Indias surprising economic miracle

Agenda
India and China: How they stand? And the way ahead. India and China: Reforms and the growth experience after the reforms FDI and Foreign capital inflows Reserve money and sterilization Various policy response options

Will India be next China??? Can India outpace China???

India Vs China How they stand??

China GDP GDP growth rate (2000-09) Population (in millions) Population growth (annual) Inflation Exports Imports $ 5.4 trillion 10.3% 1338 0.5 % 4.5% $1.1T $1T India $ 1.8 trillion 7.1% 1170 1.3% 9.36% $.252T $.352T

India shining???
Demography: a young and growing workforce. Working age population will grow by 136m by 2020 as compared to 23m in China. Democracy: Though weak and corrupt but steady, flexible and continuously improving. For next 20-25 years India will be the fastest growing country. Strong private companies having 45m entrepreneurs. Increasing awareness about education: above 80% literacy rate among 15-24 years old.

 Lousy Infrastructure: crossing border between two Indian states can be more troublesome than crossing an international border. Shortage of skills: workforce may be young and growing but 40% are illiterate and other 40% fail to complete the school. Corruption: loss to exchequer because of scams bigger than the complete fiscal year budget amounts. Adult literacy rate is 66% as compared to Chinas 93%. Negative impacts of Populism.

India shining???

India and China before the reforms

Both countries were predominantly agricultural. Industry and transport were better developed in India. Indias GDP in purchasing parity terms 50% higher. (1950) Soviet style planning models focusing on heavy industry to the detriment of agriculture. High levels of government control (more so in China) Import substitution and export pessimism policies.

What led to reforms

China A new reformist leadership Dirigisme was not working Technological obsolescence prevented rapid growth India High levels of internal and external debt Some political happenings crushed investor response Indias condition was so poor that it could barely finance 3 weeks of import

Reforms in India and China

Parameter India China Factor

GDP ($) GDP (PPP) Per capita GDP ($)

1.8 trillion 8.3 trillion 1000

5.4 trillion 4 trillion 3200

3x 2.4x 3.2x

Exports ($)
Fiscal deficit R&D (% of GDP)

$252 billion
10.3% 0.89%

1.1 trillion
2.8% 1.42%

4.1x
-

Nature of Reforms
India
Started in early 90s India was a mixed economy albeit with Stalinistic central planning character Reforms were driven by crisis tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment

China
Began in late 1970s China was a Stalinistic economy Reforms were experiential and gradual in nature introduce competition and market-oriented policies by changing from direct control into indirect control reforms in areas such as exit policy, labor and land laws, retail, decentralization of decision making

Banking and Financial Sector

Government ownership of banks is common to both economies: at between 90 and 100 percent, these levels are the worlds highest Foreign banks operating along with the public sector banks in India, while Chinas banking system was a Centrally controlled monopoly Bad loans and asset quality (Chinas on a treadmill to Hell Jim Chanos) Bond market in India is underdeveloped

Taxation

Before the reforms the tax regimes in each country were similar Both countries broadened the tax base for indirect taxes. India and Chinas tax revenues as a percentage of GDP are remarkably similar today at 17.7 and 17 percent respectively Corporate and non-tariff revenue fell in China while it increased in India due to efficient tax collection After 15 years of reform, both countries largely replaced excise taxes with a VAT 17% rate in China, and a 16% rate in India. Both countries broadened the tax base for indirect taxes The gross tax revenue of the government of India (corrected for price rise) is now more than four times what it was just twenty years ago

Factor productivity

Rural effects: Agriculture, Education and Public Health

The reasons for China having outperformed India in agriculture are threefold: technological improvements accruing from research and development, investment in rural infrastructure and an increasingly liberalized agricultural policy. Literacy rate is still not much above 80 percent, whereas in China it is 99 percent. Only 66 percent of Indian children are immunized with triple vaccine as opposed to 97 percent in China. Chinas poverty alleviation strategy developed in three steps. Before 1984 social welfare programs were used mainly to subsidize poor families, and no formal strategy existed for reducing the number of poor in rural areas. From 1984 to 1995, the government pursued a strategy of regional targeting whose objective was to alleviate poverty by developing regional or local economies. The Gini coefficient of inequality of land distribution in rural India was 0.62 in 2002; the corresponding figure in China was 0.49 the same year. the Gini coefficient of the distribution of adult schooling years in the population, a crude measure of educational inequality, was 0.56 in India in 1998/2000, which is not just higher than 0.37 in China in 2000, but even higher than almost all Latin American countries

Fiscal Policy and Government Expenditure

% of GDP Revenue expenditure(India) Capital expenditure(India) Revenue expenditure(China) 1999-2000 11.86 1.60 12.5 2003-2004 12.17 3.13 14.4 2004-2005 11.45 3.06 14.9 2005-2006 11.70 1.92 15.1

Capital expenditure(China)

3.2

4.0

3.6

3.6

Chinas public spending has recorded rapid growth over the past ten years and, although the rate has moderated somewhat since 2002, expenditures are significantly higher now relative to GDP than they were in the mid-1990s. These trends raise questions about the future prospects for aggregate spending and whether it is adequately controlled Fiscal policy in China has largely been guided by the governments medium-term focus on fiscal consolidation aimed at making room for likely future expenditures on contingent liabilities, such as the banking sectors large nonperforming loans, and a need for higher social spending as the population ages. China is able to finance all its investment on the basis of domestic savings The efficiency of investment, from the point of view of GDP growth, is almost exactly the same in India and China (ICOR data)

FDI Inflow, Net (Current US $ Billion)

Source: World Development Indicators, 2010

17

COMPARISON OF FDI IN INDIA AND CHINA

ADVANTAGES OF FOREX RESERVES

To smooth out temporary fluctuations in external payment imbalances To neutralize speculative attacks on currencies Boosting international confidence on domestic economy Can be used as collateral for international borrowing Reserve accumulation can also be used to keep the exchange rate favourable for export growth which may lead to higher economic growth and more employment in the domestic economy Massive outward movement of capital may expose the country to a greater risk of liquidity squeeze, which occasionally leads to a full-fledged financial crisis. Therefore, holding international reserves may be a quick-fix solution for this possible threat

DISADVANTAGES OF FOREIGN CAPITAL INFLOWS

INCREASE IN FOREIGN CAPITAL INFLOWS

CURRENCY APPRECIATION

BUILD UP OF FOREX RESERVES

OPPORTUNITY COST

EXPANSION OF DOMESTIC MONETARY BASE WITHOUT CORRESPONSING INCREASE IN PRODUCTION

TOO MUCH MONEY CHASES TOO FEW GOOD S AND SERVICES

INFLATION

Important Terms
Reserve Money-It is also called the domestic monetary
base of the economy. It is referred to as M0. M0 =Currency in Circulation + Bankers' Deposits with the RBI + 'Other' Deposits with the RBI Broadly speaking, a country can curb its currency appreciation by means of the following four tools: Exchange rate policy, Monetary policy, Sterilization, and Capital controls

Contd
1) Exchange rate policy: a country manages its currency in respect to foreign currencies and the foreign exchange market. Some basic types are A floating exchange rate A pegged float The fixed exchange rate 2) Monetary Policy: The countries could cut interest rates to make their economies less attractive to foreign money. But that would lead to inflation and at the moment both are raising rates to curb inflation.

CONTD
3)Sterilization - Sterilization is the process by which monetary authorities ensure that foreign exchange interventions do not affect the domestic monetary base, which is one component of the overall money supply. To ease the threat of currency appreciation or inflation, central banks often attempt what is known as the "sterilization" of capital flows

Sterilization refers to the actions taken by a country's central bank (CB) to counter the effects on the money supply caused by a balance of payments surplus or deficit
Most often sterilization is used in the context of a central bank which takes actions to negate potentially harmful impacts of capital inflows - such as currency appreciation and inflation both of which can cause loss of export competitiveness.

Contd
4)Capital Controls: Capital controls are measures such as transaction taxes or caps on volume and other limitations which a country's government can use to regulate the flows into and out of the nation's capital account.

Measures adopted by India and china in response to huge reserve build up that led to the appreciation of their currencies

VARIOUS POLICY RESPONSE OPTIONS

Sterilization through open market operations-selling

Treasury bills and other instruments to reduce the domestic component of the monetary base

Practical Limits to Sterilization

Inverse relationship of ability to sterilize with the degree of international capital mobility The scope for classical open market operations may be severely restricted by the instruments available, particularly in developing countries Heavy Fiscal cost

Discount Window-One supplementary means to contract

the money supply is to increase the cost or restrict the access to central bank credit

Practical Limits

Unless the subsidies are fully eliminated, rediscount facilities thus cannot be relied upon as a flexible tool They often cause a smaller fiscal cost, for instance, because discount rates are normally lower than market rates

Reserve Requirements -Increasing statutory reserve

requirements--the proportion of assets that commercial banks must hold on deposit with the central bank

Practical Limits

The presence of weak "problem" banks, numerous in developing countries, may make higher requirements difficult or dangerous to implement
Frequent changes can be highly disruptive to the efficient management of bank portfolios

Government Deposits -to absorb reserves is to shift public

sector deposits from commercial banks to the central bank

Practical Limits This makes it harder for them to manage portfolios efficiently If the transfers to and from are frequent and unpredictable, uncertainty is much greater for commercial banks The use of this technique is also limited by the availability of government deposits

Intervention in Forward Exchange Market - the central

bank gives domestic investors the opportunity to "hedge" the value of their foreign investments by locking in a forward exchange rate. This enables capital outflows.

Practical Limits It exposes the central bank to financial losses, and thus it can have fiscal costs Risk of excessive capital outflows

INDIAN RUPEE/US$ EXCHANGE RATE CHART FOR THE LAST FIVE YEARS

CHINESE YUAN RENMINBI (CNY)/US$ EXCHANGE RATE CHART FOR THE LAST FIVE YEARS

POLICY MEASURES BY CHINA TO CONTROL EXPANSION OF MONETARY BASE

The Peoples Bank of China tightened reserve ratios in May,2011 Creation of China Investment Corporation, the sovereign wealth fund, which is expected to receive transfers of reserves Government policy obliging commercial banks to convert part of the reserves they hold with the central bank to US dollars from CNY Possibility of the reserves to be channelled to the Bric nations to use the reserves to help stimulate a new cycle of development and trade between China and with the developing world

INDIA: FOREX PURCHASE VS RESERVE MONEY GROWTH

POLICY MEASURES BY CHINA TO CONTROL EXPANSION OF MONETARY BASE

Introduction of a new instrument called the Market Stabilization Scheme (MSS), which were bonds issued by the Indian government for the sole purpose of sterilization, known as sterilization bonds
INDIA: FOREX PURCHASE VS STERILIZATION BONDS

 India should deploy its huge forex reserves for development of the country as it has more than sufficient import cover of 9.6 months against a safe import cover of 6 months India is a developing economy with a relatively low savings rate as compared to other developing economies, like China, and as a result has to rely on capital from abroad for its investment needs

Will the tiger overtake the dragon ?

Will the tiger overtake the dragon ?

India to outpace china in 2013-15

Year

Barring global financial crisis Favourable demography Structural reforms Globalisation

Expected Growth India Real GDP
9.5% 9%

Expected Growth - China Real GDP

9% 8.6%

2013 2014

Why India lagged China in performance ?

China managed to convert growing working population to create productive jobs
Higher savings and investments Decrease in age dependency Exports

India performance lag

Lower level of support from Demography Infrastructure Labour laws Capital accumulation Lower productivity growth

Indias demographic cycle trailing china

India to start outpacing China from 2013-15

China age dependency increasing and India decreasing 26% (136 m) increase in global working age population due to India Illiteracy level to decrease Introduction of Goods and Services Tax Direct tax reforms Consolidation of the public sector deficit Divestment of the government's stakes in PSUs Acceleration in infrastructure spending (roads and power) FDI in retail marketing and distribution

Internal Challenges to sustain growth

Government and private investments in infrastructures Reduction of government revenue deficits. hence rise in savings and investments . Labour law reforms Managing social instability (income and geographic disparity) Secondary education

Thank You