Butter Before Guns, Mr. Modi

Even as strategic ties to the U.S. improve, economic relations are lagging.

Modi's reached out to the U.S. on defense, but not trade.

Photographer: Chip Somodevilla/Getty Images

The breathless excitement that surrounded Indian Prime Minister Narendra Modi's visit to Washington, D.C. last week wasn't completely undeserved. By pushing forward Indo-U.S. defense and strategic ties -- in spite of considerable domestic opposition to any de facto alliance -- Modi can claim to have made India stronger. Yet unless he puts similar effort into fixing economic relations between the two nations, much of that progress could be at risk.

QuickTake India's Aspirations

Speaking to Congress last week, Modi celebrated the fact that the strategic relationship between the two countries had moved beyond the “hesitations of history." India is now one of the biggest markets for U.S. arms makers; a long-delayed $2.5 billion deal to buy military helicopters from Boeing was recently finalized. The U.S. has now named India a "major defense partner" (subject to approval by Congress) and the two countries have agreed to grant each other access to spare parts, services and supplies from their respective military bases.

All this represents a victory for Modi over an Indian diplomatic corps and bureaucracy generally skeptical of closer ties with the U.S. At the same time, though, as former Indian foreign secretary Shyam Saran recently wrote, “the growing closeness in the security realm runs parallel to a lengthening distance on both bilateral and multilateral trade-related issues."

I’d argue that Saran is understating the problem, which goes well beyond trade. Even the biggest economic headline to come out of Modi's trip -- news that preparations would begin for six new Westinghouse nuclear reactors in India -- concealed continuing problems. Already delayed for years by disputes over liability law, the project remains vulnerable to Indian courts and regulators. There's a reason Westinghouse's own statements about the deal sound considerably more restrained than those from the two governments.

Nor will the new defense ties automatically boost Indian manufacturing, as some hope. Foreign companies still can't own a controlling stake in defense production ventures in India. Understandably, they remain reluctant to invest for fear of losing control over intellectual property. And without high-spillover investment in cutting-edge technology, Modi's "Make in India" program is likely to struggle.

Progress has stalled on a bilateral investment treaty, something India and the U.S. have been working on since at least 2008. The two countries continue to clash over intellectual property rights, in spite of Modi's promise to come out with an IPR policy to which the U.S. couldn't object. Indian bureaucrats are taking various arbitrary steps against "excessive" royalty payments to developed-world companies. And yes, trade frictions continue: After losing a World Trade Organization case over its solar panel procurement policy, India recently threatened to retaliate by filing 16 cases against the U.S.

Indian bureaucrats have long fought to insulate the country’s notoriously slow and arbitrary decision-making processes from challenges by American companies and investors. One can see why Modi, who's had to expend political capital in his bid to draw closer to the U.S. strategically, might want to demonstrate India's “independence” in other spheres.

At the same time, the government seems to imagine that a savings-rich China can provide a ready alternative to the West, especially when it comes to plugging India's nearly $1 trillion infrastructure gap. This shouldn’t be a surprise: As Chief Minister of the western state of Gujarat, Modi's preferred development model -- government-led infrastructure investment and business-friendly intervention in markets -- suggested he was far more comfortable with “Asian” economic paradigms. Vastly impressed by Chinese progress and methods, he talked often of turning Gujarat into “India’s Guangdong."

Yet such attitudes only serve to make India weaker, not stronger. Western companies are less embedded in state structure and policy than Chinese ones, and are thus a much safer bet for a big infrastructure build-out. Time and again, big-ticket Chinese investments in developing nations have gone sour, leading to difficult renegotiations and often, a heightened tension in bilateral relations. Chinese leaders have also shown little compunction about pressuring other governments in an effort to protect investments abroad. A strategy of wooing Chinese investment while isolating China geopolitically seems too incoherent to succeed.

More importantly, pressure from Western investors and governments is crucial to the Indian economic reform process. Updated intellectual-property laws, greater transparency on infrastructure regulations, more open trade with less red tape -- all these would benefit Indian entrepreneurs even more than U.S. companies. To get foreign investment up to the scale he wants, Modi will have to do more to reduce regulatory and judicial risk. That would improve economic efficiency more broadly.

A closer and less prickly economic relationship with the U.S. is as much in India’s interest as is enhanced defense cooperation, perhaps even more so. Modi has successfully whipped the Indian bureaucracy into line on the latter. He needs to do more to make the former a reality.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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