The long anticipated deceleration in the rate of the growth of China’s economy is under way. Even the normally conservative World Bank and the International Monetary Fund (IMF) are confirming that its growth is slowing down and is likely to fall below seven per cent. Even those analysts who had forecast a deceleration in its growth were unsure about when exactly the slowdown would start.
In the 2000s, I had estimated that China’s growth would decelerate below eight per cent, around the middle of the decade beginning 2010. The global financial crisis of 2008 sharply raised the probability that the slowdown would occur within the following decade despite risky efforts by China to prop up growth.
In contrast, India was forecast to achieve its potential growth rate of about eight per cent, given its export-import neutral growth model. The surprise in India’s case was the sharp slowdown from 2011-12, largely attributed to complacency and domestic policy mistakes. However, despite these mistakes, India’s growth rate from 2002-03 to 2013-14 was among the 10 highest in the world (using the old data series). Though the correction of these mistakes may no longer be enough to restore growth to earlier levels, India can and must restore growth to the average rates achieved earlier. Again, this has been recognised by both the World Bank and the IMF. These two developments taken together, imply that India’s trend growth rate is poised to exceed that of China’s in the next few decades.
Closing the GDP gap
This will start the long, slow process of closing the GDP gap with China, which was 1.4 times India's real GDP (in absolutes) in 2013. There is a common tendency to confuse relative levels of GDP with growth rates, so it is important to understand that China’s real GDP measured at purchasing power parity in 2011 international dollars is now 2.4 times that of India.
The two economies were almost equal at the end of the 1980s (China was 1.1 times that of India in 1990). During this period, its growth averaged 9.9 per cent per annum, 3.4 per cent points faster than India’s 6.5 per cent average. Even if the growth gap was inverted (i.e. became -3.4 per cent), it would take double the time (i.e. 30 years) to close the GDP gap as it took to open it.
Growth slowdown
The basic theory and empirics of growth show that fast growing economies like Japan, South Korea, Singapore and Thailand, which grew fast when they were at low or middle income levels of per capita GDP, maintained growth at high levels for one to two decades and then slowed down as their per capita GDP approached that of the (lower end) high income economies. In the case of China, the surprise was that it maintained an average growth of 10 per cent for 30 years, despite reaching middle income levels of per capita GDP about a decade ago. Many analysts who had been proved wrong in the 1990s, in their predictions of a China growth slowdown, became much more cautious. Those of us who were willing to take a reputational risk have been proved right, as China’s economy slowed below eight per cent in 2012 and is now predicted to slow below seven per cent by the multilateral institutions.
The global financial crisis ensured that the growth of world trade would slow sharply below the very high growth seen in the previous decade, aided by a correction of the bubble-like growth seen prior to the crisis. This meant that China’s (net) export-investment model was no longer sustainable and would produce slower growth in the 2010s. To delay this slowdown, China pumped large amounts of debt into the economy, with the official debt-GDP ratio rising from 55.2 per cent in 2008 to 88.1 per cent in 2013, an average increase of 6.6 per cent points of GDP per annum. Analysts have estimated that the debt in the shadow banking system may have increased by an equivalent amount, rising to dangerously risky levels. Based on a historical experience of such debt bubbles, some analysts predict that this bubble is likely to burst and reduce China’s growth rate to the three to four per cent levels. Analysts, who have greater confidence in the ability of the Chinese Communist party to manage an economic crisis, nevertheless, predict a deceleration of the trend rate of growth to a range of five to seven per cent.
Comparing growth rates
Based on World Bank “World Development Indicators” data till 2013 (till which year the GDP base for 2004-05 was fully available), we can compare the growth rates of China and India. A plot of these rates shows that the growth rate difference has been narrowing since 1990, due to a gradual deceleration of China and a stronger acceleration of India. Underlying this narrowing growth difference are variables that are drivers of or correlated with GDP growth and productivity. These include foreign direct investment (FDI) and exports, which are indicators of competitiveness, and imports, which reflect openness. The difference between China and India’s FDI-GDP ratio has been on a declining trend, from about 3.5 per cent of GDP in 1990 to a little over two per cent of GDP in 2013, suggesting slow but steady progress in attracting technology and risk capital, with a milder decline in China’s attractiveness. The difference between China’s and India’s export-GDP ratio, which was eight per cent in 1990, averaged 18 per cent during 2005 to 2007 before narrowing rapidly to about one per cent in 2013, indicating that India’s exports have held up to the global decline in world trade much more effectively than China’s. The difference between China’s and India’s import-GDP, which fluctuated around an average of 7.1 per cent points between 1990 and 2007 declined dramatically to -5.2 per cent by 2011-13, indicating that the Indian economy is now significantly more open than China’s.
Forecasting Indian growth
Analysis and forecasting of Indian growth has been confounded by the appearance of a new GDP series (2011 base) which has made some fundamental changes in methodology and data sources. As this new series provides less than three years of growth data, it is impossible to estimate the underlying trend growth rate (using this series). After the mid-year 2014 Budget, I had said: “The measures taken in the budget will be sufficient to increase growth by about 1 per cent point over the last year’s 4.7% to 5.7%. Actualization of some of the measures indicated in the budget will however be necessary to raise growth to the 6.5 to 7% range in 2015-16.” Given that the average growth rate as per the new data is about one per cent point above that, using the new data, a projected growth rate of 7.5 per cent to eight per cent is quite conservative. This seems to be the reasoning underlying the World Bank’s and IMF’s projections for India’s growth in 2015 and 2016.
The Central Statistical Organisation (CSO) has projected a growth rate of 7.4 per cent for 2014-15 and a growth acceleration to eight per cent in 2015-16. which would not be wildly optimistic. However, as many observers have pointed out, high frequency data such as the Index of Industrial Production (IIP) for manufacturing, quarterly results for companies, and tax revenues from excise and corporate income tax do not appear consistent with these high growth levels. I had argued that the global financial crisis and the consequent global demand recession and excess capacity have affected not only the export-led Chinese economy, but also the globally connected and competitive corporate sector of India (http://goo.gl/r2sdYi). Thus, post the global financial crisis, the Globally Connected and Competitive (GCC) corporations will lag overall recovery, instead of leading it, as they did in 2002-03 to 2007-08. Thus, all indicators connected with these companies, such as IIP, corporate profits, corporate and excise tax revenue would also lag the GDP recovery.
Based on the theory and empirical evidence provided by high growth economies, some analysts had predicted, since the 2000s, a slowing down of the Chinese economy during the decade of the 2010s to a rate of growth below that of India (http://goo.gl/3iHrdH). By making the export-investment-led strategy of development unviable, the global financial crises made this highly likely if not inevitable. It was also assumed in the forecasts that the Indian government would continue to carry out the minimum reforms necessary to maintain India’s growth rate at an average of the previous decade. Because the Indian government was complacent and made policy mistakes between 2010 and 2012, the Indian economy faltered seriously. Some of the momentum has been restored after the corrections introduced in the last two years. However, a sustained growth of 8 to 8.5 per cent over the next few decades requires implementation of the reform agenda even though continuing sensitivity to shocks can derail growth given that the world environment is far from conducive to sustained high growth. If this is done, we should expect to see India growing faster than China and beginning to close the wide gap that has opened between the per capita GDP of the two countries.
(Arvind Virmani, a former Executive Director, IMF, is Mentor, Public Policy & Economics, to the Federation of Indian Chambers of Commerce and Industry.)
Keywords: International Monetary Fund, China growth deceleration, India economic growth
