If China grows slower than India…
THE EMERGING markets are a very heterogeneous bunch,” writes Willem Buiter, former member of the Monetary Policy Committee of the Bank of England. “Their recent economic performance and prospects range from quite good (India, Turkey, Brazil since the end of the de-stocking implosion), to prima facie quite good (China) to pretty mediocre or bad (Central and Eastern Europe), to dismal (Russia).”
Mr Buiter goes on to argue that “those emerging markets that (1) did not have their domestic financial sectors destroyed or excessively exposed to parent banks in the North Atlantic region; (2) are not excessively dependent on export demand and (3) are not too dependent on foreign funding are likely to do best and have a ‘V’-shaped recovery. India ticks all the boxes”
Such observations have started to come, especially after the Indian parliamentary elections concluded in May. The elections were expected to throw up a hung parliament or a government that would be hobbled at inception by personal interests. However, in the end, those fears proved to be unfounded. The previous coalition government has returned without inconvenient allies.
The psychological impact that it has had on investors—domestic and overseas—is significant. The Indian stock market, which was a laggard in Asia and globally until early-May, became a tiger. Until recent correction, it had even managed to catch up or exceed the performance of China’s stock indices that were outperforming by a big margin until then. The Shanghai Composite Index and the BSE Sensex Index occupy the 5th and the 8th places respectively in the global top-ten league of best performing (measured in US dollars) primary stock indices year-to-date.
In contrast, Mr Buiter’s comments on China were trite, guarded and even sceptical. His concluding observations say it all: “I continue to have doubts about the strength of the Chinese growth performance, but would welcome confirmation that eight percent growth or more this year is truly achievable.”
Echoing these views was Stephen Roach, a long-time China-watcher, adviser to China government, Sinophile and currently Chairman of Morgan Stanley in Asia. “Shifting political winds, Mr Roach wrote in the Economic Times, “now give a well-balanced Indian economy a real chance to emerge as Asia’s biggest surprise in the years immediately ahead. India, according to Mr Roach, had slipped through the cracks in a world that had fallen in love with the China miracle. But “China now faces increasingly daunting challenges in coming to grips with long-simmering imbalances of its export—and investment-dominated macro structure. That could be a great opportunity for the “sleeper.”
Coming from Mr Roach, it would have made the Chinese government sit up and take notice. For more than a decade, he was pillorying America’s unsustainable consumption-savings imbalance while eulogising China’s rise without taking cognisance of the reality that China’s savings-consumption imbalance was the other side of the coin of America’s. He is now belatedly recognising it. For India too, this would be a new experience. It has been decades since investors have put India ahead of China.
Just the prospect of India growing faster (de facto if not ‘de reporto’) than China is likely to change the economic and political behaviour in both countries and from the rest of the world. These might even threaten the end of investors’ great romance of stock markets in emerging economies that has revived lately.
What do we see under the microscope in China?
So it is important to first evaluate how realistic the prospect that Stephen Roach and Willem Buiter allude to is.
It might be odd to talk of Indian macro-economic growth outpacing China’s, when both the World Bank and several private sector economists recently upgraded their forecast for China’s growth this year. The problem is, of course, in knowing whether they are forecasting the actual growth rate or the government’s forecast of the growth rate of the economy.
Throughout this year, many analysts—both in the private sector and some international agencies (the International Energy Agency)—have noted the apparent inconsistency of the data on electricity production declining while real GDP growth remained positive in the same period. No satisfactory explanation has been offered for the apparent failure of this reliable link to hold this year.
Then, there is the inconsistency between the continued weakness in China’s imports from the rest of the world and the surge in fixed asset investment. Usually, countries that are investing vigourously would be importing raw materials and equipment (capital goods). But there has been a slide in overall imports and in the import of mechanical and electrical products.
Further, China’s bank lending has grown at an unprecedented rate in the first five months of the year. The risk of bad loans arising out of this lending binge is under-appreciated. Given the majority ownership of the government in most financial institutions, the bad loans, if properly estimated, would constitute federal fiscal liabilities. Reckoning them into calculations would lead to the conclusion that China’s fiscal health is not as robust as is routinely and unthinkingly made out to be.
Regardless of the quality of loans, it is true that such a quantum leap in loans disbursed borrows from future growth. Writing in Caijing Economics, Andy Xie, Morgan Stanley’s former chief economist for Asia, echoes these arguments. Mr Xie contends that “the lending surge proves China’s economic problems can’t be resolved with liquidity. China’s growth model is based on government-led investment and foreign enterprise-led export. As exports grew in the past, the government channelled income into investment to support more export growth. Now that the global economy and China’s exports have collapsed, there will be no income growth to support investment growth. ”
So, if the global economy, as is likely, remains demand-constrained in the coming years, then China would continue to find it difficult to sustain the lending-inspired growth that it hopes to achieve this year. Even if it undertakes the much needed rebalancing, its result would take years to show and in the interim, actual growth rates would be around 4 percent to 6 percent.
India’s prospects are better
India is not an export-dependent economy nor it is suffering from excess lending, investment and capacity. Its problems have been under-investment in infrastructure, shackled labour market and the education sector. The last, in particular, suffers from quantity and quality constraints. The growth rate in the economy dipped in the fourth quarter of 2008 and in early 2009 due to the withdrawal of international lending and uncertainties associated with India’s election outcome.
The international lending situation has improved and trade finance has been restored. India’s election outcome has also removed residual doubts about the stability and the quality of the government that would assume office, not to mention the boost it has given to India’s image as a robust, functioning democracy. Hence, there is an air of quiet expectation about this new government’s (although it is led by the same Congress Party that led the previous government) policy thrust. In its initial message to the country through the President’s address to the parliament, the government has also sent some welcome signals about improved governance as well.
What does it mean for the bilateral relations?
Thus, the underlying risks in both the economies are different and at the present stage in the global cycle, China’s economic growth and other constraints loom larger than that of India.
What are the consequences of a growth divergence in India’s favour? It is possible that China, unaccustomed to playing second fiddle to India in the Asian growth sweepstakes, becomes a prickly neighbour and power to deal with. It has clearly demonstrated its willingness to use multilateral forums to press its bilateral issues with India. It tried persistently to block the Asian Development Bank’s loan package to India, a small part of which finances a power project in the state of Arunachal Pradesh, a part of which China claims as its own territory. In the end, India had to raise the stakes in the game and press upon other shareholders of ADB to clear the loan proposal. India should anticipate intensification of such behaviour on other fronts as well.
In fact, global media hype about the higher growth rate in India—were it to occur—would fuel and fan such aggressive reactions. That is why it is important for India to go about its task of managing its economy without adding to the ambient noise and exuberance. In the past, India has been guilty of many exaggerations of its own. It was particularly evident in the last few years when the economic growth rate touched 9 percent. Most commentators and investors ignored the rising cost of living, unaffordable home prices and mounting shortages of critical infrastructure inputs. They did not appreciate too the role benign global conditions played in boosting both India’s economic growth rate and the stock market.
In recent weeks, chest-thumping rhetoric has made a creeping comeback. Indian media is given to hyperbole and extreme emotions of either kind—euphoria and self-flagellation. Further, its competitive streak versus Pakistan and China would kick in, lending unnecessary edge and sharpness to the discourse. All of this will raise the hackles of the northern neighbour.
India has a long way to go before becoming even a middle-income economic power, let alone an economic superpower. At the same time, it should be aware that the potential exists for it to outperform a stagnant China in the near-term with a range of potential consequences and reactions.
Of course, global growth need not be a zero-sum game. Resource constraints exist but a lot is wasted. There is scope to stretch them. Two neighbouring countries emerging as big powers may be unprecedented but there has to be a first for everything. Hence, if growth has to be under-girded by peace and security, competitive instincts have to be kept on leash.
Finally, China should reflect on the appropriateness of the degree to which its past should guide the manner and the fact of its future rise.