THE ELEPHANT AND THE DRAGON
India's prime minister Manmohan Singh and China's premier Wen Jiao Bao have found more common ground than their predecessors.
Nobody can afford to ignore India and China these days: certainly not the CEOs of multinationals seeking to either leverage low-cost and increasingly skilled workforces or gain access for their products or services to the world’s largest and fastest-growing developing markets; not the US government, when China holds more than $1 trillion in treasuries and other foreign currency reserves; not cash-strapped financial institutions in need of a capital infusion; nor, for that matter, Western consumers who are having to cut back on cheap imported goods while at the same time worrying whether their jobs might be “offshored” to India or another low cost center.
Even without these credit crunch-driven concerns, the rapid rise of these two new economic superpowers, whose combined population of 2.4 billion represents 40% of humanity, compels our attention. For what is happening is a huge shift of economic gravity from West to East. Or, if you take the extremely long view, a return to the global balance of 200 years ago, when China and India between them accounted for roughly half of the world’s economic activity.
If projections based on recent annual growth rates of around 11% for China and 9% for India hold good, then these two countries will generate half of global GDP by 2050. By that time China will be the world’s largest economy, with the US relegated to second place, followed closely by India. The two Asian giants will between them consume the lion’s share of the world’s additional energy production. And unless there is a radical move away from their dependence on coal combined with an introduction of clean technologies, they will become the world’s largest emitters of greenhouse gases.
Those projections depend on a number of assumptions, the most crucial being the depth and extent of the current recession and whether recent momentum toward free trade and globalization continues. Until quite recently there was a strong body of opinion that the credit crunch and any resulting downturn would be restricted to the United States and other advanced economies while China, India and the other developing economies would motor onward. Their economies, it was argued, had “decoupled.” That was before this spring’s sell-off in Asian markets, which saw the Shanghai Composite index tumble by 43%—admittedly from high valuations of an average price/earnings ratio of around 50 times earnings—while Bombay’s Sensex dropped by nearly a third. While panic selling was mostly driven by domestic investors, the sharp correction in March also suggests they are anticipating a broader slowdown, though not so much in India, whose relatively closed economy is less susceptible to global trends.
As Norman Villamin, the Singapore-based head of research and strategy at Citi Global Wealth Management, puts it, “While Chinese shares—whether the Hong Kong-listed H-shares which foreigners can invest in or the Shanghai-listed A-shares restricted to Chinese investors—have been sold down very strongly, India’s equity market has held up well on a relative basis.”
While Villamin is unimpressed by arguments about the decoupling of emerging economies, he does not foresee the US slowdown causing a financial Armageddon. “It will be felt in the emerging world,” he says, “but that need not translate into outright recession in either China or India.” Rather, on the basis of the US economy achieving a modest 1% GDP growth this year, he sees China’s growth rate slowing from 11.5% in 2007 to a still respectable 9.8% this year and 9.3% in 2009.
Similarly, India’s growth rate is forecast to slip from 8.7% to 7.8% in 2008 before picking up again to 8.3% next year. The difference, Villamin explains, is because “with India the trade account is not so important a driver of the economy.” As a result, he sees China as being “more exposed to the global credit crunch and economic slowdown.”
Apart from the fallout from a slowdown in global trade, future growth prospects will depend very much on how far the two countries’ governments and central banks are willing to go to curb rising inflation. Again, China, with inflation currently running at 8.7%, seems to be facing the tougher challenge, and premier Wen Jiao Bao has declared this a priority. However, both countries are faced with sharply higher commodities prices on international markets—especially the recent surge in rice, which recently hit a 34-year record.
China’s top-down decision-making structure may be better placed to cope with this particular challenge. Its central bank is expected to attack inflation by freezing interest rates, tightening money supply and allowing the renminbi’s 6.7% appreciation so far against the US dollar (in which most commodities are priced) to continue.
Given the Communist party’s overriding priority of maintaining social stability, a slight cooling off of the economy is preferable to further growth with inflation. Villamin points out that during the 1980s inflationary pressure in China was one of the drivers of social instability that manifested itself most obviously in Tiananmen Square. Hardly surprising, he adds, that “the Chinese government will be happy if the economy goes through a gradual slowdown.”
India’s inflation rate has lagged China’s by around 2%, and few observers consider its economy to be anywhere near so close to overheating. Yet “one of the challenges that India faces in a world of sharply rising commodity prices,” observes Villamin, is that “as a fairly closed economy it continues to subsidize fuel and agricultural goods at prices which are well below those of the global market. With the cost of those subsidies now rising, how to fund them will be a challenge for policymakers.”
And India’s democratically elected coalition government has nowhere like the same leeway that the Chinese leadership has in imposing radical policy shifts from above. The inability of the government in Delhi to push through major infrastructure projects in the face of local interests, state governments and an independent but slow-moving judiciary that is capable of defending individuals’ rights may frustrate central policymakers and foreign investors alike, but at least it represents a system of checks and balances that is absent in China.
As Harvard Business School professor Tarun Khanna points out in his recently published book, Billions of Entrepreneurs: How China and India Are Reshaping Their Futures and Yours, the two countries’ approaches to decision-making and market forces are strikingly different. “While China courts foreign capital and has only recently and reluctantly acknowledged the private sector,” Khanna writes, “its internal opacity and lack of private property rights emasculate its internal markets in comparison to the parts of India where competition is allowed to run amuck. On the other hand, its unconstrained fiat allows it to override coalitions that might block material progress in a way that India just cannot.”
Khanna sees the two Asian giants as “inverted images of each other,” arguing that “what China is good at, India is not.” The absence of overriding central authority in India may explain why “China can build cities overnight while Indians have trouble building roads.” And the fact that each country has developed quite separate strengths—China as the world’s factory and India as its back office—did not occur because policymakers signed up to a non-compete clause but because each is “hard-wired” to excel in different fields. For instance, many Indians’ facility with English and “soft skills” make them supremely adapted to IT programming and staffing call centers, but the country’s inadequate transport infrastructure inhibits their competing in finished goods as the Chinese do. The opposite is true of China. As Villamin points out: “Actual production costs in India are quite low, and on that basis alone it could be competitive in supplying finished manufactured goods such as motorcycles. But inadequate transport infrastructure raises both costs and reliability of delivery.”
That may explain why, until recently, both India and China have focused on selling their goods and services to the developed world rather than to each other. Bilateral trade has grown from just $5 billion in 2003 to around $38 billion over the past five years. But that is small change compared to their exports to the US, Europe and other developed countries.
Reduced tension at the border is symptomatic of China and India's closer ties.
So it is hardly surprising that, during his recent visit to Beijing, Indian prime minister Manmohan Singh called for the dismantling of non-tariff barriers and tougher action protecting IT and other intellectual property rights. At the same time he sought to reassure Beijing that India’s closer relationship with the US, notably the proposed pact on civil nuclear energy and the possible purchase of 162 new fighter aircraft, does not mean it is becoming part of a broader strategy to contain China.
Mutual distrust goes back to the Sino-Indian war of 1962 and the unresolved territorial claims along their 2,000-mile Himalayan border. The two countries officially declared 2006 the first year of their “friendship,” symbolized by taking down the barbed wire on the Nathu La border pass and reopening the old trans-Himalayan trade route. (Previously a banner installed by India’s Black Cat mountain division declared, “This road leads to victory, Lhasa, and beyond.”) But the two nations still glare at each other across the “Bamboo Curtain,” and recent pro-Tibet demonstrations as the Olympic torch made its way through Western capitals have repercussions because India continues to host the Dalai Lama and Tibetan government-in-exile, which are condemned by China as “splittists.”
This historical rivalry has spread to Africa and Central Asia, where the two countries are competing for political influence and for energy and other raw materials needed to fuel their fast-growing economies. “Both the Chinese and the Indians are partnering with newly emerging resource-rich nations,” observes Villamin. Their “national champions” bid against each other—as in a re-run of “The Great Game,” when Imperial Britain and Russia vied for dominance in Asia—though occasionally they do collaborate in the interests of mutual energy security. Increasingly, the producer states with which they strike long-term energy contracts (often throwing in broader aid or arms deals) are those blacklisted by the West: Iran, Sudan and Myanmar.
The rivalry now extends to the Indian Ocean, with Delhi “pursuing defense and commercial engagement with countries such as the Seychelles, Mauritius and Mozambique in order to counter Chinese expansionism,” according to a recent report by Chatham House, the London-based think tank, which points out that “most of India’s trade and 89% of its oil arrives by sea, so keeping shipping lanes safe is a strategic priority.”
Delhi is painfully aware that, both militarily and economically, China is the dominant player. Looking ahead, however, Indians point to their “demographic dividend”—the competitive advantage 10 years out of having a larger population of working age while China’s aging population will have to support more dependents.
But in order to capitalize on this and take on China as a great manufacturing power, India needs to catch up on infrastructure. Current government estimates are of a $400 billion to $500 billion spend over the next 10 years. But as Villamin points out, “The key challenge in today’s markets is how that will be funded.” Added to which he notes that “the execution challenges of pushing major infrastructure projects through, including the nature of decision-making, are much greater than in China.”
So which of the two, the elephant or the dragon, is set to achieve global dominance? As things stand, most of the money is backing China, though a question mark remains as to whether it can continue to combine market-driven growth with a system of “social stability” built around the absence of democratic freedoms and property rights over the long term. As for India, it has been slower off the blocks and certainly needs a firmer sense of direction. But it is more likely to stay the course.