Photo: Bloomberg
Photo: Bloomberg

Opinion | China and India: Struggling to rebalance

China is struggling to manage its structural growth deceleration, while India is struggling to accelerate its trend growth

China and India make up for two contrasting—but fascinating—case studies of economic management in emerging economies. The policy response function in each is understandably tailored to suit its political structure, the economic challenges confronted and the menu of solutions. However, policymakers in both countries are struggling to rapidly rebalance their economies. China, which is demand-constrained, is trying to cushion its structural deceleration, whereas India, which is supply-constrained, is struggling to unlock its potential for higher trend growth.

Economic reforms took off in China in 1978, while India was a late bloomer, with major structural reforms seeing the light of day following the balance of payments crisis in 1991. The International Monetary Fund (IMF) pegs India’s per capita gross domestic product (GDP) this year at $2,135. This is around a fifth of China’s per-capita GDP of around $10,000. It is hard to imagine but the gap in per capita GDP in the two economies was less than $40 in 1990.

Interestingly, China was at India’s current per-capita GDP back in 2006, a gap of 12 years that is similar to the 13-year head start China had compared to India in initiating economic reforms. Subsequently, however, China’s per capita GDP surged slightly less than five times between 2006 and 2018, while India’s increased two-and-a-half times. China, of course, benefited immensely from its entry into the World Trade Organization (WTO) in 2001. Unfortunately, there is no similar-sized tectonic disruption on the horizon for India to ensure an outsized multiplier impact on its growth and economic evolution.

China adopted and adapted to the export-driven model of development, with a strong emphasis on keeping its exchange rate undervalued. The disinflationary impact of its stepped-up supply-side and the ballooning of its current account surplus also facilitated a sustained downshift in the structure of local interest rates. This in turn also boosted growth.

India’s semi-functional “do what you can, when you can" approach also has to make up for its relatively more progressive exchange rate policy that has shunned outright undervaluation of the currency. India has become more export-oriented and more integrated in trade and capital flows with the rest of world. However, frequent worries about the size of its chronic current account deficit and about its stable financing sometimes cause dislocations that undermine growth. An often overlooked feature of India’s half-baked economic model is that policymakers have reformed end product markets before addressing the entrenched problems in factor markets: high cost of capital, inadequate and insufficiently skilled labour force, and recurring palpitations with land acquisition. All these factors compromise the pace, magnitude and nature of the unlocking of India’s economic potential.

China’s early focus on education, skills and infrastructure is an important reason that it can make everything, from a simple but good-quality and reasonably-priced toy to cars; specialized and fancy electrical and electronic gadgets to high-speed railways. However, manufacturing, which is critical for absorbing the growing pool of labour, remains a suboptimal link in India’s economic evolution. Also, India is still lost about reforms in agriculture and education. Admittedly, Indian manufacturing has improved in recent decades but still remains lopsided. It struggles to make a good-quality tin opener but has carved out an encouraging niche for itself in manufacturing small cars and their export, and has an exemplary record and cost advantage in launching satellites.

China is desirous of engineering greater shift towards consumer-driven economic growth, weaning off the eye-popping multi-year investment surge that also contributed to its undisputed status as the factory to the world. In particular, the debt-fuelled investment binge that cushioned the hit from the global financial crisis in 2008 has now become the proverbial albatross around China’s neck.

To be fair, China’s focus on high-quality infrastructure was noticeable well before this problem emerged. The challenge for China—this is also closely tracked by the rest of the world—is cushioning its deceleration in growth to avoid any social upheaval from a hard landing and/or rising unemployment.

In contrast, India wants more investment-driven growth, especially focused on upgrading its creaky infrastructure, but is still struggling to jump-start the upturn in investment. Its last investment upturn was first truncated by the global financial crisis and subsequently hampered by policy mishaps. These included the inflation surge during the tenure of the previous government led by Manmohan Singh and later, the delay in timely implementation of measures to heal the banking system by the current government of Narendra Modi. Indeed, the Modi government, which came to power in 2014, appears to have underestimated the dysfunctional nature of its economic inheritance and overestimated its ability to fix things quickly.

The pace of economic rebalancing in both economies is substantially held to ransom by their banking sectors, including the shadow-banking channels. The underlying problem in both cases is home-grown, with politics distorting the more efficient allocation of savings. Both rely substantially on their clunky banking systems for intermediation of domestic savings, though India’s financial sector can justifiably claim to be relatively better regulated and more transparent than China’s. On balance, India’s challenges to unlock its growth potential aren’t unprecedented; several other emerging economies have had to cross several similar hurdles. In contrast, the nature and scale of the Chinese “too big to fail" challenge and its global ramifications give it a unique flavour.

The pace of rebalancing in both countries will continue to be slower than what investors expect. Financial markets suffer from tunnel vision and look for quick outcomes, while adjustments in the real economy take time. Local politics cannot be ignored, but in both countries faster and more far-reaching reforms rather than external factors will dictate whether policymakers and politicians end up in tears.

Rajeev Malik is a strategist at River Valley Asset Management, Singapore. These are his personal views

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