As Communists battle the locals in Nandigram and join them in their battle against Posco in Orissa, the damage caused by the Left’s inconsistencies is becoming apparent. They have made it clear that their hearts beat for China. In the process, they are willing to hurt the interests of two countries that are currently suffering from China’s economics—India and South Korea. Therefore, it makes sense for these two to join hands.
Korea has endured the most of weakness of the Japanese yen and the Chinese yuan. Japan’s political drift and economic funk have kept the yen from appreciating. Of course, there is a deliberate policy element to it. The Korean currency has appreciated substantially against the yen. According to the International Monetary Fund, Korean exports have a high degree of similarity with those of Japan and China. They compete in foreign markets and the exchange rate makes Korean exports to these two countries uncompetitive. Unsurprisingly, Korean auto exports have lost out to Japan. Korea has a large bilateral trade deficit with Japan and its trade surplus with China is shrinking rapidly.
Yet, Korea’s overall export growth has held up rather well, despite the relentless nominal and real appreciation of the Korean won. This offers important lessons for India. It also helps us understand why India had to resort to short-term demand management, rather than bask in the glory of capital inflows. Korean exports held up, as the value addition in Korean exports has risen steadily over the years. So, as Korea faced competition in low price, high-volume and in tech-lite products, it moved up the value chain and began to produce more sophisticated and high technology content products. Also, it is a world leader in shipbuilding. Third, its labour productivity shot up and largely offset the competitive drag imposed by a soaring currency.
Critics of India’s monetary policy who wonder why India alone should face problems with capital inflows should take note. Other countries had other offsets. They improved labour productivity. They were not hamstrung by infrastructure bottlenecks. A recent issue of the Indian magazine, BusinessWorld, compares India’s “improved” turnaround in ports with that of other Asian countries. India is still way behind. As observed in this column several times, the failure of the government to channel capital inflows into augmenting its productive capacity left monetary policymakers with no choice but to manage demand.
It is not as though Korea didn’t resort to managing or reining in capital flows. It noticed that foreign bank branches had contributed to an explosive rise in short-term external debt for the purpose of arbitraging interest rate differentials. Small and medium enterprises were also engaged in hard currency borrowing. The central bank moved to ban external debt for purely domestic applications and imposed outright caps on external borrowings. Late in the economic cycle and even after problems in the US housing market began to surface, the Bank of Korea raised interest rates twice in 2007 to cool the fervour in the mortgage market, even though Korea’s mortgage debt as a percentage of GDP was rather low as in India. Evidently, the argument that unsustainably high growth rates in mortgage debt from a low base should not be curtailed did not find favour with the Bank of Korea.
As global economic growth looks set to falter in the coming years, Korea, with its pre-emptive monetary tightening, is better positioned to lower interest rates and ease monetary conditions through currency depreciation as well. South-East Asian nations do not have that cushion. Further, Korea’s energy pricing policy is far more rational than that of many other Asian nations. Energy prices are passed through to end-consumers without government-induced distortions.
As luck would have it, the top three economies outside the Eurozone—the US, Japan and China—look set to stumble in the coming years on account of their policy errors, indecisiveness and hubris. In some sense, there is a risk that the world’s economic growth could come to an abrupt halt. It is up to middle income countries such as India and Korea to collaborate so that they can minimize the fallout on their economies.
India has a demographic advantage. Korea has the capital and the technological base, and its demographics look set to worsen. And both countries, in different ways, have to deal with China’s geopolitical ambitions and economic expansion. They are better off joining hands in facing this formidable challenge. Korean corporations have strong balance sheets. India should actively woo foreign direct investment and technology from Korea. A strategic deepening of ties would be?in?India’s long-term interests.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at email@example.com