Rebalancing China and India's Economies

When the global financial crisis swept across the world in 2008, it was widely hoped that the external demand shock would affect India as badly as China.  After all, exports of goods and providers accounted for about 40 percent of Chinese GDP, and domestic consumption for around 50 percent, whilst India consumed over two thirds of its GDP and released only around 20 percent. Because things turned out, while both economies initially had a fairly soft landing, Indian development has dipped far more sharply than that of China.

Why?

The popular notion is that Indian growth delivered because there was a decline within domestic demand driven by the levelling of rural income growth, while productivity of funds also declined due to installation infrastructural and governance bottlenecks. But the drop in India’s GDP development has had more to do with external demand than is often believed. As export growth floundered due to a 2nd dip in the global economy following the sharp recovery of 2010, India’s GDP development fell sharply.

This was simply because external drivers had in fact been an important part of India’s growth story prior to the crisis. The sharp increase in India’s pattern growth after 1991 went together with greater outward alignment. Goods and services exports were less than 7 percent of the national income in 1990. But this was to change dramatically, driven by the growth of both manufacturing as well as services exports, led in particular by India’s dynamic Information Technology Allowed Services (ITES). After 1990, products exports’ share of GDP bending, and services’ share almost trebled.

Unsurprisingly, this shift coincided with a sharp rise in trend growth in GDP. Nevertheless, India remained much less dependent on global demand than The far east at the outset of the global financial crisis, exporting just 20 percent of its goods and services, compared to China’s 40 percent in 2007.

By 2012 India’s move ratio had risen in order to 24 percent, while China’s had declined to 27 %. India’s adjustment to the fall in global demand within the wake of the global financial crisis had been thus more imbalanced than that of China. This short-term maladjustment partly explains why India’s growth declined more sharply.

The other reason is structural. As is well known, the last few decades witnessed a rebalancing of global demand with trend growth declining in OECD nations even as it accelerated in emerging markets and creating countries. The direction of Indian merchandise trade modified to this by moving away from the OECD and former Soviet nations to China, ASEAN and the Middle East. On the other hand, the direction of India’s booming service sector exports, which grew robustly on the back of high for each capita incomes in OECD countries, has not shifted.

This has meant that the actual drop in demand in OECD countries in the wake of the global financial crisis badly affected India’s service exports. Importantly emerging markets felt both the sharp recovery and 2nd dip much more than in OECD nations. For this reason, Indian merchandize export overall performance in the wake of the global financial crisis was relatively good by global yardsticks, but has tended to fall off sharply within recent quarters. The share and services information exports, which remain more determined by OECD demand, stagnated at around Eight percent of national income between 2007 and Next year. Over the same period, manufacturing exports rose from 13 percent to almost 17 percent of Gross domestic product.

The sharp slowdown in development in both China and India suggests that their strategies for cushioning the impact of the global slowdown are not sustainable if the drop in demand in advanced economies is long term, which might well be the case.

Both economies need rebalancing. China needs to reduce its reliance on foreign demand and domestic investment while increasing domestic consumption. This is exactly what it seems to be consciously trying to do, although its recent currency devaluations may be a sign of having second thoughts.

Given global headwinds, India as well needs to reduce its reliance upon external demand over the medium term, while also more fully leveraging its traditional power, namely domestic demand. This means the government’s ‘Make in India’ campaign should focus more about the domestic market than you are on the external.

Over the long-term, India’utes ITES sector needs to develop more domestic demand linkages and diversify away from its narrow US–The european union focus, just as its products exports have done over the years.

Unlike China, the Indian economy needs to commit more, especially in infrastructure, whilst improving the ease of doing business. Langsing up consumption to revive development without boosting productivity will probably lead to macroeconomic imbalances in the form of inflationary and current account pressures that ultimately derail growth.

A more sustainable strategy to boost development lies in improving the efficiency associated with capital deployed (capital put in to GDP is by absolutely no means low) over the medium term. This would involve shifting public expenditure away from usage towards plugging growing facilities gaps and improving the atmosphere for private investment. This would produce jobs and enhanced incomes, boosting consumption in a sustainable method.

China, India and global headwinds is republished with permission from East Asia Forum