a comparison to most EMEs, and especially China. Even if the global interest rates rise, India is unlikely to face a debt crisis, though there could be instability in the foreign exchange market in the short run. But the question of whether India can avoid a prolonged period of slow growth (without a change in policies) is another matter.
Question 2: Can China change its debt and investment-led growth, given the incentive structure of local governments and their access to bank credit? In other words, can China disembark its credit-led investment growth strategy to keep employment growth going without causing political unrest? In other words, is it a case of Chinese policymakers riding the political tiger?
Answer 2: Given China’s seemingly solid macro foundations, there is no apparent reason why the government cannot shift public investment away from physical infrastructure (road, rails, bridges, and urban housing) to schools and hospitals, and make them available for free for poor. Descriptive accounts show how Chinese struggle to get treated in good public hospitals (Burkitt, 2012). The answer probably lies in China’s contradiction between centralized politics and the decentralized economy.
India, on the other hand, may find it hard to reverse the declining domestic investment rate given: (i) the NPAs of the banking system, (ii) reluctance of foreign private capital to step up investment given the debt situation of the PCS, and (iii) government’s reluctance to raise public infrastructure investment given its commitment to fiscal orthodoxy.
Question 3: Can China embrace consumption-led growth given the interests of local state for revenue from land sale and property development? Can India curb its consumption-led growth towards public investment- and capital good-led industrialization?6
Answer 3: It is well known that China’s social infrastructure and personal consumption growth are modest, though claimed to be improving. These need to be stepped up and physical infrastructure growth needs to curtailed if China is to change its growth pattern. But very little of it seems evident on the ground (despite avowed objective). China’s disposable income is just 44% of GDP. Why? (comparable figure for India is 86%). The answer, perhaps lies in the incentive structure of the local party-state. Building public hospitals and better schools or providing better facilities does not seem to bring in revenue for the local governments and the private benefits to party-bureaucracy in the same way as infrastructure and real estate investments do.
Question 4: Housing starts and sales are declining, but prices continue to rise. Why? Access to non-bank credit (shadow banking) seems to be a cause for concern. Will the inflated real estate prices deflate gently as demand grows, or could it result in a burst causing a disruption?
Answer 4: Could China’s high-debt ratio trigger a financial crisis is the million dollar question among China watchers, but the answer is anybody’s guess. Economic literature provides very little guidance in this matter.7 Those raising a red flag about it are mostly guided by the debt–GDP ratio and its steady rise since the GFC in 2008. The ratio is among the highest in the world. My cautious answer to the question is as follows: Though very high, China’s debt is mostly domestic, and China’s domestic saving and investment ratios are also very high by any standards. Moreover, the party state has enough instruments (though some of them blunt) to quell any financial meltdown. However, Japanese-style prolonged deflation or stagnation cannot be ruled out if return on investment falls drastically, and the state is unable to stimulate domestic consumption faced with an aging population.
India, on the other hand, needs to get its fixed investment rate back to 38–39% of GDP (to secure East Asian-like economic outcomes). Given the current levels of bad debts, it is really wishful to expect PCS to resume a fresh investment cycle, unless the government writes off loans (or socializes their costs). Perhaps a better option would be to step up public infrastructure investment by adopting a flexible fiscal deficit targets. The ‘Priority sector’ lending for agriculture and SMEs needs to be revived, boosting capital formation in the unorganized or HH sector, implying a stronger role of the state in steering the economy. Correspondingly, the objective of FDI needs to be to augment capacity expansion to meet ‘make in India’ campaign, not for augmenting import-led consumption growth (as mentioned above).
If India cannot get its policy act right, the reasons for this would be policymakers’ commitment to fiscal orthodoxy not the economy’s objective conditions.
Section 4: Summary and Conclusion
Both China and India are still poor countries with low per capita income — with the average of OECD member countries being $38,423 as of 2014. There is a need (and a potential) for substantial growth of China and India that can help revive global economy. Both countries have large domestic markets that are their biggest advantages in present times, which can help withstand external demand shocks. China needs to move away from housing and infrastructure investment to social sector investment and consumption-led growth — though widely admitted, it finds it hard to change the policy gears apparently due to political economic reasons. Rules governing the distribution of fiscal resources between the center and provinces perhaps need to be redrawn to reduce the incentive for provinces to rely on land sale and real estate.
India perhaps needs to make a move in the opposite direction of regaining the investment-led growth witnessed during the last decade to improve not just physical infrastructure but social infrastructure to stimulate private investment and improve human resources. This is urgently needed if India has to seize the one time opportunity offered by potential demographic dividend.
Critical questions: Will China succumb to Japanese-style debt deflation? It is a difficult question to answer. India does not seem to face a similar fragility; it may be growing slowly and its growth numbers may be suspect, but the prospect of macroeconomic crisis seems remote relative to China. India’s external financial position is not very sound, but in a comparative EME perspective, the risks do not seem large. Though India’s corporate debt is very large compared to its past levels, it is not high by the contemporary levels among EMEs. India also has greater political stability and certainty, its market institutions are more rule-based and hence supportive of market economy. China on the other hand is far more state dominated; though it may appear strong, it is in fact brittle.
I suspect a contradiction could emerge in China between the center’s desire to stabilize the economy on to a more sustainable path, whereas the provinces may continue to pour money (via bank credit) into fixed investments and shadow banks would continue to finance real estate investment. (This is evident from the fact that when the central government decides to scrap excess capacity in manufacturing or close down unsafe mines, the efforts are thwarted by local interest groups who tacitly oppose it, because such efforts are not in the interests of provisional party-state in terms of keeping peace and generating employment and earning tax revenue for provinces.) Then, at some point, the economy risks spinning out of control of the central government and monetary authorities, unless the rules of engagement between the center and provinces are amicably changed with an alternative political incentive structure in place.
Acknowledgments
The author is grateful to Lynette Ong and Yue Zhang for the comments and suggestions on an earlier draft of the chapter and to the participants of the Conference on ‘Political Economy of Emerging Market Countries: The Challenges of Developing More Humane Societies’ held during January 2–4, 2017, in Santiniketan, West Bengal.
Appendix 1: China’s Economic Indicators (Source: IMF’s country report, 2016).
Sources: CEIC Data Co., Ltd.: IMF, Information Notice System; and IMF staff estimates and projections.
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