During the economic contraction that came in the wake of the North Atlantic financial crisis, both China and India successfully stimulated their economies by doing what they are best at. China used its banking system to spend on infrastructure projects. India used its budget to spur consumption.
The share of investment in Chinese gross domestic product shot up from 42% before the financial crisis to around 50% today, a level never seen in global economic history. China bears say that this massive capacity buildup has pulled down the return on capital and will eventually lead to a pileup of bad loans in the Chinese banking system.
A shopkeeper does paper work in Beijing, China. (Reuters)
The global economy is once again in trouble, and economic growth in both China and India is faltering. On Wednesday, the World Bank cut its forecast for Chinese economic growth this year to 8.2%. India is expected by other agencies to expand at an even slower pace, around 7% or so. Earlier this week, Morgan Stanley pegged the Indian growth rate for this year at 6.3%.
What happens now will be interesting to watch. China is already talking about a new stimulus. Wen Jiabao has called for policies to support growth. Citing a newspaper backed by the Chinese state, Reuters reported on Wednesday that China will fast-track approvals for new infrastructure projects. This could lead to a rerun on what happened in 2009, despite the fact that China needs to rebalance its economy towards more consumption.
The talk is India seems to be quite different. Finance minister Pranab Mukherjee set the cat among the pigeons in parliament last week, when he mentioned the A-word --- austerity. Spending cuts at this juncture will hurt growth even more, but the mess in public finances and high inflation could eventually force India to swallow the bitter medicine. The Manmohan Singh government is now boxed in, with a very high fiscal deficit giving it little scope to spend its way out of trouble while high inflation does not leave the Reserve Bank of India with much room for monetary stimulus.
China may falter, perhaps even end up with a hard landing, but there is little doubt that it has more options to fight the slowdown right now than India has. The mismanagement of the economy by the United Progressive Alliance government has left us with too few bullets to fire.
