Tuesday, February 09, 2010

India's Economic Strength Compared To China

Why is China the “workshop of the world” when Indian labour is even cheaper and her entrepreneurs admired worldwide? There are many reasons, including (until recently) the anti-foreign-trade policies and small-scale industry reservation policies as well as poor infrastructure in power, roads, water and ports. Perhaps even more important are the restrictive labour laws and certain other regulations, which encourage Indian manufacturing units to “stay small”, thereby forgoing the classic industrial economies of scale and scope.

Both China and India have sizable population, both are seeing a growing middle class by improving the economic livelihood of those in the rural areas. Yet as an economic engine or superpower, India seems to be bogged down by certain factors. The biggest division is that one is state planned centralised economy while the other is probably to most democratised country in Asia with many "almost independently managed states". However, thats the big picture, the reality would show that India's economy is more powerful and resilient in many ways when compared to China.

As a percentage of GDP, China's domestic consumption is the lowest of all major economies, hovering at just 1/3 of GDP. Most of China's growth in 2009 had come from infrastructure spending or speculation in domestic assets. In India, the domestic consumption accounts for 2/3 of GDP - now that is food for thought. China's artificial suppression of the yuan restricts domestic spending. As great as the surpluses are, more than 3/4 of China's capital goes to the 120,000 state controlled entities. That being the case, most of the profits in China end up in state coffers.

The OECD’s Investment Policy Review of India says India has designed policies to encourage investment as part of market-oriented reforms since 1991 that have paved the way for improved prosperity.

“Restrictions on large-scale investment have been greatly relaxed. Many sectors formerly reserved to the public sector have been opened up to private enterprise. Import substitution and protectionism have been replaced by an open trade regime,” the OECD report notes.

But further reforms are needed. India’s policy framework for FDI still remains restrictive compared with most OECD countries. Meanwhile, its investment needs remain massive, with poor infrastructure holding back improvements in both living conditions and productivity.

India’s growth is led by domestic demand and growing incomes in the coming years will continue to boost domestic demand and industrial activity. Reforms, the growth of home-grown corporations and rising scale of foreign direct investment are also pluses. Large domestic savings (37% of GDP in 2007), both by households and corporations, have played a pivotal role in India's economic growth. High domestic savings and the development of homegrown corporations have boosted investment (39% of GDP in 2007), helped by cheap foreign capital. Combined with a large private consumption (55% of GDP in 2007) base and a low trade dependence (imports and exports account for around 20% of GDP), the Indian economy is perceived by foreign investors as a "domestic demand-led story".

Due to the economic slowdown in 2008, household savings in financial assets fell to 10.9% of GDP in 2008 from 11.5% in the previous two years led by the large decline in holdings of shares and debentures. Households also shifted their savings from mutual funds to bank deposits due to an increase in risk aversion in 2008. With the decline in risk aversion in 2009, households will slowly shift back to equities. India's gross domestic saving rate might have declined from 37.7% in 2007 to 31% in 2008-09.

Indis' middle class stands at a formidable 300m while China's figure is around 150m. Half of China's population is in rural areas while India still have 2/3 of them in rural areas. According to a recent study by MIT School of Management, China's absolute levels of poverty and illiteracy have doubled since 2000, while India's have been halved! In India, economic growth in rural areas have outpaced growth in urban areas by 40%. Rural India now accounts for half of India's GDP, it was 42% in 1982, and it contibutes about 2/3 of India's growth . Rural China accounts for only 1/3 of China's GDP, and contributed to just 15% of the country's growth.

Increasing the growth potential and attaining the Chinese type of economic growth is constrained by India's democratic set-up, which requires political consensus to implement economic reforms. Coalition governments in the recent years have slowed the approval of reform and liberalization-oriented legislations. However, policymakers argue that slow and sequenced reforms and liberalization over the years have in fact helped India achieve strong and sustainable economic growth and limited the impact of global cues on the Indian economy.

India's medium term challenges include reducing dependence on foreign oil, increase efficiency in oil consumption to reduce its impact on fiscal and trade deficits. Cutting down oil and agriculture subsidies to reduce unproductive fiscal spending and large budget gap. Structural reforms include improving agriculture yields, development of infrastructure, health care and education access to increase absorptive capacity of economy. Other challenges include: The stance on Foreign Institutional Investors (FIIs) and capital inflows, and managing their role in generating credit and asset bubbles. Balancing private sector and foreign investors' role with concerns about social stability. Reducing corruption, and income and wealth inequality, especially between states and between rural and urban areas. Boosting human capital development and job creation can raise consumer spending, especially for the lower and middle income groups and in rural areas. Liberalizing foreign investment caps, broadening and deepening the domestic capital markets, easing capital controls on companies to borrow from abroad, and improving financial intermediation of domestic savings can buoy investment.

We should reconsider India in relation to China in their path to dominating the global economic scene over the next 20 years. Both will be taking very different path and will have major consequences to the global competitive paradigm. China's still lags in a several areas and the rural dislocation and to a certain extent the "forgotten group" being left behind will have grave social and economic costs in the coming years, if not properly managed and improved on.

p/s photos: Asin

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