The current global economic situation hinges around what happens in China. While, according to the IMF, in 2016 the main growth impetus is to emerge from the developed nations, the China factor will continue to dominate the financial landscape for some time. Discussions do surround the issue of whether or not India can fill in the gap left by China, which may border around hubris, as there are similar underlying factors that lie in the economic stratosphere which we should guard against.
The Chinese model of growth, which took the world by storm by promising more, was based on the premise that heavy investment, especially in infrastructure, can be the road to sustained prosperity. As long as it happened, it was good for everybody. The Chinese economy grew very well and the double-digit growth rate became the norm. Chinese goods based on cheap labour flooded the market, which was good for importing countries. China became the largest consumer of materials, especially natural resources, which meant that the exporters of minerals and crude were happy.
As China consumed larger quantities, a chain had been built that dragged along all other nations. At the same time, China’s tryst with growth became an obsession as the yuan became an increasingly important currency—to the extent of entering the Special Drawing Rights (SDR) basket last year. Across the world, investors in both stocks and commodities gained from this meteoric rise of China. The so-called decoupling theory held after 2008, where the growth waves emanated from the Forbidden Kingdom.
The flaw in this model was known but not accepted, as it was assumed that gravity would keep this chain never-ending. The chink in the armour was that growth cannot be sustained without consumption. An investment-based model works only up to an extent, and China revelled in the infrastructure boom with roads, super highways, trains, ports, airports, etc, which added substantial delta to the GDP. But there are limits to this kind of growth, and unless there are more people to use the same structures that have been created, the momentum cannot be sustained.
A second fallout of this route was that growth was financed by the institutions at state-controlled interest rates, with dictates from above. This resulted in a weak banking system, and while the NPL levels are low, there could be a lot hidden in the books.
Third, growth has not been inclusive and it is only the higher echelons which have gained in this model. The percolation has not taken place, and with the one-child norm being pursued as policy and substantial migration to the US and Europe of the skilled youth, the country is to run against the wall of shortage in skilled labour, which will only get exacerbated as more people join the retired gentry.
Fourth, in a move to prop up the economy, the government is pursuing a dual path of pushing up investment by lowering interest rates as well as letting the currency fall to edge up exports. Both these moves could be counterproductive, since higher investment may not be the need of the hour and, by doing so, one may just be creating another set of bad assets in the absence of consumer demand. The decline in the currency has not been taken too positively by other emerging markets and a series of competitive depreciations can be witnessed where, at the end of the day, there could be no winners.
The China syndrome will continue to play out and go on distorting the global markets; what was seen in the currency market to begin with has percolated to the stock markets where tremors on the Shanghai exchange are felt in New York and Mumbai.
Are there any lessons for us in India?
We have not yet fully optimised the investment-route model and, hence, with the existence of spare capacity there is room to leverage the same while filling in the lacunae. But the problem of consumption remains for us too. Over the last three years, it has been observed that household consumption has also come down on two scores.
One, incomes at the lower levels have not increased, where the population is large in number. Therefore, purchasing power has been limited to a fixed class which is not expanding at the desired rate. This section typically is satiated and, with the exception of replacement demand, would only find use for new goods in the market. Two, high food inflation has dented the consumption power of households, leading to less demand for non-food items.
Clearly, we have to improve the income distribution of the country to ensure that consumption keeps increasing, or else we would encounter the same issues and challenges as China.
India too has been trying to follow the investment route to growth, but has been constrained by the availability of funds; this is not so in China, which has also managed to attract large doses of FDI with an enabling environment. However, it has been observed that, in a democratic set-up, an investment growth model will never be smooth due to a plethora of issues relating to land and environment; this was not a limiting factor for China where the state controlled all decisions.
In addition, forced low interest rates can result in higher NPAs when there is a downturn, which was the case between FY12-15 when projects came to a halt for a variety of reasons. It is only appropriate that RBI while lowering interest rates is continuously cautioning banks on the quality of assets.
Last, on labour force, while the challenge is not that acute given our young population, the challenge is really with skill development, which is what the government has been focusing on. Having a large labour force can be counterproductive unless it is trained in relevant skills, or else the demographic dividend can turn into a nightmare.
Therefore, there are lessons to be learnt from the China model and not focus just on investment but also consumption. For the latter to happen, a lot has to be done to lower inequalities so that the relatively-less-rich people enter the spending stream in a big way. Creation of jobs and direct support from the central and state governments is pragmatic as we have reached a state where tackling inequality is not a moral compulsion but an economic necessity.
It is, hence, quite appropriate that both the government and RBI keep talking of inclusive growth in terms of income as well as access to credit.
The author is chief economist, CARE Ratings. Views are personal