8 Aug, 2011

China, India Outline Lessons Learnt From Debt Crisis

Imtiaz Muqbil

This dispatch includes two commentaries published in the official Chinese publication People’s Daily Online and its comments blog section on the lessons that China has learnt and what it could/should do in the wake of the U.S. and European debt crises, and a speech by Indian Finance Minister Pranab Mukherjee assessing his country’s economic strengths and weaknesses.

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Financial Crisis Comes Back To Bite China

By Li Hong (People’s Daily Online)

August 05, 2011 — The sudden bout of the Wall Street Thursday and stock market plunges elsewhere speaks it out: the global financial crisis, though receding in 2010, is haunting us again.

The market’s fear of sputtering economic engines in the United States, Europe and Japan is thickening, exacerbated by the just-concluded political fight in Washington to cut drastically government spending when the anemic U.S. economy needs it most.

And, previously hidden jitters about spread of fiscal woes in Europe, from Greece, Ireland and Portugal to Spain and Italy, has never abated, and it is increasingly likely that bigger euro-zone countries will ask for bailouts, if they do not default on debts.

The origin of problems remains with people’s “exuberance” of rushing for bubbling equities and fortunes among the developed economies in the early years this millennium. Governments’ complacence and regulators’ negligence – including U.S. Federal Reserve’s extraordinarily low rates to fire up American houses and stocks – are central cause of all economic troubles.

When the sub-prime mortgage takers, who should not have been given a cheap loan in the first place, failed to pay back, the dominos fell bringing banks and financially feeble governments down. Some in Europe haven’t seen a light in the tunnel.

Wild swings

Yesterday, the Dow Jones industrial average fell 512 points, its ninth steepest drop. Friday, stocks in Japan and Hong Kong lost more than 4 percent, and China’s Shanghai composite index lost nearly 60 points or 2.2 percent. More bleeding is to be expected in the coming days.

Ask any head-shaking investors, and they would tell you they were awed by the wild stampede to sell off holdings, a scene reminiscent of the wild swings that defined the peak of the crisis in September 2008. In just two weeks, up to $1.9 trillion in market value has evaporated at Wall Street.

The Federal Reserve and other central banks in the developed countries will soon ease monetary policy letting printing houses churn out trillions of paper currencies – so-called “quantitative easing” – to drag down market rates and deflect deflation. The results are known to us – a short-time normalcy of life, but once the oxygen respirator is taken away, all the previous ill symptoms come back.

Like 2008, China and other emerging economies could not insulate them from another recession in the developed West. However, they are endowed with strong fundamentals – less debts and a rising middle class willing to spend – so they are expected to weather a crisis better.

For China, it is wise for authorities in Beijing to clamp down hard on ever-surging housing prices in early 2010 and prevented a dangerous property bubble from enlarging. It has learned from the downs of the developed economies.

Next, China’s central bank is expected to halt the streak of raising interest rates to spur private growth and investment at home. But, it will face an even harder job to hold back inflows of hot money – released by Western central banks, and may have to be prepared to elevate banks’ required reserve ratios to prevent a credit flood from wreaking havoc in the country.

China Can Learn From U.S. Fiscal Woes

Source: People’s Daily Online, 07 August 2011

By Yukon Huang, senior associate at the Carnegie Endowment and a former country director for the World Bank in China.

As the largest foreign buyer of US government securities, China can only fret as the value of its holdings is held hostage to a fractured political process in Washington. But while the longer-term implications of these developments are likely to hurt the United States’ democracy and human rights agenda as far as China is concerned, ironically, they will help its international financial situation.

On the political front, China’s leadership will quietly welcome comparisons with the relative ease with which its system is able to move on collective action within a tightly-controlled political process. This will reinforce self-serving messages as the Communist Party celebrates its 90th anniversary, especially as the party has been under considerable pressure lately to redefine itself, as its society is no longer isolated, rural, and poor, but is now globally integrated, urban, and fixated on wealth accumulation.

And, while China struggles to achieve a ‘soft landing’ from its economic stimulus programme, the fiscal problems in the United States will be used as a reminder to its restless constituents that democracy doesn’t guarantee that the right compromises will evolve to support the common good. Nor will the problems in Europe in forging a collective sharing of looming default burdens, or the continued decline of the Japanese economy, strengthen the case for liberalizing China’s political system. Indeed, all this will make it even harder to bridge the cultural divide that separates China from the West over the way they view global issues.

Aggressively Reshape Policies

But on the economic front, recent developments are likely to push China’s leadership to move more aggressively to reshape the policies relating to the country’s exchange rate and trade regime that have exacerbated tensions with the United States over the past decade. The United States’ fiscal woes will reinforce the view that it makes little sense for China to continue generating trade surpluses that must then be used to buy US securities, which may only diminish in value over time. Any lingering notion that mercantilist tendencies still drive Chinese policymakers should now be discarded.

Some estimates suggest that with unchanged external policies, China’s foreign exchange holdings could increase from the current $3.2 trillion to $5 trillion by 2015. But with the prospects of all three major reserve currencies under a cloud, parking such amounts in foreign securities is unappealing, making it unlikely that these levels will materialize.

China’s overseas direct investments—which amounted to less than $5 billion seven to eight years ago, but now run around $60 billion annually—are another option for channelling these surpluses. But sensitivities among OECD countries make it unlikely that China can find enough attractive opportunities in the resource- and technology-based industries to make this a serious alternative. While growth in overseas investments will be brisk in the coming years, this won’t satisfy China’s desire to diversify its holdings, and returns would still be vulnerable to exchange rate fluctuations.

High-valued services

As a result, China’s leadership no longer sees much to be gained from accumulating foreign reserves. Its former preoccupation with job creation from export production makes less sense as its population ages and the labour force begins to shrink within the next few years. Increasingly, the challenge is to meet the job expectations of unemployed college graduates as their numbers have doubled over the past decade, instead of just trying to create largely menial positions. The pressure is now on to develop more high-valued services and knowledge-intensive product lines—with quality rather than quantity being the primary concern.

For these objectives to be achieved, though, more rapid appreciation of the renminbi rate will help rather than hurt. But exchange rate changes alone won’t be enough. Much more important is reversing the tax, subsidy, and interest rate policies that discourage the requisite high-value service activities from emerging.

The shift away from mercantilist objectives will be reinforced by the desire to move more rapidly to internationalize use of the renminbi. The authorities see greater use of the renminbi abroad as a means of insulating themselves from the instability and declining value of the dollar, euro, and yen. They also welcome the prestige factor and advantages in having the renminbi as an international reserve currency. But they face the predicament that the preconditions for being an international currency are that it must be freely traded in global markets, with its value and availability subject to market forces rather than government controls.

Hybrid-type global currency

For the moment, China will push much harder for the renminbi to be used for settling trade and services transactions, but continue to be cautious about freeing up capital flows. As such, the world will probably see the emergence of a hybrid-type global currency that will be used relatively freely to settle current account transactions, but remain controlled in terms of the volume and purpose of renminbi-denominated capital flows. This would, in principle, still allow China to retain tight control over its monetary policies and exchange rate adjustments.

However, these artificial separations can’t be sustained. China is moving down a slippery slope and, over time, the pressures to liberalize capital flows and allow the value of the renminbi to be shaped by market forces will prove to be overwhelming. This will force the country to accelerate the process of creating the necessary institutions and regulatory safeguards for the renminbi to be a true international currency. In doing so, it will complement other policies that will help reduce China’s trade imbalances.

And the current US fiscal woes will have at least one beneficial side-effect — they will help to lower the tensions that have arisen during the recent ‘currency and trade wars’ between the two countries.

India Can Absorb Shocks, Maintain Growth

Source: Public Information Bureau, Govt of India

The Union Finance Minister Mr Pranab Mukherjee addressed the National Conference of Confederation of Indian Industry (CII) last Friday. The conference bore the theme “Two Decades of Reforms: The Way Forward.”

He said that India would continue to achieve appreciable growth despite negative sentiments across the world. Mr Mukherjee said that our growth story is intact and the fundamentals are strong. He said that he is sure that our markets have the capacity to withstand the negative sentiments affecting the external world. The Finance Minister Mr Mukherjee said that we have taken several measures to make our markets attractive, robust and vibrant and would continue to do so making it an attractive investment destination for the foreign capital. The Finance Minister said that as global investors look for opportunities across the world, India’s attraction as an investment destination would continue to grow.

The Minister said that it is true that sometimes the process of reforms has been held hostage by political events and this is in the very nature of our democracy and its polity. He said that despite ideological differences the principal political parties have been able to work together on most issues. It is in that context that he has no hesitation in saying that the process of economic reforms in India is irreversible and that the economic stakeholders have no reason to fear introduction of any regressive policy measures at any point of time. Thus, for instance, there are no proposals for introducing dual pricing for diesel or increase in duties for bridging any perceived shortfalls in tax revenues, as has been highlighted by a speculating media in the past couple of days.

Mr Mukherjee said that the year 1991 stands out as a landmark year for the change it brought in economic policy and administration in the country. He said though the winds of change had started gathering momentum in the early 1980s, yet it was the Union Budget of July 1991 that brought out major economic policy initiatives to the forefront. Mr Mukherjee said that it gradually helped the economy towards newer heights of achievements, opportunities and capacity to confront the ever changing challenges of a globalised world. CII has been an important stakeholder in this journey and I acknowledge its contribution to the process, the Minister added.

He said that he has always maintained that reforms are an on-going process, not a one-time event. He said that the developments in 1980s created the platform for major changes that occurred in July 1991 and the subsequent years. Similarly, developments in the past decade have set the stage for the future agenda of our economic reforms, the Minister added. Mr Mukherjee said that it is sometime suggested that we were perhaps a decade or two late in launching our reforms. He said that there are also some who are of the view that these changes should have never happened. But Mr Mukherjee said that he doesn’t sympathize with either of these positions. In life one has to be pragmatic, he added.

The economic reforms since 1991 have enjoyed a bipartisan support, with successive Governments at the Centre working towards liberalising and unshackling the restrictions on enterprise, and addressing distortions in different markets. The result has been the flowering of Indian private enterprise, which has made its mark at home and at the most competitive international level. As we take stock of the two decades of economic reforms and the state of our economy today, it is important to also dwell on where we want to go from here and how do we want to reach that destination.

Economy Rapidly Globalised

The global economy has just witnessed one of its worst crises in recent history and is still suffering from its aftermath. He said that it is a matter of pride that the Indian economy experienced only a brief pause in its rapid growth and could recover with an average of over 8 per cent growth in the years following the out-break of crisis. In the past two decades, the Finance Minister said that the Indian economy has rapidly globalised and from around 2003-04, it has moved on to a higher trend GDP growth rate of 8.5 to 9 per cent per annum. Today, India is the second fastest-growing large economy in the world, and is widely expected to be among the top three economies in the next two decades.

The experience in the post-2004 period shows that economy has become resilient to both external and domestic shocks. He said that it has undergone a significant structural change with a decline in the share of agriculture and allied sectors to about 14 per cent and a rise in the share of services to nearly 58 per cent and that of industry to 28 per cent. The Minister said that we have been able to increase the rate of savings and investment, our exports have increased robustly and at USD 250 billion in 2010-11 have crossed the USD 200 billion mark for the first time.

The foreign exchange reserves, which were almost depleted in 1991, have crossed USD 300 billion mark. The Government’s tax and non-tax revenue have increased manifold and the fiscal health is robust. It has provided us with the means to bridge our development gaps and renew the efforts to overcome the disparities in social well-being by implementing some flagship programmes. The social indicators have improved and the poverty incidence has come down.

The agriculture diversification has added to its resilience in the face of uneven and sometimes delayed monsoons. The agriculture year 2010-11 has seen production record a new high, he added. Mr Mukherjee said that the food grain production at 242 million tons has grown by 11 per cent over last year’s production.  The Finance Minister said that we are getting close to self-sufficiency in pulses with record production of over 18 million tons.

There are several reasons that growth is almost universally predicted to be sustained at a high rate of 8 to 9 per cent per annum and more, over the next few decades by economic analysts.

He said first, the savings and investment ratios have gone up in the last few years and are reminiscent of the high growth East Asian economies. Secondly, India’s working age population is young with over half the population is in the twenties. Thirdly, growing middle class incomes have led to self sustaining buoyancy in domestic demand, particularly in the rural areas. Fourthly, India is making rapid progress in infrastructure, both social and physical and along with better access to cutting edge technology is likely to see improvement in productivity. The Minister said although these are the primary factors for India’s dynamic growth, yet there are many other drivers of India’s growth story including the energy and vibrancy of our entrepreneurs, strong services sectors, emerging knowledge spheres and sunrise sectors and growing number of engineers and scientists.

Mr Mukherjee said that he is recollecting these factors here because Indian industry seems to be less optimistic about the economic prognosis for the country today, than it was earlier. Private sector investment has been a critical growth driver in the recent past along with growth in private consumption. The Finance Minister said that rise in the share of private investment in domestic demand helped in improving economic efficiency and productivity. Mr Mukherjee said that while the momentum in consumption has been sustained as the economy has recovered from the slowdown in 2008-09, the recovery in private investment growth has been held back. The Finance Minister said that it is a matter of concern and we must together do what is required to improve business sentiments to restore the investment growth seen in the years before the global crisis.

Inflation Major Challenge

India’s major challenge in the short-term is inflation, which has implications of sustaining our growth momentum. Inflationary pressures persist both from higher global commodity prices and domestic structural demand-supply imbalances in several commodities. The management of inflationary pressures in the medium term is critically dependent on an improvement in the supply response of agriculture to the expanding domestic demand and in the short-term by taking steps to moderate aggregate demand. In the past few weeks we have taken measures to address these concerns.

Mr Mukherjee said that the monetary policy has been gradually tightened, at the same time new initiatives were announced in the Union Budget to address some of the bottlenecks in the food supply chain that were behind the inflationary spikes in past years. The monetary measure may end up moderating the growth rate, if they have to be persisted for an extended period of time. He voiced hope that we should together be able to repeat the growth performance of 2010-11 in the current year as well.

As India looks ahead to join the ranks of developed countries in the coming decade or so, there are several challenges that it needs to address in the medium term.

“First, our future reforms will need to improve economic efficiency and spread the benefits of growth equitably across States and address disparities between urban and rural areas. Growth has to be more inclusive and pursued more vigorously. He said that improved productivity in agriculture is central to meeting this objective. There is urgent need to address the constraints on the growth of output and incomes in this sector. We have to renew our efforts and perhaps find new mechanisms to incentivize the State Governments to take a lead in addressing local policy gaps in agriculture.

Human Resource Deficit

Secondly, education with special thrust on skill formation, health and sanitation are core areas that should receive urgent attention. We need to bridge the human resource deficit that could prevent us from harnessing the demographic dividend and sustain high growth. Policy and regulatory framework is being put in place for the higher education system to develop the required intellectual capital for growth and development.  Similarly, vocational education has to be reoriented in such a way that imbalance between supply and demand in skills at different levels and tiers are gradually bridged. I am very optimistic about the progress being made by the ongoing mission led by the Prime Minister’s National Council on Skill Development. I expect the private sector to strongly participate in skills development activities to make our emerging large workforce globally capable and competitive.

Thirdly, India needs to invest an additional 3-4 percent of GDP on infrastructure to sustain current levels of growth, or higher, over the next couple of decades. Development of quality infrastructure and ensuring its broad-based, regional and rural-urban balance is central to sustaining high growth. Areas like power and energy, ports and airports, water resources, rural connectivity and urban infrastructure are in need of resources and managerial best-practices. The Government has laid emphasis on Public Private Partnerships (PPPs) which combine the efficiency and technological prowess of the private sector, with the public welfare orientation of Government. We have established unique and innovative financing support such as the scheme to support Viability Gap Funding for PPP projects. The enabling framework for Infrastructure Debt Funds to effectively meet the long-term debt requirements of the infrastructure sector has been finalized.

Fourthly, issues like land acquisition, environment clearance and resettlement and rehabilitation have to be addressed satisfactorily, with a view to de-risking development and meeting environmental concerns. He said that the new land acquisition bill is in the public domain and is likely to be introduced in Parliament shortly. Mr Mukherjee said that a committee constituted by the Group of Ministers (GoM) to consider all issues relating to reconciliation of environmental concerns emanating from various development activities related to infrastructure and mining and to examine the efficacy and legality of existing forest clearance norms and procedures being followed, has just finalised its report which will be considered in the next few days. The Minister said that B.K. Chaturvedi Committee related to Coal sector, Vinod Dhall committee on Public Procurement Standards and Public Procurement Policy and Ashok Chawla Committee on Allocation and Pricing of Natural Resources are also in the process of being taken-up for consideration by GoM.

Deepen Policy Reforms

Fifthly, we have to deepen the policy reforms in the financial sector and address gaps in the overall economic regulatory architecture. The Government has outlined a significant legislative agenda for the financial sector which we hope to purse in the coming days in the ongoing Parliament session. The Financial Sector Legislative Reforms Commission that has been constituted is working towards the harmonization of the existing laws, regulations and rules. The FSDC has become operational. It will ensure better inter-regulatory coordination for financial stability and development. SEBI has already approved the new Takeover Code keeping in view the interests of the domestic industry, help mutual funds get more retail investors and making it easier and safer for small investors to access the markets.

Finally, we have to recognise that the success of our efforts in the coming years hinges critically on our ability to strengthen our macro-economic environment. Mr Mukherjee said that we need to have the necessary head-room and policy flexibility to address challenges emanating from global markets. In the post-global crisis context, we have already begun the process of fiscal consolidation and succeeded in reducing the fiscal deficit to 4.7 per cent in 2010-11. He said that he is committed to the fiscal balance targeted for the current financial year end. The State Governments also need to work towards fiscal sustainability for meeting their development goals in the medium term.

We have taken some steps to simplify and place the administrative procedures concerning taxation, trade and tariff and social transfers on electronic interface, free of discretion and bureaucratic delays. We need to move further in that direction. It will set the tone for a newer, vibrant and more efficient economy.