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In 2003-04 high economic growth rates in China and India lent much needed support to a global economy that was then going through a recession. Chinese real GDP growth, which has been in excess of 8 per cent for all but three of the past eight years, was recorded at 9.1 per cent during 2003. At the same time the Indian economy grew at 8.2 per cent - its best performance since 1988 - during the year ending 31 March 2004. In terms of Purchasing Power Parity, China and India are the second and fourth largest economies in the world. Partly as a result of their spectacular performance during 2003 and the subsequent pickup of the US and, to a lesser extent, the Japanese and EU economies, global economic growth in 2004 is expected to be of the order of 5 per cent - a magnitude unprecedented in 30 years.
However, the short-run economic prospects for China and India present contrasting pictures. China's economic growth has largely been investment-led. In terms of components of aggregate demand in China, while net exports have grown at a lower rate than GDP, the growth of consumption has been high (but somewhat lower than that of GDP) whereas investment growth is leading GDP growth in almost every year.
The continued high growth has placed high demands on infrastructure and problems of shortages of power, water, migrant labour, management skill, arable land and transportation facilities have deteriorated. This indicates that demand may be growing faster than supply. Power shortages have now become a nationwide problem. So far, 24 out of the total 31 provinces are rationing electricity consumption, and various industry authorities estimate the shortage at 3 to 6 per cent of expected demand. Inflation has recently become a worry. Much of the coastal economy experienced a shortage of migrant workers during the first half of 2004. With mounting current account surpluses, pressures on China to revise its currency peg have increased.
Starting April 2004 China introduced a series of policy measures to cool its economy. However, until October 2004 with the only exception of the central bank raising deposit reserve requirement ratios, other policies, such as consolidation of investment projects, slowing pace of credit expansion and control of land use were selective administrative and microeconomic tightening measures. Economic data for the past few months confirmed that the new policies achieved only partial success as the pace of investment and industrial production eased, but consumption picked up. Subsequently, even investment picked up again and, after a long hiatus, the Chinese central bank raised interest rates. Whether this will have the effect of cooling down the Chinese economy, especially as the clamour for revision of the exchange rate peg increase after the hike in interest rates, and whether this will be a soft landing for the Chinese economy, remain to be seen.
India needs to sustain high growth rates to make a significant dent on its problems of poverty and unemployment. A GDP growth rate of 7 per cent per annum is necessary merely to absorb new entrants into the labour force and keep the unemployment rate from rising. In September 2004 India's Planning Commission and in October 2004 the Reserve Bank of India ruled out the possibility of attaining this objective. Growth forecasts for 2004-05 for India are now in the range of 6-6.5 per cent. Hence, India has been finding it difficult to sustain growth rates in excess of 7 per cent. Another contrast with China is that recent economic growth in India has been consumption-led. This is true both of private as well as public consumption. Thus the savings rate has fallen steadily from 24.2 per cent of GDP in 1999-00 to 23.5 per cent in 2001-02. Investment has remained almost stagnant at 21.8 per cent of GDP in 1999-00 and 21.9 per cent in 2001-02. Concurrently, public sector consumption expenditure has grown steadily. The combined deficit of central and state governments has gone up from 9.5 per cent of GDP in 1999-00 to 10.1 per cent in 2002-03. The revenue deficit of the central government (i.e., the deficit unrelated to capital expenditures) has gone up from 64.6 per cent of total fiscal deficit in 1999-00 to 82.2 per cent in 2002-03. Hence both private and public consumption have been on the way up and have sustained a consumption-led growth. Fuelling this has been the low-interest rate regime.
High growth rates in India could be sustained under certain conditions: (i) continuation of low interest rate regime; (ii) reduction of public dissaving (fiscal deficit) so that more resources could be released for investment; (iv) improved FDI climate; and (v) stable and supportive policy regime.
However, the outlook has turned dimmer since May 2004. Several reasons can be cited for this. First, global interest rates are on their way up. Further, several years of consumption-led growth led to demand outstripping supply and a build-up of inflationary pressures. This has occurred concurrently with drought like conditions in some part of India along with floods in others and petroleum price rises have merely acted as a trigger to raise inflation. Further, the 2004-05 Union budget has overestimated tax revenues. The government is forecasting nominal GDP growth this year of around 12 per cent (real GDP growth of 7-8 per cent). Normally tax receipts would rise by the same percentage but the budget has predicted a 22 per cent rise in tax revenue. However, since economic growth is expected to slow this year the chances of attaining even 12 per cent growth in tax revenue are remote. Moreover, state government deficits are unlikely to come down from the 2.5 per cent of GDP attained in 2002-03 and there are now competitive calls by several states for 'special packages' from the central government. Further, the incidence of contingent liabilities is now likely to go up. A number of credit initiatives for which the central government is the implicit guarantor were announced in the Union budget. Fourth, the central government is committed to compensate state governments for any revenue shortfalls consequent upon the introduction of the VAT (on 1 April 2005). Hence, the outlook on the fiscal front does not appear promising.
In the short-term, the change in political arrangements after the recently concluded parliamentary elections have also affected market perceptions and expectations. Following the defeat of the NDA coalition in May, there has been concern about policies and the fate of the reform process. The United Progress Alliance (UPA) government is dominated by the Congress Party, which has a good record on reforms, but its dependence on the Left and other regional parties could make decision-making tough. Its key allies, including Left parties, all face local state elections in the next one to two years and will likely have their own priorities and are, indeed, rivals of the Congress in these states. A stable government is one thing, aggressively pushing the reform agenda forward is another.
WATCHPOINT: Will raised interest rates have the effect of cooling the economy in China; and, what progress will the current Congress-led government in India make in pushing forward a reform agenda?
About our company:
AFG Venture Group is an Asia and Australia based corporate advisory and consulting firm with over 20 years experience in creating alliances, relationships and transactions in Australia, South East Asia and India; including a 15 year history of corporate and equities advisory in Australia, undertaking merger, acquisition, divestment, fund raising and consulting for private and public companies.
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