Summary and RecommendationsObservation 1: The Indian economy recently encountered serious turbulence and will require important reforms to stabilize it. To some extent, India's problems reflect India's deep and ongoing financial integration with the world economy. For example, between 2010 and 2012, India received about $160 billion in foreign capital inflows. With the US Federal Reserve planning to reverse its unconventional monetary policy, and as the US economy has rebounded, some of this money is flowing back to the United States, causing currency declines and turmoil in several emerging markets, especially India. But India's problems also have deeper domestic origins, and require serious reforms to overcome them (elaborated in my recent New York Times article). Fiscal consolidation, based on eliminating wasteful subsidies and introducing new taxes, will be critical. But looming elections could complicate reform actions and perpetuate uncertainty and turbulence.Observation 2: Economic uncertainty over the last year has triggered unprecedented liberalization of foreign direct investment (FDI) and other capital inflows. This seems paradoxical, at first blush, but is consistent with international experience that governments take action when a sense of crisis looms. In the last year, India has liberalized its FDI regime in several sectors-multi-brand retail, defense, petroleum and natural gas, stock exchanges, telecommunications, infrastructure-to a greater extent than in recent history. In order to attract foreign capital, the government also relaxed a number of constraints to foreign equity, portfolio, and debt inflows.
Prediction: Further opening to foreign investors, especially providers of financial services, is likely.A new pension-related bill has just cleared one of the two chambers of the Indian legislature. This bill paves the way for foreign investment-up to 26 percent-in the sector, with additional increases in the foreign limit linked to the draft insurance legislation. This insurance legislation, if passed, would allow for increased foreign ownership of insurance firms from 26 percent to 49 percent. The new governor of the central bank has signaled an openness to reforming the financial sector and to encouraging foreign participation in the Indian banking system.Recommendation 1: The time may be ripe for pursuing a bilateral investment treaty (BIT). The recent spate of FDI liberalization-as well as competitive pressure from US-China investment