The 2013 U.S.-India Strategic Dialogue
Expectations and Priority Issues for Each Side

The annual U.S.-India Strategic Dialogue will be held on June 24 in New Delhi. This will be Secretary of State John Kerry’s first visit to India since taking on his new role earlier this year. It will also be the first Strategic Dialogue for his counterpart, India’s minister of external affairs Salman Khurshid, who took on his current role in October 2012.

There are no significant signs that either side is prepared to make major commitments to reshape, renew, or strengthen the nascent strategic partnership during the upcoming meetings. I suspect we will see many smaller commitments but few profound deliverables. This is due in part to recent economic-policy developments in both nations that have chilled the environment somewhat. In addition, Indian prime minister Manmohan Singh is now expected to come to Washington in the fall, so the Strategic Dialogue may instead be an opportunity to explore some potential “big ideas” for the heads-of-state meeting later this year. It is also worth noting that the U.S.-India CEO Forum is expected to meet in mid-July, serving to reinvigorate the economic agenda.

India’s Economic Environment

As we head into the U.S.-India Strategic Dialogue, the Indian economy is in its weakest position in at least a decade, a factor that has partially shaped the environment ahead of these meetings:

• Economic growth last year hit a ten-year low of 5.0%

• The rupee is at a record low, at more than 58 rupees against the dollar. This is about 33% higher than its five-year average.

• The trade deficit last year hit an all-time high of $191 billion The fiscal deficit remains relatively high at 4.9% of GDP

For these reasons, together with the government’s inability to enact difficult economic reforms, Standard & Poor’s has India’s sovereign debt on watch for a possible downgrade to junk status.

In July 2012 the decisive and technocratic P. Chidambaram became India’s finance minister for the third time in his career, infusing new energy and business intellect into India’s economic debate. The government quickly took steps to combat the economic crisis, and in September 2012 grabbed international attention by announcing a series of economic reforms meant to stimulate the economy (e.g., liberalizing FDI in retail trade, airlines, power trading, and television) and attacking the fiscal deficit (by decreasing subsidies on petroleum).

Nine months later, we find that the real impact of the September reforms, particularly those meant to stimulate growth, has been fairly limited. Reducing onerous sourcing rules for FDI in single-brand retail has brought in a rush of investment proposals—most notably, IKEA’s application to make a $1.9 billion investment. However, the other reforms have yet to attract new investment. Other long-pending reforms, including adopting a national goods and services tax and increasing the foreign investment cap in insurance and pensions, remain largely frozen.

Most renowned think tanks and economists predict India’s economy will bounce back in the current fiscal year. However, I am concerned that most of the reasons experts provide for optimism are dependent on uncertain variables—a good monsoon, economic recovery in Europe, faster infrastructure investment approvals by a new cabinet committee on investment, election campaign spending, and interest rate easing by the Reserve Bank of India. All of these things are prospective; nobody can yet point to “green shoots” indicating that the country’s economic recovery has already begun.

Politically, India’s leaders are busy preparing for parliament elections which must take place by May 2014. The Indian government has focused on enacting policies that will shore up votes ahead of this key election, either by providing new social benefits or forcibly stimulating the development of favored industries. Several of these measures have, intentionally or not, dented U.S. perceptions of India’s investment climate heading into the Strategic Dialogue. Some recent examples of the Indian government’s economic policies that may harm U.S. firms include:

• Domestic product preferences for government (and some private sector) technology procurement. The government has adopted new rules stating that government procurement of high-technology products should preferably be sourced from local manufacturers. These rules have three key effects in mind: to cut India’s massive trade deficit, enhance the security of technology products deployed in the country, and stimulate the development of local manufacturing. Products covered under these new rules include solar power equipment, information technology, electronics, and communications equipment.
• Expanding availability of free/low-cost pharmaceuticals. The government of India is seeking to reduce the prices of drugs through means such as compulsory licenses and the expansion of explicit price controls on pharmaceutical products. This has raised questions about India’s commitment to patent protections, eroding the market’s attractiveness for many foreign pharmaceutical firms.
• Minimum corporate social responsibility targets for public companies. The pending Companies Bill, which passed the lower house of parliament in December 2012 and is being considered by the upper house, includes a provision that would require large and medium-sized companies to spend 2% of profits on corporate social responsibility activities.

India’s Political Environment

If one were to only read the international press (and some of India’s English language press), you would think the Congress Party is in deep political trouble heading into the Strategic Dialogue. A weak economy, an inability to launch new reforms, a splintering coalition, and numerous corruption scandals all add up to a bleak picture when looking from a distance. However, when looking at the most important measure of the net impact of these policies—how the Congress Party has recently fared in important state elections—the numbers tell a dramatically different story:

• The Congress Party is winning recent state elections. Since January 2011, the Congress Party won re-election in 3 states, lost in 2 states where it held power, and picked up 4 new states. The 2 states they lost, Pondicherry and Goa, have a combined population of only two million people and three seats in the Lok Sabha (lower house of parliament). During the same period, their main opposition party, the Bharatiya Janata Party (BJP), has been reduced from 7 states to 4 states out of India’s 29 states and territories that have locally-elected bodies.
• The Congress Party defeated the BJP in Karnataka. Among the states the Congress Party won from other parties in recent years, none was more important than the state election held in Karnataka in April 2013. Karnataka was the first southern state where the BJP was able to form a government and was the largest source of BJP’s parliament seats in the 2009 election. Now the state is back in the hands of the Congress Party. In the 1999 national election, the state provided it with its highest number of parliament seats.
• The Congress Party currently holds 14 states. This marks their largest total since 2006 and only one fewer than the most states they have held at a single time in more than twenty years.

While I am sure many Indians are disappointed at the nation’s slightly tarnished international press, the Congress Party’s political leaders have seen their socially focused policies yield positive results at the ballot box. It is difficult to believe that the U.S.-India Strategic Dialogue meetings will alter India’s strategy of sacrificing long-term economic gains for short-term political benefits in instances where the government believes these choices are zero-sum. Critical elections in the large states of Rajasthan and Madhya Pradesh later this year will offer further insights into how the electorate views the Congress Party versus its chief rival, the BJP, ahead of next year’s national vote.

On a more positive note, as we approach the Strategic Dialogue, contrary to popular belief, the upcoming national election does not mean India is incapable of doing “big things” to strengthen its image or deepen our strategic partnership. Most notably, in July 2008 the Singh government approved the nuclear safeguard agreement. This step, highly controversial within India, took tremendous political courage just nine months ahead of the 2009 national election. The Congress Party severed relations with their difficult Communist allies, and barely survived a motion of no confidence in parliament. A few months later, the government also pushed out a pair of moderately important foreign investment reforms covering print news and the definition of foreign versus domestic companies.

In early June, I met with a senior BJP leader from the rural state of Bihar. We were discussing economic reforms, and I asked, tongue-in-cheek, “Sir, what are your constituents saying about these issues?” He laughed and said that voters in his district do not know about or care about the insurance FDI reform, nuclear deal, or anything else on the table for the Strategic Dialogue. They want running water in their village, electricity in their home, and for their kids’ teachers to show up at school. So the government of India does have some political space to introduce policy reforms that do not conflict with their overriding goal of winning next year’s election. The country’s political leaders understand that at the end of the day Indian voters will not elect or reject a candidate on the basis of these issues.

The Strategic Dialogue: Hopes and Expectations

Let’s review the highest-priority issues each side could be expected to raise during the dialogue.

Priority issues for the American side include:

• Addressing recent legal/regulatory changes that have impaired the opportunity for deeper economic cooperation. U.S. investors are more deeply concerned about the investment climate in India today than at any other time in recent history. Their list of grievances includes issues like local content rules for government (and some private) contracts, questionable application of tax rules on cross-border transactions and R&D investment, and concerns about India’s commitment to patent protection.
• Raising new and expanded areas for economic cooperation. There are a handful of areas that U.S. firms indicate are ripe for investment if the Indian government can enact critical reforms. These include parliamentary approval of the long-pending increase to the insurance FDI cap, revising the weak retail FDI policy, and removing barriers to foreign investment in real estate.
• Promoting nuclear trade. India’s Nuclear Liability Act, passed in 2010, does not cap liability for nuclear suppliers. This essentially precludes U.S. contributions to India’s nuclear power development—a frustrating circumstance since the U.S. government and industry had worked hard to bring India into the global nuclear trading establishment.
• Expanding defense cooperation. Joint military exercises are slowing due to U.S. budget cuts, but the United States hopes to expand defense exports to India. While U.S. defense sales have increased dramatically in recent years, defense companies still feel that India has yet to adopt a broader strategic shift toward the United States as a defense supplier.
• Additional issues. The U.S. team will also seek to increase cooperation in education and in fostering innovation, among other areas.

Priority issues for the Indian side include:

• U.S. immigration reform. India’s IT-services industry is deeply concerned about H1B provisions in the pending immigration bill before the U.S. Senate, which would increase fees and block some firms’ ability to use H1B visas.
• Importing natural gas from the United States. The shale gas boom is expected to help turn the United States into a net hydrocarbon exporter in the near future. But current U.S. restrictions only allow natural gas exports to non-FTA countries on a case-by-case basis. India would like to be included as a natural gas export market.
• U.S. force reduction in Afghanistan and its impact on South Asia. India is very worried about the reduced role of the United States in Afghanistan. While India does not directly share a border with Afghanistan, it is likely to suffer consequences if Afghanistan destabilizes further. India has traditionally had a solid relationship with Afghanistan and would like to see a stable, moderate government remain in control of that country.

Overall, expectations for the Strategic Dialogue are fairly modest, which is not necessarily a bad thing. We may see a slight relaxation in how the local content rules will be applied in India, an expansion of support on both sides for educational linkages, and perhaps a pledge to review natural gas exports to India. But it will be difficult to do anything to rival the strategic depth of the nuclear deal announced in July 2005. The wild card is whether an external factor—such as the Chinese military’s frustrating incursion into disputed border territory in May—will whet India’s appetite to seek deeper U.S. commitments on strategic ties, and if the United States is prepared to reciprocate.

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Richard Rossow is director for South Asia at McLarty Associates, leading the firm’s work for clients in India and the neighboring region. Mr. Rossow has been a leader in the private sector efforts to increase market access, resolve investor disputes, and take advantage of new business opportunities in India since 1998.