In spite such large recurring deficits, India has built up over $300 billion in foreign exchange reserves. How does it do it? The simple answer is: Foreign money inflows in the form of debt and investments mainly from the West keep the Indian economy afloat.
|Sources of FDI in India Source: Financial Express|
"Seen through the narrow lens of the West’s security and economic interests, the great internal contradictions and tumult within these two large nation-states (India and Pakistan) disappear. In the Western view, the credit-fueled consumerism among the Indian middle class appears a much bigger phenomenon than the extraordinary Maoist uprising in Central India".
Here's how the Asian Development Bank (ADB) describes the rising inflows of foreign, mainly western, capital into India:
"Gross capital flows have increased nearly 22 times from $42.7 billion in 1991-92 to over $932.3 billion in 2010-11. As a share of GDP, this amounted to an increase from 15.5% in 1991-92 to 55.2% in 2010-11. Much of the increase in financial integration occurred between 2003-04 and 2007-08. Given the impressive economic performance indicated by close to 9% growth rate, higher domestic interest rates and a strong currency, India's risk perception was quite low during 2003 to 2007. Furthermore, this period was associated with favorable global conditions in the form of ample liquidity and low interest rates in the global markets—the so-called period of Great Moderation."
Many other economies have been growing faster and producing higher investor returns than India. So the returns do not justify the increased capital flows. Such flows are driven much more by the changing geopolitics of South Asia region and the world since the end of the Cold War in early 1990s. Without these inflows, Indian economy would collapse and India would be at IMF's door seeking last resort loans.
Lesson: Geopolitics drive economy. It's the reason for over a trillion dollars of western capital flow into India since the end of the Cold War. It also explains China's massive $46 billion investment commitment in Pakistan agreed during President Xi Jinping's state visit to Islamabad.
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