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China, India and the emerging markets slowdown


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China and India are in the vanguard of a historic ‘shift to the East’. While economies in the West shrunk during the global financial crisis (GFC) and remained in a funk afterwards, China, India and other emerging markets bounded ahead. But then the global economic slowdown hit them as well. India has seen a dramatic fall in growth, China a more gradual, milder decline. This has exposed deep fault-lines in both countries. Is the shift to the East still happening? And where will it go from here? Emerging markets hit Most countries in the West had accumulated unsustainable levels of household, corporate and government debt. The GFC hit them particularly hard, and recovery since has been anaemic. Most emerging markets, however, went into the GFC with much healthier balance sheets. Hence they were not as badly affected and rebounded quicker. China and India continued to enjoy rates of growth of 8-10% annually. This short-term divergence of economic performance between the West and emerging markets (in Asia in particular) accelerated the long-term convergence of emerging markets on the West. Between 2007 and 2012, developed economies grew by 2% (at purchasing-power parity). But, in the same period, China grew by nearly 60%, India by over 40%, and developing Asia by close to 50%. Now a global economic slowdown has hit emerging markets as well. This first appeared in 2011, notably in Russia, Brazil and India. It got worse in these countries last year, when China too slowed down. And it has worsened this year, especially with the threat of tightening monetary policy in the USA. The IMF projects China to grow at just under 8%, India by just under 6%, and developing countries by 5%, in 2013. Why has this happened? Start with India, which has seen a vertiginous drop in growth from 9% to 5% or less in two years. This is almost entirely the result of a hopelessly incompetent, blundering Congress-led government since 2004. It inherited high growth as a result of market reforms carried out by its BJP-led predecessor. But it did virtually nothing in terms of further market reforms until late 2012, and since then it has been a case of too-little-too-late. It has also backtracked in several respects. Public expenditure has ballooned, and been squandered on hugely wasteful, corruption-ridden projects. Domestic and foreign investment has been deterred by long delays in project approvals, myriad regulatory restrictions and red tape, and a wilfully obstructive bureaucracy. Much-needed reforms on labour markets, infrastructure development, the energy sector, taxation, property rights and land acquisition – to name just a few areas – have long been stalled. India now finds itself with a falling rupee, high current-account and budget deficits, relatively high inflation, low growth – and even talk of a looming balance-of-payments crisis. All this is home-brewed. China’s growth slowdown China’s growth slowdown is milder. Prima facie, its economic problems seem less acute than India’s. But China too has mounting problems. Market reforms stalled under the decade-long Hu-Wen leadership; high growth rates meant they had no incentive to reform. And there was backtracking. Industrial policy became more interventionist to boost giant national State-Owned Enterprises (SOEs). Then came massive fiscal and especially monetary stimulus in the wake of the GFC. This went overwhelmingly to SOEs, channelled through state-owned banks. The public sector gained at the expense of foreign multinationals and domestic private business. Monetary stimulus flooded the country with cheap credit, much of it squandered on white-elephant projects and resulting in asset bubbles. Debt has spiralled to about 200% of GDP. These measures have propped up China’s economic model of high savings, high investment and low consumption. This model has run its course; it can no longer deliver high and sustainable growth rates. The economy needs to be “rebalanced” – lower saving, lower – but more productive – investment, and higher consumption. But that cannot be engineered by a quick fix. It needs deep market reforms, especially in the factor markets of land, labour and capital. These, however, are politically much more sensitive than previous market reforms. Financial-market reforms, for example, would go to the heart of the political system that unites the Communist Party, the government apparatus, SOEs and state-owned banks. So far, the new Xi-Li leadership has sent ambiguous signals on further market reforms. Exaggerated claim So the shift to the East has been exaggerated. Emerging markets’ growth over the past decade was artificially boosted, first by skyrocketing commodity prices, and then by cheap credit as a result of loose monetary policies around the world. In the meantime, governments became lazy and complacent. They coasted on high growth rates and neglected market reforms. Distortions built up, not least a mountain of public and private debt. Now the commodity supercycle seems to have come to an end, and cheap money is on the verge of becoming tight. This exposes deep fault-lines – in China and India, but also in Brazil, Indonesia, Russia and a host of other emerging markets. Big reforms are needed to avoid a prolonged growth slowdown, and even to avoid crises and crashes in some countries. Still, the shift to the East is real, despite the hype. Most emerging markets retain the potential of big ‘catch-up’ growth for years, indeed decades, ahead. But they need to crack on with long-delayed market reforms. Can governments operating in malfunctioning political systems and with still backward economic institutions deliver these reforms? That is a vital question, not least for China and India. (The author is Visiting Associate Professor at the Lee Kuan Yew School of Public Policy in Singapore and Director of the European Centre for International Political Economy in Brussels.)

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