India's Leaders Must Decide Between Growth and Protectionism

After negotiating a trade pact with Mexico and Canada, President Donald Trump has turned his attention toward trade policy with India. In characteristic Trump fashion, he mixed insults, praise and bravado in his opening salvo.

“India, which is the tariff king—they called us, and they say, ‘We want to start negotiations immediately.’ … They said, ‘No, we want to keep your President happy.’ Isn’t that nice? Isn’t that nice? It’s true. They have to keep us happy because they understand that we’re wise to what’s been happening,” Trump said.

Larry Kudlow, Trump’s top economic advisor, confirmed with reporters Thursday at the White House that trade discussions have started with India, a “very valuable ally.” Lower-level U.S. officials and India’s trade ministry  have been haggling for weeks over tariffs on a range of products. India, which did not receive a waiver from Trump’s steel and aluminium tariffs, has deferred retaliatory tariffs until Nov. 2.

Amid that backdrop, India’s prime minister Narendra Modi faces a critical test Monday, when the Reserve Bank of India plans to begin enforcing a data localization mandate. The regulation scheme, strongly opposed by many global financial institutions as a non-tariff barrier to trade, will require financial firms providing services in India to house their data within the country’s borders.

Ultimately, Indian leaders must decide if they want to promote open trade and economic growth or pursue this protectionist path. Global payment firms such as MasterCard, Visa and PayPal have urged the RBI to delay the diktat to allow more time to comply, but recent news reports indicate Modi’s government remains steadfast. Many U.S.-based firms such as Google and Amazon have signaled they will comply with the regulation, loathe to lose market share in a country of 1.3 billion people—78 percent of adults have a bank account, which covers 99 percent of households.

That level of market penetration can be attributed to a series of initiatives launched by Modi’s government to boost electronic payments, including a biometric ID card for access to financial services and the Jan Dhan Yojana (literally, “prime minister’s people money scheme”). It’s meant to ensure every Indian has a bank account. It comes with a debit card—a portmanteau of the currency rupee and payment called RuPay.

Axis Capital estimated RuPay seized a 38 percent market share from its launch in 2012 to 2016. The National Payments Corp. of India, which operates RuPay, is both a quasi-regulator—setting rules for the industry—and a competitor among payment processors. This provides RuPay an unfair advantage while U.S. payment networks are largely shut out of these programs.

Modi and other top government officials have channeled nationalist pride in promoting RuPay, claiming that using the “homegrown network” will fund state roads, hospitals and schools. He even compared swiping with RuPay to serving in the armed forces.

"Not everyone can go and fight on the borders,” Modi said in June. “Using RuPay is also a kind of national service.”

The problem with this mercantilist approach to financial services regulation is that ultimately closing the country’s payments system and fostering only government-driven solutions will limit innovation and reduce access to industry-leading technology.

Multiple studies show that forced data localization laws will sharply increase the cost of providing data services by roughly 30-60 percent, could cause a nearly one percent drop in Indian GDP and raise costs for Indian consumers by about $14 billion.

The Indian economy is currently growing at a pace of nearly 8 percent, but those gains elude many ordinary citizens. A recent Gallup poll found that just 3 percent of Indians agreed they were economically “thriving” in 2017, down from 14 percent in 2014. Job creation has more or less remained stagnant since 2014 as one million people per month enter the workforce.

Modi should reconsider the impact of imposing this data localization measure: higher financial costs to Indian citizens, lost opportunities with firms deciding against expanding in India and further fraying of trade tensions with the Trump administration.

The United States has long advocated the free flow of data across borders and opposes forced local data storage requirements similar to those imposed by Russia and China. India’s data localization mandate will present a fundamental obstacle to the further development of digital trade with America.

India’s government should also consider the long-term implications of this policy. The international flow of data has fueled the growth of the IT outsourcing industry, of which India has captured 55 percent of the world’s market. As Indian firms seek to expand their competitive advantages to data analytics and artificial intelligence, they will need to depend on data fluidly flowing across borders.

Even respected institutions in India that support some data localization efforts have criticized the overbroad approach pursued by Modi’s government.  “One cannot deny the extensive costs data fiduciaries will have to incur to maintain local servers,” according to a policy analysis of the data localization regulation by the Takshashila Institution, a centrist think tank based in India. “At the outset, data localisation for all kinds of data (at different levels) need not have been inserted in the statute. There were other ways of leveraging this such that it did not come in the way of innovation or security.”

As long as President Trump can claim a win in trade negotiations with India, he’s not likely to dictate the details. But policymakers, business groups and other stakeholders who value minimal barriers to free trade should insist U.S. negotiators press Modi to drop this protectionist policy.