Decoding the Economy; Can India follow China’s growth model?

By Ipshita Agarwal

Chinese_Tiger_Versus_Dragon_by_HeatherbeastChina is the world’s most populous country. India follows. Yet, they grow at incomparable rates. China shooting ahead, India lagging behind. One might blame the Indian economic policies for this. Still others might commend the Chinese Government for successfully implementing growth oriented policies, by maintaining an undervalued exchange rate.

There is a school of thought that prevails in the country that India should ape whatever steps China has taken. Hence we should move next into labour intensive manufacturing growth, using an undervalued exchange rate. The low consumption helps limit domestic demand, making it easier to maintain an undervalued exchange rate.

The question here, is not, whether India should do the same? But CAN it do the same? Can India, being a democratic land of such diversity, afford to ape the Chinese?

India and China are two very different nations, similar only in terms of their population probably. China, has, since yesteryears, followed a policy of regulating its trade by strictly controlling its currency. The Chinese currency has always been devaluated to increase exports. The increased capital inflow, in turn, has given the Chinese Government enough money to buy dollar on a large scale, thus increasing its demand, and therefore devaluating Yuan. While increased money supply might mean increased inflation, but this is not the case with China. The Chinese Government follows a policy of sterilizing the foreign exchange inflows with step-wise increase in the reserve requirements of its commercial banks. This leaves them with less money to create credit, leading to depressed demand, and thus prevents inflation from rising.

All this paints a rosy picture.

However, all is not good. As China continues to ‘sterilize’ inflows, it observes inflationary pressures and cannot raise the bank rate any further, from the already high 19-20%. As it competes with the dollar, it realizes the potential threat that a weak US economy poses. Its major importer’s weakness will signal a decline in its exports. Real wages in China are low and small scale borrowers are finding it increasingly difficult to obtain credit. The country seems to be going towards an ultimate appreciation in currency, and an unstable economy as the shift takes place.

Even then, China’s economy is at a far better place that India’s today. Goldman Sachs predicts China’s growth at 7.6% against India’s at 4%. Rising food inflation in India signals the inefficient public distribution system and lack of investment in agriculture. In China, the CPI is a mere 2.7% against India’s 9.64%. China is ahead of India on the human development front as well. It has contributed more to developing its health and education system, than India has, in the past few years.

China is now more open to letting its currency appreciate, and allow a bit of the inflation that follows. Unemployment is one issue that it has to tackle.

china1India has been an open economy ever since the 1991 reforms, and is based on the belief that competition should be free and fair, imports and exports should be allowed freely. While China’s illustrious growth trajectory might seem tempting to India to adopt, we believe that the very economic and political foundations of the two countries are SO distinct, that they do not allow the same policies to be adopted, to achieve the same results.

In China, devaluation helped to boost exports and create a current account surplus. But India’s manufacturing industry is too small to ramp up quickly, and manufacturing capacity too narrow to support large scale production for large scale export. So a turn-around in the balance of payments may take time during which investors could panic. The weaker currency may destabilize the domestic economy by adding to inflation and increasing the government’s subsidies on fuel and thus its borrowing, as we observed in the 2013 crisis when the rupee’s value plunged and the Government’s fuel bill skyrocketed.

While China had a conventional growth pattern, moving labour from agriculture to labour-intensive manufacturing; India followed an unconventional pattern, shifting directly from agriculture to services sector, thereby giving very little time to the manufacturing sector to develop. While agriculture contributed less to GDP, it still employed more than 50% of the workforce, just eliminating the possibility of a labour-intensive manufacturing process.
India’s import substitution policy created a base for capital intensive manufacturing, as opposed to China.

India and China thus have inherently different growth models. What works for one, might not work for the other.

P. Chidambaram announced the interim budget recently, reducing excise duty and promoting the manufacturing sector. Today, India faces the ‘growth challenge’ more than ever before. Growth is a solution to our problems. Aping China won’t work. Growing like China, will. The need of the hour is to grow.

Can we make 2014 the new 1991?

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