India and Korea have both emerged as strong Asian economies demonstrating increasing resilience to deal with crises. Both countries have been subject to various economic crises. Beginning the 1950s, India ran trade deficits that increased in magnitude in the 1960s. In 1966, foreign aid slowed, and the response was devaluation accompanied by partial liberalization. By 1985, balance of payments problems reappeared and by 1990 turned into a serious macroeconomic crisis. South Korea also had its share of experiences of economic crises.
The approach to combat those economic crises has been different in India and Korea. Comparable to the 1991 crisis in India was the 1997 crisis in Korea that was triggered by the inordinate rise in short-term foreign debt, especially the high leverage of Chaebols. Korea’s government began its policy reaction to the crisis quickly and much ahead of the other affected economies such as Thailand and the Philippines. Several initiatives were undertaken to address problems associated with the Chaebol system and the financial system even as the government began talks with the IMF in November 1997 for a bailout package. The policy response was quick and decisive as illustrated by the fact that while GDP growth rate fell from 7.1 percent in 1996 to -6.8 percent in 1998, it rebounded just as rapidly to 10.7 percent in 1999.
In 2008, the Korean economy was better equipped to deal with the economic crisis compared to the 1997 crisis. First, sufficient foreign reserves had been built up in the interim that helped diminish the impact of a sudden reversal in capital flows. Although the large accumulated short-term foreign debt made the Korean economy vulnerable to a foreign liquidity shock, the amount of foreign reserves was still sizeable to cover all short-term foreign debt. The restructuring of chaebols in 1997 meant that the debt-to-equity ratio of the corporate sector had plunged to around 100% in 2008 from over 400% in 1997. This improvement in financial buffers greatly helped Korean firms to withstand the credit constraints and demand contraction posed by the global crisis that was triggered by the now well known Lehman Brothers collapse in 2008. In addition, banks were better placed to absorb shocks in 2008 than in 1997, based on improved prudential regulations. Increase in manufacturing exports, on which the Korean economy was heavily dependent, to China served to cushion the dramatic collapse in global trade. China’s import recovered faster than other regions, which in turn was the result of the global rebalancing. In retrospect it is clear that sound pre-crisis fundamentals coupled with post-crisis macro-policy choices were crucial to Korea’s performance. Thus large amount of foreign reserves, improved financial structures of firms and banks, a prudent government balance sheet and timely and focused interventions meant that Korea successfully recovered from the crisis. The value of pre-crisis fundamentals achieved by the restructuring processes since the 1997 crisis cannot be overemphasized.
On the other hand, although India’s response to the two crises in 1991 and 2008 respectively was also measured and swift, the pre-crises fundamentals were much weaker compared to Korea. But India did not follow through the reform process to its logical extreme, notwithstanding its implementation and institutional bottlenecks. The 1991 crisis provided the opportunity to bring about a fundamental change in development strategy, an abandonment of the import substitution model, reducing sharply the role of the public sector by de-licensing many sectors. While growth did revive, it did not pick up to the heady levels of 9% until 2003-04. It was subsequently interrupted by the 2008 global crisis. According to Srinivasan (2002) the relatively modest of success of Indian reforms cannot be attributed to their rapidity. At the same time reform did not help increase the share of manufacturing in GDP-fast growing sectors remained either capital intensive or skilled-labor intensive. Transformation would therefore need a structural shift to labour intensive manufacturing to absorb the huge surplus labour from the farm economy. This requires reform of labour laws and building of infrastructure, especially power.
The financial crisis of 2008 thus occurred when much reform was pending, although the political will to implement it naturally weakened after the onset of the crisis. While the crisis lowered the growth rate from 9.7 % in 2007-08 to 6.5 % in 2008-09, the economy recovered quickly to grow at 7.9 % in 2009-10 and 8.3 % in 2010-11 on the back of tax cuts and a fiscal stimulus. But the high rate of growth has not been sustained and declined to 5 percent in 2012-13. It has also become more variable. India’s self-confidence has also been shaken. While other economic indicators – rupee, inflation, current account deficit and fiscal deficit- have all taken a beating along with slowing growth, India’s travails have a conspicuous domestic context.
Structural problems – infrastructure deficits, inflexible labour laws among others have resulted in a stagnating manufacturing sector that could absorb the abundant and cheap, unskilled labour. Manufacturing requires transparent rules and reliable infrastructure and India lacks both. Mounting corruption in the allocation of land, spectrum and mines led the Supreme Court to pronounce that all natural resources must be assigned by auction. The verdict must be seen in the context of a deep sense of resentment at the collective failure of India’s institutions. But exclusively picking a market mechanism over an administrative allocation mechanism is an extreme reaction to institutional failure. The high-powered Committee on Allocation of Natural Resources opposes such a ‘one-size-fits-all’ straitjacket while recognising that there can be no substitute for strengthening institutions.
The two crises of 1991 and 2008 both brought to the fore structural problems and institutional weaknesses in India that otherwise tend to get hidden in times of good economic performance. While reform has been gradual, it has also suffered from poor implementation. Going forward it is equally if not important to address institutional and implementation bottlenecks as it is to design better policy for improved economic outcomes. To reiterate, the Korean experience is instructive in this respect.