Wednesday, April 29, 2015

India-China Growth Reversal & GDP Gap


      The long anticipated deceleration in rate of the growth of China’s economy is under way. Even normally conservative World Bank and IMF, are confirming that China’s growth is slowing down and is likely to fall below 7%.  Even those analysts who had forecast a deceleration in China’s growth were unsure about when exactly the slowdown would start. The author had estimated in the 2000s that China’s growth would decelerate below 8 per cent, around the middle of the decade starting 2010.  The global financial crisis of 2008 sharply raised the probability that the slow down would occur within the following decade, despite risky efforts by China to prop up growth.

      In contrast India was forecast to achieve its potential growth rate of about 8 per cent, given its Export-import neutral growth model. The surprise in India’s case was the sharp slowdown from 2011-12, largely attributed to complacency and domestic policy mistakes. Despite these mistakes, however, India’s growth rate from 2002-03 to 2013-14 was among the ten highest in the world (using the old data series).  Though, the correction of these mistakes, may no longer be enough to restore growth to earlier levels, India can and must restore growth to the average rates achieved earlier. Again, this has been recognized by both the World Bank and the IMF.     These two developments taken together, imply that India trend growth rate is poised to  exceed that of China’s in the next few decades.

GDP Levels vs Growth rate

    This will start the long, slow process of closing the GDP gap with China, which was 1.4 times India’s real GDP in 2013.  There is a common tendency to confuse relative levels of GDP with growth rates, so it is important to understand that China’s real GDP, measured at Purchasing power parity in 2011 international dollars, is now 2.4 times that of India's GDP. China's GDP PPP was 1.1 times India's GDP PPP in 1990, with the two economies almost equal in size in the mid-1980s. During 1990 to 2013, China's growth averaged 9.9% per year, 3.4% points faster than India’s average GDP growth rate of 6.5%.  Even if the growth differential was inverted and China's GDP henceforth grows an average 3.4% points slower than India's GDP (say 5% - 8.4% = -3.4%),  it would take 30 years to eliminate the GDP gap, about the time it took to open it.

Previous Growth Forecasts

    The basic theory and empirics of growth, show that fast growing economies like Japan, S Korea, Singapore and Thailand, which grew fast when they were at low or middle income levels of per capita GDP, maintained growth at high levels for one to two decades and then slowed down as their per Capita GDP approached that of the (lower end) of the High Income economies.  The surprise in the case of China was that it maintained an average growth of almost 10% for thirty years, despite reaching middle income levels of per capita GDP about a decade ago.  Many analysts, whose predictions about China's growth slowdown had been proved wrong in the 1990s, became much more cautious thereafter. Those of us who were willing to take a reputational risk, have been proved right, as China’s economy slowed below 8% in 2012 and is now projected to slow below 7% by the multilateral institutions.
    The global financial crisis ensured that growth of World trade would slow sharply below the very high growth seen in the previous decade, aided by a correction of the bubble like growth seen just prior to the crisis.  This meant that China’s (net) export-investment model was no longer sustainable and would produce slower growth in the 2010s.  To delay this slowdown China pumped large amounts of credit into the economy, with the official Debt-Gdp ratio rising from 55.2% of GDP in 2008 to 88.1% in 2013, an average increase of 6.6% points of GDP per year. Analysts have estimated that the debt in the shadow banking system may have increased by an equivalent amount, with total debt rising to dangerously risky levels.  Based on historical experience of such debt bubbles, some analysts predict that this bubble is now likely to burst and reduce China’s growth rate to the 3% to 4% range. Analysts who have greater confidence in the ability of the Chinese Communist party to manage economic crisis, nevertheless predict a deceleration of the trend rate of growth to a range of 6% to 7%. A safe intermediate prediction is a gradual growth slow down to 5 to 6 per cent rate over the next 10 years.

Comparative Growth

   Based on World Bank, World Development Indicators data till 2013 (till which year India's GDP base 2004-5 was fully available), we can examine and compare the growth rates of China & India. A plot of these rates shows that the growth rate difference has been narrowing since 1990, due to a gradual deceleration of China and a stronger acceleration of India. Underlying this narrowing growth difference are variables that are drivers of or correlated with, GDP growth and productivity. These include FDI and exports, which are indicators of competitiveness and Imports which reflect openness.
     The difference between China and India’s FDI-GDP ratio has been on a declining trend, from about 3.5% of GDP in 1990 to a little over 2% of GDP in 2013. Underlying this is slow but steady progress in attracting technology and risk capital to India, with a milder decline in China’s attractiveness. China’s Export GDP ratio which was 8 per cent points higher than India’s in 1990, rose 10% points to an average of 18% during 2005 to 2007. It then narrowed rapidly to about 1% in 2013, indicating that India’s exports have held up to the global decline in world trade since 2008, much more effectively than China’s. The difference between China and India’s Import-GDP, which fluctuated around an average of 7.1% points between 1990 and 2007 declined dramatically to -5.2% by 2011-13, indicating that the Indian economy is now significantly more open than China’s.

Base Change Implications

       Analysis and forecasting of Indian growth has been confounded by the appearance of a new GDP series (2011 base) which has made some fundamental changes in methodology and data sources used.  As this new series provides less than three years of growth data it is impossible to estimate the underlying trend growth rate using this series.  After the mid-year 2014 budget I had written that “The measures taken in the budget will be sufficient to increase growth by about 1 per cent point over the last year’s 4.7% to 5.7%. Actualization of some of the measures indicated in the budget will however be necessary to raise growth to the 6.5 to 7% range in 2015-16.”  Given that the average growth rate as per the new data is about 1% point above that, using the new data, a projected growth rate of 7.5% to 8% is quite conservative. This seems to be the reasoning underling the World Bank’s and IMF’s  projections for India’s growth in 2015 and 2016.
      The CSO has however projected a growth rate of 7.4% for 2014-15 and a growth acceleration to 8% in 2015-16 would not be wildly optimistic.  As many observers have pointed out however, high frequency data, such as the Index of Industrial production for manufacturing, quarterly results for companies and tax revenues from excise and corporate income tax, do not appear consistent with these high growth levels. The author has argued in the policy paper, “Indian Growth Puzzle,” ( Policy Paper No. WsPP 3/2015, New Delhi, April 2015 ) that the global financial crisis (GFC) and the consequent global demand recession and excess capacity, have affected not only the export led Chinese economy, but also the globally competitive and connected corporate (GCC) sector of India. Post GFC, the GCC corporations will lag overall recovery, instead of leading it, as they did in 2002-3 to 2007-8. Thus all indicators connected with these companies, such as IIP, corporate profits, corporate & excise tax revenue would also lag the GDP recovery. The Indian Government needs to be aware of this issue and be prepared to manage central government expenditures subject to a slower recovery in tax revenues.


    Based on the theory and empirical evidence provided by high growth economies, some analysts had predicted since the 2000s, a slowing of the Chinese economy during the decade of the 2010s to rate of growth below that of the Indian (“China-India growth Projections” and other papers at  By making the export-investment led strategy of development unviable, the global financial crises made this highly likely if not inevitable. It was also assumed in the forecasts that the Indian government would continue to carry out the minimum reforms necessary to maintain India’s growth rate at an average of the previous decade. Because of complacency and policy mistakes by the Indian Government between 2010 and 2012, the Indian economy, faltered seriously. The corrections introduced in the last two years, have restored some of the momentum.
    Sustained growth of 8 to 8.5% over the next few decades, however requires implementation of the reform agenda and continuing sensitivity to shocks that can derail growth, given that the World environment is far from conducive to sustained high growth.  If this is done we should expect to see India growing faster than China and beginning to close the wide gap that has opened between the per capita GDP of the two countries. This has implications for China and India's foreign policy towards each other, that need to be kept in mind. Given the wide Gap between the GDPs of the two countries, it is however, likely to take at least 30 years for India to eliminate the GDP gap with China.
A version of this article appeared as the Lead article in The Hindu dated 29th April 2015 under the banner. "Tracking Two Growth Stories" :

No comments: