Recession likely to hurt China more than India

Worlds apart

31 March 2009 00:00  [Source: ICB]

It may be the differences more than the similarities that determine how well India and China emerge from the turmoil now roiling the global economy

When China's economy took off in the 1980s, a question arose: Why did India lag so far behind? The gap in growth rates has narrowed considerably over the last decade, and Indian confidence has soared, but a new question has been prompted by the deepening global recession: Which of these countries is better positioned to endure such a crisis - and to prosper over the long term?

The two economies are as different as Shanghai and Mumbai, cities that represent the leading edge of commerce in each nation.

Shanghai, with its maglev train, extensive highway system, massive redevelopment projects, numerous industrial parks and towering skyscrapers, reflects the centralized, top-down, export-oriented policies of China's authoritarian government.

In China, no objective is so ambitious that a demolition crew and a fleet of concrete mixers cannot achieve it.

Mumbai, on the other hand, sprawling and chaotic, its crumbling infrastructure groaning beneath the booming business sector, its teeming slums rolling up against gleaming factories and global headquarters, reflecting India's bureaucratic inefficiency, socialistic heritage, ethnic diversity and fractious democratic institutions.

India seems to succeed, despite itself, owing to a vibrant entrepreneurial culture.

In the struggle to deal with fiscal and economic crises, the comparison might appear to favor China, which has a broader array of tools at its disposal than India.

However, China's heavy dependence on exports, which contribute about 40% to its gross domestic product (GDP), will prove to be a difficult handicap to overcome, observes Arpitha Bykere, lead analyst at New York-based economic and financial analysis firm RGE Monitor.

WEAK POINTS
India is less exposed to exports, which account for only about 20% of its GDP. However, the country is vulnerable in regard to foreign exchange reserves, the fiscal deficit and capital flows, key factors in a government's ability to influence the economy through fiscal policy, monetary policy and direct intervention in the private sector.

In each respect, China has greater capacity, given its large foreign exchange reserves and the government's broad powers.

China's foreign exchange reserves, almost $2 trillion (€1.47 trillion), vastly exceed India's, which are close to $250bn and falling as the government draws upon them to defend the Indian rupee, which has lost 27% of its value against the US dollar since March 2008. In the last eight months, India's foreign exchange reserves have dropped by over $50bn, notes Bykere, whereas China's continue to grow, if more slowly, given the plunging exports.

The rupee's troubles stem from the withdrawal of foreign capital in response to the financial crisis. Another outcome of this outflow has been a correction in the real estate and stock markets. India is more vulnerable to such fluctuations, says Bykere, because of its greater dependence on short-term capital flows such as portfolio investment and foreign bank borrowing. Capital flows in China, given the larger contribution of foreign direct investment (FDI), are more stable.

China's superior financial resources are evident in its aggressive fiscal stimulus package of yuan (CNY) 4 trillion ($585bn), or 14% of the country's CNY29 trillion gross domestic product (GDP).

"Therefore, we believe that, here, Chinese policy is more impressive," says Bykere. "It was able to bring in a large fiscal stimulus package and try to hold up consumption and investment. India has implemented [a number of] fiscal stimulus packages, but they've been a very small share of GDP, and we believe that they won't be effective in reducing risks of growth slowdown."

Bykere also finds China's monetary policy to be more aggressive.

"India has been cutting interest rates to improve credit access to businesses, and also injecting liquidity into the banking systems," she acknowledges. "But we believe China has been more aggressive in its monetary policy, especially because it has also directed its banks [which are government controlled] to lend to the private sector. India, trying to maintain private sector independence, cannot influence private banking decisions."

For the same reason, she notes, the Chinese government has a freer hand to prop up the stock and real estate markets when they are correcting, and also to intervene in the corporate sector.

"Basically, firms that are in trouble can be taken over by the government and restructured," Bykere observes. "In India, it is difficult to intervene directly in the private sector. India is therefore trying indirect measures to help the private se­ctor - ease credit access, or ease rules for foreign investment or other regulations."

THE LONG VIEW
The global economy is not normally in a state of crisis, of course, and however advantageous a tight grip may be in an emergency, it may not offer the most sustainable path to prosperity.

"Certainly, democracy in India is not as efficient in allocating and enabling infrastructure projects and initial responses to, particularly, an economic crisis, as is China's more authoritarian and consensus-based political system," says Christopher Runckel, president of Runckel & Associates, an international business consulting company based in Portland, Oregon, US.

"But one thing that I would note, on India's behalf, is that Indian banking and economic officials often have much greater and deeper experience than their Chinese counterparts," he adds.

"The Indian stock market is more transparent, better regulated and more predictable than their Chinese counterparts. This same set of facts also applies to the Indian banking and banking regulation system and helps to support Indian development."

China's reluctance to privatize state-owned enterprises (SOEs) also diminishes the efficiency of the economy. In 2006, SOEs accounted for 31% of China's industrial output, according to the Organization for Economic Cooperation and Development.

"State-owned enterprises are generally not efficient utilizers of capital in China, Vietnam and elsewhere in socialist economies in transition," Runckel points out. "Further moves to equitizing these companies in a responsible manner that protected worker and other interests, in my view, would be a major plus for China."

Although India's socialist legacy still constrains private capital, the country has fewer state-owned companies.

"India, in my view, and the view of many others, is a much more efficient utilizer of capital," says Runckel, "and long term, China's failure to deal more aggressively with its state-owned enterprises will be a drag on other sectors."

Runckel believes both India and China have responded well to the crisis so far, but he says the real test will come as the depth of the problem becomes clearer, and the governments have to take further action.

"In this scenario, I think the depth of Indian experience with financial markets, entrepreneurship and economic management will give it an increasing edge," Runckel says. "China will have to work harder and perhaps take more chances to develop the further policies needed to deal with a deepening crisis."

RGE's Bykere expects China's collapsing exports - which plunged 21.1% year over year during January and February - to take a severe toll on the country, leaving it with a more difficult path to recovery.

"Though the government will try to cushion the workers and of course the corporations, ultimately China's growth will be determined more by how quickly the global economy recovers," she says. "I believe China will have a hard landing by the end of this recession, with a much greater loss in output as well as employment. Therefore, there is a much higher risk of social unrest arising in China compared to India."

Some observers believe China should reduce its dependence on exports, boost domestic consumption, and channel the country's high rate of savings into its own financial institutions.

"That will be a major challenge," says Bykere. "Only time will tell whether China will change its whole growth model from export-led to domestic demand-led growth."

India, she says, needs to address its current account deficit by reducing its dependence on oil imports. It should also encourage more resilient forms of capital inflow, she adds. In 2007, FDI totaled only $24bn.

"This crisis will probably lead the Indian government and central bank to further improve corporate sector governance and banking sector regulation," Bykere says. "And the central bank going forward will be more vigilant about real estate and equity market bubbles, and the inflow of foreign money into these markets."

Paul Hodges looks at key influencers shaping the chemical industry

By: Clay Boswell
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