an open question.
One is inclined to argue that the outcome would ultimately depend on political economic factors. Apparently, China is a strong state (yet brittle state?) with the capacity to carry through its political mandate (even if it means high social and economic costs). But if there are serious fissures in the state apparatus, as seems to be emerging after the crackdown on corruption under the present regime (which is apparently hurting many powerful political actors as evident from their efforts to hide their investments abroad), the outcome could be unpredictable.
India
India witnessed a decade-long cycle of boom and bust, starting in 2003. During the boom, the Indian economy grew close to 9% annually, led by IT services and exports. This was accompanied by a rapid rise investment to GDP ratio (to 38–89% of GDP) largely in the PCS financed by rising domestic saving rate (35–36% of GDP), and supplemented by a flood of foreign private capital peaking at 10% of GDP in 2007–2008. This was accomplished under benign macroeconomic conditions, especially with stable fiscal balance as the state withdrew from infrastructure investment in favor of PCS to reduce fiscal deficit.
After the GFC in 2008, economic growth recovered quickly on the strength of capital inflows caused by QE in the advanced economies and fiscal stimulus and monetary easing undertaken to stimulate domestic demand to compensate for the loss of external markets. However, the high growth rate could not be sustained beyond 2011–2012, when the macroeconomic conditions changed quickly. GDP growth rate plummeted below 5% in 2013–2014, but recovered somewhat thereafter, though it is hard to be sure of the strength of the recovery.
After the boom went bust, India is now saddled with excess capacity in manufacturing due to lack of investment demand and plummeting external demand for both services and manufacturing. A large number of infrastructure projects under private–public partnership (PPP) remained incomplete, as the cost of financing shot up and legal and technical issues bogged down their completion. This non-financial PCS is saddled with an unprecedented amount of unserviceable debt, which has turned into banking sector’s non-performing assets (NPAs), pulling down its profits and thus adversely affecting fresh lending. This is associated with a sharp fall in domestic saving and investment rates. The problem of bad debt is unprecedented, but seems quite in line with many EMEs currently, but it is smaller than that of China’s.
With poor economic recovery from the great recession (Nagaraj, 2013), India’s external market for services and its capital- and skill-intensive manufacturing have dwindled — with explicit protectionist law such as ‘Buy America’ enacted by the Obama administration and the Trump administration’s explicitly protectionist policies, along with the threat of automation. India as well as China have the advantage of a large domestic market. Yet the PCS is not in a position to step up investment given the high debt ratios and declining profitability. Therefore, the way out of the present impasse is to step up public infrastructure investment to ease demand constraint for capital and intermediate goods industries and supply cheap credit to agriculture and small-scale sector so as to augment food production and to labor-intensive manufactures.5
In political economic terms, unlike China, India is a liberal democracy, with reasonable political stability, with well-defined separation of powers between political executives, legislators and judiciary, well-developed market-based institutions such as capital markets, a strong domestic PCS, and market regulators (Huang and Khanna, 2003).
Section 3: A Comparison between China and India
Similarities
Both the economies slowed down after the financial crisis and both lost their export markets; thus, they face excess capacities, high-corporate debt, and corporate invisible debt via subsidiaries.
Differences
China is an investment-driven economy, and household consumption is just one-third of GDP; India’s investment rate is lower than China’s, and it further declined rapidly after the financial crisis. The consumption/GDP ratio in India is over 60%, with supply constraint still a matter of long-term concern. China’s debt is 260% of GDP; the ratio for India’s is just about 60%. Excess capacities in India are probably modest compared to China’s. China is over-invested in infrastructure and housing, whereas India suffers from shortages in these areas.
Question 1: Can China avoid further deterioration of growth rate, given the debt overhand and the limits of further debt-led growth? Can India engineer a turnaround with more reforms and FDI without public investment (as envisioned by current policymakers) — given the overhang corporate debt on the banking sector?
Answer 1s: In both China and India, after the financial crisis, growth was sustained by easy credit extended to PCS by domestic banks and by foreign capital inflows (facilitated by QE) — China much more than India. Growth in China’s debt/GDP ratio is unprecedented; in India, the rise in the ratio has been modest (if at all).
It is a question of degree, not kind: External debt in both the countries is higher than officially reported because of debt taken on by subsidiaries of private corporate firms (as highlighted by Shin of BIS).
Can China avoid a debt crisis? Given China’s huge foreign exchange reserves, the possibility of external debt crisis seems remote. But if there is panic, no amount of reserves probably matter, as evident from last year’s episode when China almost lost $1 trillion in no time at all.
However, since the majority of China’s private sector debt is denominated in domestic currency, which in principle can be rescheduled without destabilizing the external sector, the question arises if China can avoid getting into Japanese-style debt deflation, which is another matter entirely. Japan’s debt was (and continues to be) mostly in the domestic currency, more so than China today.
Similarly, China’s real estate market seems to be in the bubble territory. The Chinese government seems unable to regulate it adequately since much of it seems financed by shadow banking. So, whether China can avoid a real estate crash remains an open question. Admittedly, Chinese authorities are tightening the rules for real estate lending by increasing the equity or the contribution of the buyer.
India’s external debt is modest in a comparison to most EMEs, and especially China. Even if the global interest rates rise, India is unlikely to face a debt crisis, though there could be instability in the foreign exchange market in the short run. But the question of whether India can avoid a prolonged period of slow growth (without a change in policies) is another matter.
Question 2: Can China change its debt and investment-led growth, given the incentive structure of local governments and their access to bank credit? In other words, can China disembark its credit-led investment growth strategy to keep employment growth going without causing political unrest? In other words, is it a case of Chinese policymakers riding the political tiger?
Answer 2: Given China’s seemingly solid macro foundations, there is no apparent reason why the government cannot shift public investment away from physical infrastructure (road, rails, bridges, and urban housing) to schools and hospitals, and make them available for free for poor. Descriptive accounts show how Chinese struggle to get treated in good public hospitals (Burkitt, 2012). The answer probably lies in China’s contradiction between centralized politics and the decentralized economy.
India, on the other hand, may find it hard to reverse the declining domestic investment rate given: (i) the NPAs of the banking system, (ii) reluctance of foreign private capital to step up investment given the debt situation of the PCS, and (iii) government’s reluctance to raise public infrastructure investment given its commitment to
