, 2005

Current Issues

2005. Deutsche Bank AG, DB Research, D-60262

Frankfurt am Main, Germany.

India’s geopolitical future depends on

the skill and wisdom of its future

political leadership

1 Asuncion-Mund (2005).

2 Indian Ministry of Finance. Economic Survey 2005. Table 1.8.

India as a global power?

* Guest authors express their own opinions which may not necessarily be those of Deutsche Bank Research.

Please see page 2 for a short biography of Teresita C. Schaffer.

India Special

Authors

Teresita C. Schaffer*

Pramit Mitra

CSIS, Washington

Editors

Maria L. Lanzeni

Jennifer Asuncion-Mund

+49 69 910-31714

jennifer.mund@db.com

Technical Assistant

Bettina Giesel

Deutsche Bank Research

Frankfurt am Main

Germany

Internet: www.dbresearch.com

E-mail: marketing.dbr@db.com

Fax: +49 69 910-31877

India Special

Deutsche Bank Research

December 21, 2005