A number of factors have been ascribed to explain this performance: high consumption in India, as compared with China, and lower exposure to the global economy, again as compared with China. High home consumption is desirable as it gives support to the domestic economy in the face of a collapse of international trade, as happened during the GFC. Additionally, lower exposure to international trade reduces the impact of external shocks. The existence of substantial controls on the banking sector is said to explain the fact that no Indian bank had to be ‘rescued’. In addition, credit also is sometimes given to ‘good policy design’ by the government.
The first two factors are certainly true. Indians save just over a third of their income and invest a bit more whereas the Chinese save and invest well over half of their income. India’s trade exposure, as measured by the percentage of exports plus imports to GDP, is a fraction of China’s as is India’s exposure to global financial flows. But as the Reserve Bank of India (RBI) has reminded us, India’s exposure to global financial flows is growing very rapidly although at the margin, particularly as a consequence of significant liberalisation of the capital account as it applies to corporations.
For both these reasons, then, Indian growth rates should have been higher than China’s. Why then, is China’s growth rate substantially higher than India’s and why is the gap only expected to rise in 2010? Should the difference be ascribed to differences in policy in the two countries?
In particular, attention has focused on the much larger stimulus package in China than in India – something that was not possible in India because India has a much larger fiscal deficit and much smaller fiscal room to manoeuvre. We could accept this argument only if we control for the much larger shock that the Chinese economy, with its lower consumption rate and higher exposure to external shocks, was subject to as compared with the Indian economy. This has not been demonstrated so no claim of this sort can be made.
What can be commented on is the course of Indian economic policy during and after the GFC (assuming we are out of it). Even before growth rates had picked up sufficiently (and there remain question marks on the pace and extent of global recovery), monetary policy has tightened. A crescendo of voices raises hackneyed arguments about the need to control the fiscal deficit even though the greatest debtor of all, the United States, is approaching this issue with greater equanimity and may yet use deficit reduction strategically.
Some have argued that high inflation in India necessitates the tightening of monetary policy. But inflation in India is not homogeneous. Even at the height of the GFC, with wholesale price index (WPI) inflation reaching alarmingly low levels, consumer price index (CPI) inflation was high in India. As of November 2009, the latest period for which the Ministry of Finance has made data available, year-on-year inflation in terms of WPI was 4.78 per cent for as compared to 8.48 per cent in November 2008 whereas CPI inflation was in the double digits.
This is not an argument for monetary tightening. A key contributor to the recent dynamics of CPI inflation has been the rise, just before the Lok Sabha elections of 2009, in procurement prices of food-grains. Prior to that, food prices had been rising and, under pressure, the government imported food grains, at substantially higher prices than was being paid to Indian farmers. The rise in procurement prices was inevitable, particularly given that 2009 was an election year. That rise in procurement prices is now filtering to higher wholesale and retail prices, leading to further imports. These imports would again be higher than the prices being paid to Indian farmers whence there will be pressures for the procurement prices to be raised.
In this context, restrictive monetary and fiscal policy will certainly lower growth and perhaps, WPI inflation. Higher food imports will hit the balance of trade. Thus, CPI inflation has a dynamic all its own.
Interesting discussion, but China and India’s growth (and monetary policy) story’s for 2009 differ vastly and cannot really be compared. China is undergoing an unprecedented boom in credit, and this has led to a corresponding boom in investment spending, which an official was reported as saying accounted for three-quarter’s of GDP growth in 2009. Compare this to India, where investment has made a minor contribution to growth (private investment may even have contracted, though a breakdown is not published in a timely manner). Rather consumption and government spending drove growth (and national accounts would probably show a greater rate of increase in government spending in India over China for 2009).
The main difference behind the differing investment stories is monetary policy and market systems. In China lending and deposit rates are almost meaningless. Banks extended loans at an unprecedented rate in 2009 because they were trying to please the government, while SOE’s (and also private sector entities given incentives) were only too keen to invest. In fact, the PBOC has maintained a higher policy rate than the RBI (lending rate of 5.1% vs Repo rate of 4.75%). Yet that being said, the monetary stimulus in China has been arguably greater than in any other developing economy (as alluded to before, policy rates are pretty meaningless in China, at least based on my understanding).
Compare this to India, where persistently high costs of funding and slumping confidence led to a pullback in lending. Banks were reluctant to ramp up lending despite a falling policy rate, even to the extent that they continually tried to refuse RBI and government requests to lower their rates and ramp up credit.
While I agree with you that there is no need for the RBI to aggressively tighten monetary policy and India’s inflation problem is overstated, even if the RBI were to leave rates low it would not spark an investment boom ala China. In this instance I do not think the two nation’s growth story’s and monetary policy responses can be compared.
Thanks for your comments.
This article did not compare the monetary policies of China and India. It was focused on India.
Further, I disagree with the view that India cannot grow faster with current investment rates. Kelkar and others pointed this out much earlier. My main concern was with the divide between WPI and CPI inflation and the fact that CPI inflation, in particular food price inflation, is being fueled at the current time by higher procurement prices filtering to wholesale and retail prices which then lead to food imports (at prices higher than those paid to the Indian farmer) which then lead to higher procurement prices. So, the cycle resumes.
This is the main point of the article which then goes on to say that tighter monetary policy will only tangentially affect the CPI dynamic although it might hurt growth and lower WPI inflation, such as it is.
Thanks again for writing.
Reading back through my comments and your article, your critique of my comments about China-India MP is spot on.
I was too focused on arguing that India and China should not be lumped together as I see happen so often in the financial and economic literature, but you have not made that mistake.
I also should have said in my last comment that I really appreciate all the contributors on this forum. The contributions are of a very high quality, insightful and very often sparks my interest.