China: Tariff war, Debt bubble, Over investment & Growth.

Q1: The IMF has downgraded China's economic growth by 0.2 percentage points to 6.2% for the (calendar) year 2019. Meanwhile, you have predicted China's growth could slip to below 5%. When do you expect this to happen?

A1: All official forecasts, including IMF, World Bank, ADB, relate to official country data. My forecast of a decline in China's GDP growth rate to 4.5% to 5.5% , relates to the real (underlying)GDP growth rates. The gap between official & real rates in China is likely to rise sharply next year and then close slowly. This official data may only reflect the full extent of real growth slowdown in about 3 years i.e. 2021!

Q2: How will China's growth slowdown impact the rest of the world? What will be the impact on the Indian economy?

A2: We must distinguish the immediate short term (ST) impact from the medium & long term one (MLT). The ST effect will be to slow China’s export growth and Imports linked to it i.e. natural resources from developing countries, capital goods from developed countries & intermediate inputs from Asian supply chains. Therefore, GDP growth in these countries may be adversely affected in short term. In MLT a slowing of Chinese growth and investment in manufacturing & other tradable goods will reduce excess global capacity in tradable goods. This will increase profitability in manufacturing, investment & GDP growth in India and other competing countries.

Q3: You have pointed out that China's growth will be impacted by the tariff war and domestic credit bubble. Can you quantify the impact of these two factors?

A3: The USA is the largest market for China’s exports. A rise in US tariffs on imports from China has both a direct effect on its exports and an indirect effect on FDI investment in supply chains located in China. Together these could reduce China’s growth by 0.75% to 1.25%, if higher US tariffs are maintained. Exit from the debt-credit bubble would reduce growth by 0.5% to 1%. These supply chains will relocate out of China over next year or two, increasing FDI & investment in competing countries in Asia, and increase exports from & GDP of these countries.

Q4: Tariff war is largely being pushed by President Trump. If the restrictions do not escalate into a war, is the Chinese economy still at risk?

A4: The effect of an additional (above rates for others) 25% US import tariff on all imports from China, if sustained for 3 to 5 years will result in a deceleration of China's GDP growth. The measures directed at preventing forced transfer of technology and theft of technology from US companies will continue in parallel and ensure that, reverse engineered US R&D cannot be passed off as innovation.

Q5: How bad is the domestic credit bubble in China? Can the country manage a soft landing?

A5: The Chinese economy has seen among the largest increase in debt among the systemically important economies (US, Euro Area, Japan, UK, India), since the Global Financial crises(40% of total global debt increase). An earlier debt-credit bubble burst in 2015 & a new one was initiated in 2016, but channeled a little more through the fisc and combined with a tightening of capital controls on residents/citizens. Increased external & internal controls make it easier to ensure a financial soft landing. They do not ensure a soft landing in terms of real Economic growth.

Q6: How can China maintain its growth momentum in a de-globalized world

A6: The massive increase in World Trade ended with the Global Financial Crisis. China which benefited hugely from this globalization, has avoided the severe consequences of this reversal of globalization by increasing its share of global import and by pumping credit into its economy. These measures have kept its growth from falling below 6.5%. The US tariffs on China mean that countries which have lost because of the mercantilist growth model followed by the communist party of China are no longer willing to accept these costs. Similarly credit fueled growth cannot be sustained indefinitely. Thus, a decline in China's GDP growth rate is inevitable. The only question is when and how smoothly? China can smoothen the adjustment to a lower growth rate by allowing wages to rise to level consistent with its Per Capita GDP & eliminating directed lending to unprofitable SOEs, Exporters, Party capitalists and high risk, low return investments.

Q7: You have talked about the opportunities for India from the US-China tariff war. What are they?

A7: From the start of the US-China tariff war, late last year-early this year I have emphasized the huge opportunity for India to attract supply chains located in China to India. The new US approach to China's communist party run non-market, non-transparent economy creates great uncertainty for export-oriented supply chains located in China. Given India's free market, open democratic system the Indian economy provides a stable long-term location for such investment. This is particularly so for labour intensive products & processes and where cyber security is a concern as in electronics, telecom & electrical control systems. However, we need to get our own policies and institutions in order. The EoDB external indicator is still very poor. Complaints of tax terrorism are still heard from foreign companies. We need to drastically simplify bureaucratic procedures for FDI & other Export production.

Q8: There is talk of decoupling or disentangling of the US and Chinese economy, what are your views?

A8: There is very high likelihood of a decoupling of the US and Chinese economies over the next 10 years. This will affect significant effects on Geo-economics and Geopolitics. We must be prepared to grab the opportunities this will throw up while remaining alert to the dangers.

To read more,

 "Effect of China Slowdown on India", Policy Paper No. WsPP 1/2017, April 2017, ChinaIndia17feb20Apr.docx .

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A version of this Q&A appeared in digital Financial Express at, https://www.financialexpress.com/economy/avind-virmani-exclusive-china-gdp-growth-could-crash-to-just-5-and-it-is-profitable-for-india/1345357/ and at https://www.financialexpress.com/economy/china-gdp-growth-could-fall-below-5-former-cea-arvind-virmani-tells-when-and-why-it-will-happen/1343910/

Q&A on Economy & Trade

 Interview given to Bijoy Kumar Sing of PTI on August, 9, 2018:

Q1: What is you assessment of current macroeconomic situation in India? Some experts believe that  the macro situation is becoming more challenging in the last year of Modi  government? FDI growth hits 5-year low in 2017-18, rupee has depreciated, oil prices and inflation are rising? 

A1: Economic growth, which has been subject to many ups and downs over the past seven years, seems to be back on a recovery path. The most important indicator of this is the rate of growth of real fixed investment, an essential element of sustained, sustainable growth. On the external front some challenges such as the threat of rising interest rates and commodity prices are the negative face of a rise in developed country growth. So they are partly offsetting. The rise in oil prices due to Geopolitical factors, like Iran sanctions are however a concern.  The US-China Tariff war however provides an opportunity to increase India’s exports to the USA and to attract, labor intensive elements of the global supply chain unsettled by higher “China risk”, to India. Domestically the main risk to macro stability, is politically driven Govt consumption spending at the cost of investment and fiscal prudence. If this temptation is resisted, the country will be back on a firm 7.5% plus growth track. 

    Q2: India has emerged as the sixth largest economy replacing France? How do you see this development?

A2: in a series of papers since 2004, I had predicted the rise of China and India as economic powers (https://sites.google.com/site/drarvindvirmani/india-great-power ). India will become the fifth largest economy in 2018 and the 3rd largest, after USA &  China, by 2025 (in current US dollars). According to the index I developed for making these projections, VIPP, India will become a great power by ~ 2035. It is very important for our elites to understand both the strengths and the limitations of these developments. We must start planning our global interactions and acting like a leading power, without ignorantly imagining that we are already a Great Power (that is 20yrs away). 

    Q3: The US actions on trade have emerged as the biggest worry for global growth. What will be impact of rising trade tensions on Indian economy and what should be India's strategy?

A3: We must distinguish between US trade actions against market economies like EU, Canada, Mexico and other market economies from those against non-market China. The conventional wisdom that everyone will loose from a trade war applies to the former, but not to the latter. A single party dictatorship has dozens of ways of imposing non-tariff barriers on imports & foreign investment, that free open democracies, run by rule of law, cannot even imagine. The US-China tariff war will have some short term disruptive effects on global economy, but provides great opportunity for India to attract Labour intensive, export oriented and Indian market oriented investment from those currently located in China. The Indian Govt, private industry and PSUs must make an effort to attract them to India.

    Q4: The general elections are less than a year away and there is a possibility of populist policies being announced by both the central and state governments. Is there a possibility of slippages in the fiscal deficit?

A4: Historically every Govt pushes up what are referred to as populist expenditure in the year or so leading up to the election. The test is if they keep it modest and don’t disturb the trend in fiscal responsibility. There is therefore always a risk of fiscal slippage. At State level, this is partly linked to losses incurred by State electricity distribution. 

    Q5: Prime Minister Narendra Modi had said that demonetisation will reduce generation of black money in India. But money deposited by Indian's in Swiss banks rose by 50 per cent last year. So, how do you read the effects of demonetisation nearly two years later.

A5: The data that I have seen shows that money deposited by Indians in Swiss banks has been on and remains on a downtrend. As as demonetization, I had written the week after demonetization that it would reduce the growth rate of the economy by about 0.5-0.6% in the 6 months following the demonetization or about 1% for the year as whole (assuming the recovery takes a year). My subsequent estimates show a loss of 1.2% of GDP in the 12 months following demonetization. On the positive side I had predicted an increase in income tax compliance, which seems to be happening (as per limited data available). The effect on black money in real estate and elsewhere did take place, but seems to have been less permanent. 

    Q6: There is common perception that departures of foreign' economic advisers (Raghuram Rajan, Arvind Panagariya and Arvind Subramanian) underline the Modi administration's rejection of free trade and open market approaches to policy in favor of protecting domestic industries and farmers. Your comments.

A6: Since I retired from the post of Chief Economic Advisor at the end of 2009, my successors as CEA (Kaushik Basu, RaghuRam Rajan and Arvind Subramanian) have all returned to jobs abroad, after completing their Indian tenure. The same happened in the case of Arvind Panagriya of NIti. In my judgement this is not primarily due to any disagreement on free trade and open markets, which is indeed one of the weak points of the current Govt (I have argued for trade reform in the, Bibek Debroy edited, book, “India at 70, Modi @3.5 “ )

    Q7: Recently Commerce Minister Suresh Prabhu had said that 40 per cent of India's GDP will come from exports by 2025, and India's economy will be a USD 5 trillion economy 2025. At present, exports constitute only 18 per cent of USD 2.6 trillion GDP. Do you agree with Prabhu?

A7: An open economy is one of the drivers of growth in a connected and liberal world, which is why I have continuously argued for reform and liberalization of EXIM policy(agriculture) and of import tariffs and export duties. I continue to do so. However, given the anti- free trade sentiments sweeping the world, we have to be a little more selective and cautious in dealing with non-market, non democratic countries which find it easy to follow non-transparent policies that harm our interests. This poses a challenge for instance in concluding the RECEP agreement.

Impact of TPP & US-China Trade War?

Q&A with India Today (Ananth Krishnan), January 28-29, 2017

Q1:  Are we heading to a China-US trade war? If Trump goes ahead with 45% (or high) tariffs on Chinese imports, do you think he is in a position to do a lot of damage to the still struggling Chinese economy? 

A1: A selective import tariff on US Imports from China and an equivalent tariff on Chinese imports from US would do much more damage to the Chinese economy than to US economy, because of the asymmetry in current account balance & the ease with which imports can be substituted compared to exports. Such a move would accelerate the crash landing of the Chinese economy. My guess still is that US will find other ways to address China's non-market that don't undermine WTO system.

Q2: Do you think withdrawing from the TPP is really as big a gift to China as many analyses are suggesting? What do you think India's response should be? And what would an increasingly inward looking US (at least on trade) mean for us?

A2: The TPP has been highly over-rated by conventional wisdom (CW) for both its real economic and its geopolitical benefits to members. There is some psychological loss to the members and corresponding psychological gain to China, but this is very minor compared to the general economic & geopolitical uncertainty created by the sceptical approach of the new president towards foreign relations/policy.

Q3: Do you think this is going to speed up the RCEP negotiations or on the other hand allow China to relax and drag its feet? On RCEP, India has been concerned about the services aspect. How do you think we should approach RCEP in this changed climate?

A3: The direct effect would tend to be to speed up RCEP negotiations. On the other hand the greater uncertainty separately created with respect to US-China economic relations,would tend to induce a wait & watch attitude. Net effect is unclear.

Q4: The Chinese have been pushing an FTAAP at the last few APEC Summits (seen by some as a TPP counter). Given China's mercantilism (and the imbalance it enjoys with most countries in the region) do you see this going forward at all? 

A4: Given its mercantilist approach, and its slowing economy, there is little indication that China is willing either to change its economic development model towards genuine openness or make sacrifices for other countries. This constraint to FTAAP remains unchanged.