India-China Growth Reversal & GDP Gap

Introduction

      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.

Conclusion

    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 https://sites.google.com/site/drarvindvirmani/growth).  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.

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A version of this article appeared as the Lead article in The Hindu dated 29^th April 2015 under the banner. "Tracking Two Growth Stories" :

 http://www.thehindu.com/opinion/lead/india-and-china-tracking-two-growth-stories/article7151377.ece

China's Growth relative to India's

   I have predicted since the early 2000s, that China's Growth rate will decline below that of India's around the middle of this decade [ Figures & Tables ]. Both the World Bank and the IMF have come around to this view in their latest forecasts.

The projections were based on the theory and emperics of "Catch up" growth. Very succinctly the reasoning is that with the right policy poor economies(low per capita GDP) can grow much faster than the advanced economies(high per capita GDP) and thus close the gap between them. Maintance of the higher growth rate requires further policy and institutional reforms. However, even if appropriate policy reforms are made, the  growth rate will still slow down gradually, though it can remain higher than that of the developed countries.

China, with its unprecedented growth rate which averaged close to 10% over 30 years, seemed to continually violate this rule. Nevertheless, I had projected that it would start slowing down in the 2010s. The advent of the Global Financial Crisis, increased my confidence that it would happen. The fact that it recovered quickly and continued to grow faster than India, was easily explained by pump priming, through large injection of credit, given its party controlled banking system.  My judgement in 2010 was that such pump priming could be maintained comfortably for 3 years and would start getting dangerous after 5 years. Five years have now passed since the huge injection of credit started, and the dangers of a debt default related melt down with keep rising, unless China stops the excessive pump-priming.

There are two views about its future growth trajectory. One is that China will undertake the needed re-orientation in the economic policy framework (from investment to consumption and from manufacturing to services) and growth will slow to the 5,5% to 7% range. The other view is that if it continues the credit fueled growth (some say even otherwise) its growth could collapse to the 3-4.5% range. I continue to believe that the former is the more likely scenario.

Indian economic growth averaged about 7.7% for the decade from 2002-13 to 2011-12.  However, as I had warned in 2009 [in my last economic survey(June 2009) as CEA and in follow up interviews], India's high growth shouldn't be taken for granted. Unfortunately this warning (and subsequent ones) were not headed and growth collapsed from 2011 to 2014.  With the reform steps taken and in process since last year, I expect growth to recover steadily to its full potential by 2018-19. The trend growth rate of India will therefore exceed that of China by the end of this decade.  However, at the growth rates that I have projected (till last year), India.s economy will be only be half (1/2) the size of China's by 2025 (in real PPP terms).

[Great Powers & Super Powers ]

New Development Bank (NDB): BRICS Bank

Introduction

    The leaders of the BRICS countries approved the formation of the BRICS Bank at their meeting in Brazil, on July 15, 2014. The idea of a BRICS Bank was floated by India in 2011-12 during its chairman ship of the grouping .  A study group was formed in 2012 to explore the idea further.  The leaders of the BRICs countries, approved the setting up of an inter-governmental group at their meeting  in S Africa in March 2013, to work out the modalities.  The unresolved issues have been resolved and final approval given by the leaders in their summit in Brazil.

BRICS

  Plurilateral discussions among the four largest non-OECD economies, China, Russia, Brazil and India started in late 2006 on the sidelines of the UN. They were given a strong impetus by the start of discussions in 2007 on the IMFs 12^th General Quota Review (GQR) slated to be completed by January 2008. It was feared that the Europeans and the US which controlled the management and equity of the IMF (and the World Bank) would continue to resist giving a greater share of equity to the BRICs and other developing countries. As a consequences the Executive directors of these four countries based at the IMF & World Bank, started meeting informally in Washington, to exchange views on the GQR and to co-ordinate their approaches to the extent approved by their “principles” in respective capitals.  The Governors of the IMF from these countries (three Finance Ministers and one Central Bank Governor) also started meeting on the sidelines of Bank-Fund annual and bi-annual meetings. The limited success achieved in the 12^th IMF GQR and the corresponding review of World Bank capital, led the BRICs to heighten their interaction. A full diplomatic meeting was held in Russia in May 2008.  The global financial crisis that erupted in 2008 in the developed countries, highlighted the need for BRIC countries to provide an alternative to the philosophy and economic thinking of the G7 and to work together to change governance structures at the IMF and the World Bank. This paved the way for the first formal summit of BRIC leaders in Russia in June 2009. There has been heightened co-operation between the BRICs countries from 2009 onwards, with respect  to the IMF and World Bank, even though the interests of individual countries sometimes differed from the rest.  Efforts were also initiated to expand the areas of collective action, of which the BRICS bank and the Reserve Fund are an outcome. South Africa was invited to the BRICs summit in China in 2010 and admitted to the group thereafter. 

Infrastructure Financing

      India, along with other developing countries in Sub-Saharan  Africa, faces an enormous challenge of finding the financing to upgrade its infrastructure.   Traditional funding sources are heavily constrained, both in the total funds available for development and for the financing that they are able or willing to allocate for development of new infrastructure projects.  At the same time China and oil-gas exporting countries have surplus funds, which are currently being recycled primarily through international financial markets in the Developed countries.  A New Development BRICS Bank has the potential to intermediate these savings from the surplus emerging economies to developing economies with a deficit of finance for infrastructure investment thus accelerate economic growth of developing and emerging economies.

   My friend (and former colleague in Washington), Amar Bhattacharya has estimated that the Developing and Emerging economies need for infrastructure funds will increase from the current $800 bi per year to about $2.4 trillion a year in the next two decades. Of this the about $1.2 trillion a year is for new greenfield projects, essential for accelerating and/or sustaining growth and improving the welfare of its people.  Besides networks of railways, highways, ports and airports, the surge in urbanization will put huge demands on both the quantity and quality of urban infrastructure. In many countries the rural areas still lack basic facilities like clean water, sanitation and sewage, which must be built. In addition, budgetary resources of many countries will be stretched just maintaining existing stocks of infrastructure at acceptable levels of quality.  Private investment through Public Private Investment (PPP) is another source of infrastructure investment but has its own limitations.

World bank

    The multilateral institutions like the World Bank are struggling to maintain infrastructure funding at old levels, given new demands and lack of lending capacity.  The World Bank’s lending is reduced to half of what it was before the global financial crisis.  It is unable to increase its capital base for further lending, because of the fear of loss of traditional control of this institution by the developed countries. Private lending for infrastructure has shrunk to one-third of its pre-crisis level.  The BRICS bank is a small but significant step to fill this yawning gap in infrastructure funding.  Just the idea of a BRICS bank had energized the management of the World Bank to set up a special fund for infrastructure. It is likely that the actual setting up of the Bank will induce to bank to improve its own rules and procedures for infrastructure lending. However, given the large disparity in share capital, the BRICS Bank will not be a major threat to it in the next five-ten years.

Equity Shares & Power

     The New Development bank (NDB) will be $100 bi Bank with an initial subscribed share capital of $50bi with equal shareholding of all five BRICS countries (i.e. $10 bi each). Of this $10 bi will be put up in cash by the five countries in cash over seven years. The remaining $40bi will be in the form of guarantees.  Thus India will have to budget for cash infusion of about $300,000/year or Rs 1.8 crore per year for the next seven years. Any future expansion of the subscribed share capital to bring in new ones, will ensure that the BRICS continue to have a majority ( > 55%) shareholding.

  Our experience of the World Bank and IMF tells us that this is a necessary condition for an equal share in governance of new Bank. This also ensures that all five will have an equal voice in defining the philosophy, operational rules and procedures and governance of the bank.  The bank will have to raise debt capital on international capital markets, for lending to potential borrowers. The IMF and World Bank follow the conservative practice of a 1:1 Debt-equity ratio, and the NDB may also have to follow this practice to ensure a high safety rating.  Even if China is a major supplier of this debt capital, it will be at competitive rates, through open bidding and will therefore give no additional power to China as a bond holder (not anymore than it has over the US treasury/Govt. as a buyer of US Govt. bonds).  Its equity share and power over NDB lending decisions will be 1/5^th .

    On issues of vital national interest to any of the shareholders, a consensus of five countries is likely to favor status quo.  For instance it is likely that the BRICS bank will be unable to make loans to projects in parts of India like Arunachal Pradesh, expansively claimed by China, if India has already accepted such conditions in the ADB and World Bank.

Bank President

     The first President of the NDB, who will be an Indian with a six year term, will play a vital role in setting up the management philosophy, rules and procedures under which the Bank will operate. It will be very important to appoint a banking-financial expert, familiar with the latest instruments, practices and procedures of a competitive private bank,  who can develop a 21^st century development bank to compete with the 20^th century one like the World Bank.  One possibility is an eminent Indian who rose to the top of an international bank, but has retired from the job and thus had the time to reflect on broader issues.

   The Indian presidency will be followed by five year terms for Brazilian and Russian nominees. From this we can assume that the new president will have one extra year to complete all the formalities necessary to create a functioning organization.

Conclusion

  Some have bemoaned that Shanghai and not Delhi is the seat of this new Bank. For this we have no one to blame but ourselves: We have been talking about making Mumbai and international financial center for a decade or more and are no closer to it than when we started! Some analysts have raised the concern that China will have an inordinate influence on the functioning of the Bank. There is nothing in the agreed structure of the Bank that would justify these fears.  Others are concerned about India budgeting so much money for a plurilateral bank. Rationally this should be compared to our funding for World Bank, IMF and other multilateral and Regional Banks and the benefit-cost ratio of each.  In my judgement the benefit-cost ratio will not be any less and perhaps somewhat more.

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A version of this article appeared in the Economic Times of 17 July 2014 under the banner, “BRICS Bank will help fund infrastructure projects in Emerging Economies” http://economictimes.indiatimes.com/opinion/guest-writer/brics-bank-will-help-fund-infrastructure-projects-in-emerging-economies/articleshow/38504229.cms