US embassy cable - 05NEWDELHI8397

C O N F I D E N T I A L SECTION 01 OF 05 NEW DELHI 008397 
 
SIPDIS 
 
STATE FOR SA/INS 
TREASURY FOR INTERNATIONAL -- ANDY BAUKOL 
 
E.O. 12958: DECL: 10/27/2015 
TAGS: EFIN, ECON, BEXP, PGOV, PREL, IN, Indo-US 
SUBJECT: SCENESETTER FOR SECRETARY SNOW'S VISIT TO INDIA 
 
Classified By: AMBASSADOR DAVID C. MULFORD, REASONS 1.4 B,D 
 
1.  (C) Mr. Secretary, I want to warmly welcome you to India, 
a vibrant, diverse, multi-ethnic, multifaceted democracy -- 
much like our own in important respects -- that is emerging 
as an economic powerhouse and has growing global ambitions. 
Your visit will help set the stage for President Bush's trip 
to India next year.  It will advance the President's 
directive to add depth and breadth to our bilateral 
relations, which have strengthened on virtually every front 
during the last four years.  Your public message should be 
that you have come engage in a conversation with the Indian 
Government, Indian business and the Indian people about 
India's role in the international economy at the onset of the 
21st century. 
 
A STRATEGIC PARTNERSHIP 
----------------------- 
 
2.  (C) Your visit follows an extremely successful visit to 
Washington by Prime Minister Manmohan Singh in July, when the 
release of the Joint U.S.-India Statement signaled an 
historic turning point in our bilateral relationship. 
Although the civil nuclear component received the most public 
attention, the Joint Statement goes far beyond that.  In it, 
the two countries pledge to a partnership to address global 
and regional challenges for decades to come.  We agreed to 
work together to work for democracy and economic growth 
around the world.  We agreed to revitalize the Economic 
Dialogue, cooperate in the fields of education, agriculture, 
science and technology, and space launch.  The Joint 
Statement confirms our growing committment to work together 
across the whole range of activities that comprise human 
endeavor.  We are now cooperating in the health sector, 
particularly in HIV prevention.  We have a new and promising 
security relationship, in which topics such as 
interoperability of our militaries and defense coproduction 
are being openly discussed.  In sum, we have a truly 
comprehensive, across the board engagement, which promises to 
be the foundation of one of our closest international 
partnerships in the decades ahead. 
 
3.  (C) American interests and Indian interests converge on a 
wide range of transnational issues -- terrorism, 
proliferation of WMD, illicit drugs, trafficking, promoting 
democracy in the world, and climate change.  We have 
determined that the world would benefit if the two nations 
mobilize their military, political, and economic assets to 
address these challenges together as India emerges as a major 
power in the 21st century. 
 
4.  (C) India, too, has dramatically changed its policy 
towards the United States.  On economic and commercial 
issues, the UPA government has moved incrementally on issues 
of importance to us: it has concluded an Open Skies policy; 
strengthened its IPR regime; taken steps to resolve our 
bilateral irritants; it has raised foreign direct investment 
limits in several sectors; and has lowered tariff rates in 
sectors of importance to our industry.  A symbolic FDI legacy 
issue, the Dabhol dispute, which was complicated by the Enron 
collapse, was resolved by the GOI this July just prior to the 
Prime Minister's Washington visit.  The state-controlled Air 
India has selected Boeing to supply $9.5 billion worth of 
commercial aircraft. 
 
5.  (C) On the political front, it is clear that the GOI 
wants a closer relationship with us.  From the early days of 
this UPA government's tenure, it has sent us public and 
private signals that it views its ties with the US as its 
most important international relationship.  Prime Minister 
Manmohan Singh has taken considerable heat from his own 
party, his coalition partners, and the opposition for his 
decision to side with us against Iran at the IAEA last month. 
 Our close coordination in responding to the Tsunami last 
year and to the ongoing Nepal crisis are other examples of 
increasing trust and cooperation between us on regional and 
international matters. 
 
UNPRECEDENTED OPTIMISM 
---------------------- 
 
6. (C) In this context, your visit comes at a time of 
unprecedented optimism about the US-India relationship.  Our 
message to the Indian public that we want a strong and 
prosperous India will get heavy press play.  You should 
highlight the benefits to be derived from a strategic 
partnership with the US as India emerges from its cold war, 
socialist past.  You should underscore the U.S. commitment to 
a comprehensive partnership with India and highlight 
President Bush's directive to support India's efforts to 
become a global power.  On other topics, we suggest you press 
the GOI to liberalize FDI in financial services sector, 
remove internal and external trade barriers, and accelerate 
economic reforms.  In Delhi, you will be present at the 
signing of a bilateral agreement that allows USTDA to 
continue its activities to support Indian economic 
development and US trade and investment. 
 
THE ECONOMIC DIALOGUE 
--------------------- 
 
7.  (C) The U.S.-Indian economic partnership extends beyond 
trade and investment.  The intensifying and increasingly 
complex economic links being forged between our two countries 
are having a profound impact on our respective economic 
outlooks in the 21st century.  The principal tool we have 
used to strengthen the economic relationship is the US-India 
Economic Dialogue (ED).  The ED is headed by Al Hubbard of 
the White House and Deputy Planning Commissioner Montek 
Ahluwalia, who is a close confidant of the Prime Minister. 
The goal of the ED to advance the President's directive to 
transform U.S.-Indian relations by revitalizing the 
U.S.-India economic and commercial relations. 
 
8.  (C) You last met with Chidambaram at the G-20 meeting in 
Beijing.  We are pleased that you will be leading the 
engagement of the Financial and Economic Forum as it will 
enhance the effectiveness of the Economic Dialogue.  In your 
bilaterals, you should reaffirm the USG commitment to the 
Dialogue and its Finance track, the Financial and Economic 
Forum. 
 
CEO FORUM 
--------- 
 
9.  (C) A new CEO Forum was established this July to advise 
policy makers on what is required to remove structural 
impediments to greater trade and investment ties.  Both 
governments recognized that input from the business community 
is an integral component of a successful bilateral economic 
dialogue and agreed to create this high-level private sector 
forum to exchange business community views on key economic 
priorities.  The CEO Forum, which first convened at the White 
House in the presence of President Bush and Prime Minister 
Manmohan Singh on July 19, is composed of 10 chief executives 
from each country. You will be meeting with the Indian CEOs 
of this group in Mumbai, where you should underscore the 
importance of the CEO forum and the USG commitment to take 
its views seriously. 
 
10.  (C) The CEOs represent a cross-section of industrial 
sectors, particularly those that have a stake in improving 
the commercial climate between our two countries.  The CEO's 
collectively represent about a trillion dollars in capital. 
As the contributors of capital and bearers of risk, who have 
a global perspective, they have been tasked with identifying 
key issues and recommending a handful of high priority issues 
and measures that will enhance economic growth and employment 
in India and accelerate bilateral trade and investment.  The 
CEOs Forum is working on a "CEO Forum's Key Policy Issues" 
document which they will present to President Bush and PM 
Singh during President Bush's planned visit to India next 
year. 
 
ECONOMIC REFORMS AND COALITION MAINTENANCE 
------------------------------------------ 
 
11.  (C) In the US-India economic relationship, our most 
important priorities are continuation of economic reforms, 
redirecting uneconomic subsidies, and promoting financial 
market liberalization.  Fifteen years of economic reforms 
have raised India's GDP growth to the 7-8 percent range, 
improved income levels, reduced poverty, and instilled 
increasing confidence within the country about its present 
and future international role.  The quite visible benefits 
accruing from these reforms have created growing public 
support for more deregulation, liberalization and openness. 
This includes a whole new generation that in unencumbered by 
India's socialist decades.  You should use your visit to 
congratulate the Prime Minister on his reform accomplishments 
to date and highlight our strong desire to use the U.S.-India 
Economic Dialogue to: resolve commercial disputes, identify 
and remove blockages to bilateral trade and investment, and 
increase private and government technical and regulatory 
exchanges. 
 
12.  (C) Successive Indian governments are moving these 
reforms forward, albeit within the political constraints 
imposed by India's vigorous and sometimes frustrating 
democratic system.  Analysts predict several decades of 
sustained robust economic growth, thanks in part to India's 
youthful population and its technical and scientific prowess. 
 As India's largest trading partner and foreign investor, the 
Indians realize we are critical to their goals, which gives 
us considerable leverage in shaping their regional and global 
actions. 
 
13.  (C) Although the first generation of economic reforms 
has yielded good benefits for the country and its people, the 
second generation of reforms is encountering a stiff 
headwind.  Even in the best of times, economic reforms in 
India are slow because they require a political consensus 
across a wide political spectrum before they can be 
implemented.  Prime Minister Manmohan Singh and his economic 
team are finding it particularly difficult to move.  They 
feel increasingly boxed in: on the left from their Communist 
coalition partners who have made a cottage industry out of 
opposing any reforms that the GOI proposes, including 
privatization, labor reform, and easing restrictions on FDI; 
on the right, from the BJP which never misses an opportunity 
to attack, even if the GOI's proposals are reforms that the 
BJP had originally proposed; and down its own middle, from 
the populist politicians in the Congress party itself, who 
are responsible for the budget-busting employment guarantee 
bill, and having tasted blood, this group feels emboldened to 
press for even more populist measures as it see the party's 
electoral prospects stall or deteriorate in many key states. 
 
14.  (C) With this as a political backdrop, economic reforms 
will be implemented on an ad hoc basis.  Issues that do not 
attract political flak, like opening up the civil aviation 
sector, reducing bureaucratic red tape and lowering tariffs 
and simplifying the tax code, will move forward. 
Agricultural reform, privatization and labor reform will 
encounter strong opposition, but to its credit, the GOI has 
at least opened up a public debate about these measures. 
 
ECONOMY IS GOING STRONG ... 
--------------------------- 
 
15.  (C) The economy, led by manufacturing and services 
sector strength, started the fiscal year 2005-06 well, 
beating out most forecasts when growth accelerated to 8.1 
percent in the April-June quarter.  Growth in the 
agricultural sector, which accounts for 22 percent of GDP and 
supports 65 percent of the population, remained tepid, 
however.  Projections are that growth for 2005-6 fiscal year 
will be in the 7-7.5 percent range.  Key indicators point to 
continued economic growth and most analysts agree that over 
the medium and longer terms, Indian economic growth will be 
robust. 
 
16.  Inflation: Headline inflation seems subdued, currently 
at about 4.4 percent this year as compared to 6.4 percent 
last year.  Inflation this year is expected to rise to the 
5-5.5 percent range due to petroleum prices hikes which are 
beginning to work themselves in the economy.  The full impact 
of the oil price increases has been cushioned on the backs of 
the state-owned oil companies, which have not been allowed to 
pass on more than a minimal portion of the increases to 
consumers. 
 
Interests Rates: After steadily declining for several years, 
interest rates have bottomed out.  On October 27 the RBI 
hiked its repo and reverse rates by 0.25 percent to 6.25 and 
5.25 percent, respectively, to address short-term 
inflationary pressures emanating from higher international 
oil prices and imports. 
 
External Sector:  Helped by the strong economy, Imports from 
the US have surged 50 percent in the first quarter of 2005-6, 
with aviation equipment, electronic goods, machinery, 
transport equipment and scientific instruments among the 
biggest sellers.  India's trade with the rest of the world 
has been increasing sharply as well.  India could run up a 
current account deficit of nearly 3 percent of GDP this year, 
close to what many economists would regard as the 'danger 
zone'. 
 
Rupee: After a 6% appreciation in the last 12 months, the 
rupee has begun to show distinct signs of weakening vis--vis 
the dollar.  The rupee now ranges between Rs 44.5-45.4 to the 
dollar. 
 
Foreign Exchange: India's foreign exchange reserves were 
$143.3 billion on October 7 and have been steadily increasing 
since the balance of payments crisis in 1991 when India 
almost ran of foreign exchange. 
 
Foreign Direct Investment: While India's ability to attract 
FDI lags far behind China's, foreign investors are beginning 
to discover India.  Foreign institutional investment alone is 
expected to top $5 billion in 2005-06.  As a result of strong 
FII inflows, FDI will likely exceed $7 billion during the 
current fiscal year as compared to $3.8 billion for the 
previous year. 
 
... BUT CLOUDS HOVER 
-------------------- 
 
17.  (C) Fiscal Deficit:  The chronic fiscal deficit 
headlines the macro-economic trouble spots.  The combined 
federal-state deficit this year is expected to be 7.6 percent 
of GDP.  Interest payments on government debt, which is 
estimated at 80 percent of GDP, consume nearly half the 
revenue received from taxes. The recently enacted plan to 
guarantee 100 days of work to every rural family will put an 
even greater strain on the country's fiscal performance. 
 
Fiscal Reform:  In April, several states implemented a VAT 
system to replace a complex web of indirect taxes.  The VAT 
experiment has been highly successful, with an average 
increase of 16% in revenue collections by the VAT states. 
More states, including those governed by the opposition BJP 
are preparing to adopt VAT.  While there is increasing debate 
about tax reform, the GOI efforts to broaden the tax base 
have not been very successful. 
 
BANKING REFORM 
-------------- 
 
18.  (C) Earlier this year, the Reserve Bank of India (RBI) 
published a long-awaited "road map" for foreign banks in 
India.  The rules place tight restrictions on the ability of 
foreign banks to take stakes in private sector Indian banks 
until at least 2009.  Until then, foreign banks will only be 
allowed in most cases to grow "organically" via wholly-owned 
subsidiaries or a branch network, with severe restrictions on 
expansion.  The roadmap promises to open up the market to 
large-scale foreign stakes in 2009.  However, that horizon is 
too far away and probably too uncertain to mean anything for 
our contacts in the Indian banking sector.  We and the CEOs 
of several large US financial institutions in New York and in 
India view the roadmap as a major step back and victory for 
the Communists and the RBI, and in particular its 
conservative Governor Y.V. Reddy and his "go-slow" to 
"move-back" approach to further FDI in the Indian banking 
sector.  You should raise the issue in your meetings with 
Chidambaram, Ahluwalia, and RBI Governor Reddy. 
 
19.  (C) FM Chidambaram appears for the moment to be 
unwilling to take on Reddy.  The institutional strength of 
the RBI would be difficult to overcome, particularly with the 
left on whom the government is dependent having openly 
expressed their opposition to any more liberal FDI policy 
toward foreign involvement in the banking sector or 
consolidation within the domestic sector.  We may not have 
heard the last of the road map issue, although at this point 
in time we are not optimistic that there will be forward 
movement anytime soon.  The tensions between the MOF and the 
RBI are well known.  The MOF scored two important victories 
over the RBI in the past year: it pulled the RBI back from 
its plans to reduce current FDI limits in banking to 5 
percent, and the Finance Minister quickly put Governor Reddy 
in his place after Reddy had suggested imposing a tax to 
limit FII inflows. 
 
INFRASTRUCTURE 
-------------- 
 
20.  (C) One factor that may stymie India's growth prospects 
is its failure to develop a world class transportation 
infrastructure.  Indian airports, road, railways, and ports 
are wholly inadequate to sustain the country's 
competitiveness in the global market place and threaten to 
thwart the country's aspirations of becoming a global 
economic and political power.  Successive governments have 
recognized this but failed due to inadequate political 
leadership.  Ambitious plans have been drawn up in the past, 
but they have languished due to failure to mobilize the 
resources, lack of clarity of purpose, and poor 
implementation.  Nor is the problem just one of lack of 
funds.  The problem has been a culture that intrinsically 
believes that it is the responsibility of government to plan, 
build, and operate these projects. 
 
21.  (C) India's capital markets are not sophisticated enough 
to channel or mobilize resources to fund large projects. 
India also lacks a culture of private project finance.  There 
is no market for long term debt.  The GOI needs to stimulate 
the creation of such capital markets by allowing an increase 
in the number and types of financial players.  There are 
signs that the UPA government has learned the lessons of the 
past and will do things differently.  Prime Minster Manmohan 
Singh has made infrastructure one of his government's top 
priorities, and announced the goal of attracting $150 billion 
in foreign direct investment to the sector.  A government run 
by economists appears to understand the vital role of the 
private sector in infrastructure development but needs help 
in creating appropriate incentives.  Singh's government has 
signaled its intention to build public-private partnerships 
in developing these projects.  On the other hand, the 
government's negative attitude on liberalization of FDI caps 
for insurance companies and pension managers does not bode 
well for development any time soon of markets for long term 
financing or for large scale, long term public private 
project.  It is an open question whether India will be able 
to break from the habits of the past and address what 
everyone in the society, except the Left, believes is a 
pressing need. 
 
Conclusion 
---------- 
 
22.  (C) In sum, you will come to India at a time when the 
President's goal of establishing a key strategic relationship 
is becoming a reality.  Your visit will move us forward in 
building new habits of collaboration with one of the world's 
rising giants.  My team looks forward to welcoming you to 
India and ensuring a successful visit. 
MULFORD