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Macroeconomic policies in China and India

China and India are the two giant’s economies of Asia, which are now regarded as the “success stories” for their massive economic development for the past two decades. On their way to economic growth they have more dissimilarities than similarities. The most common things among them are their ancient civilizations, population, covering substantial geographical areas and developing economies of the world. They both apparently benefited from globalization as well sound macro-economic policies. But on the other side they have different socio-economic-political set ups they had followed different development strategies. China followed the socialistic pattern from the very beginning; India resorted for “mixed-economy” for economic growth. In this paper I would like to discuss how China outpaced India in their economic growth even though both started their journey over same period of time. A brief analysis on their GDP’s, inflation, unemployment and foreign exchange reserves, as well how the global recession had affected their economies.

A Comparison of China’s and India’s GDP:

China:

China started its economic reforms in 1958 when Mao broke with the soviet model and announced the “Great Leap Forward”, which aimed at rapidly increasing industrial and agricultural production. But its economic growth rapidly changed with its market-oriented reforms when it opened its arms to the world in 1979.Today Chinese population is about one-fifth of the worlds and its GDP contribution is about 10 percent of the world’s total, making it to be the third largest economy in the world in 2009. But latest sources tell us that China is second next to United States in GDP surpassing Japan. GDP of China at the end of third quarter is 9.6 percent. China’s GDP reached its peak during 2007 with 14.2 percent and was not affected much during the global recession. (U.S. Department of State, 2010)

The major factors influencing China’s economic growth is exports. Exports of goods and services contributed around 26% in 2009 while the agricultural sector contributing only 10% of its GDP. China’s policy makers decided to move from their traditional agricultural economy to world’s manufacturing hub. This very step of theirs in early 1980’s helped them in their rapid economic growth making their presence felt in the world. The projected real GDP for this year is expected to be around 10.5% according to International Monetary Fund.

India:

India liberalised its economy in 1990 when they faced balance of payments problem. India is basically an agricultural oriented economy concentrating less on manufacturing sector and on FDI’s. India economy started gearing up with the economic reforms in 1990 from where on its GDP increased at an average 7.08% annual growth since 2000.First half of the decade was little slow and with its FDI and manufacturing sectors increase it put up a good show in the second part of the decade. The global recession had affected it very much where its annual GDP was just 5.1% in 2008.Projected real GDP of India is about 9.7% for this year according to International Monetary Fund.

China and India both had followed centralized planning; China followed the strict communism to implement policies where as India approached the democratic policy. China carried the reforms aggressively in 1980’s and 1990’s contrastingly India started its reforms in 1990.China followed the traditional development model but India tried to jump from agriculture to service sector resulting very low manufacturing growth for India compared to China.

GDP Growth (annual %)

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

China

8.4

8.3

9.1

10.0

10.1

11.3

12.7

14.2

9.6

9.1

India

4.0

5.2

3.8

8.4

8.3

9.3

9.4

9.6

5.1

7.7

(Adapted from: The World Bank Group, 2010)

Foreign Direct Investments in China and India:

Foreign Direct Investment one of the driving force behind these two economies. China is the frontrunner in this sector. China anticipated this much before India and liberalised its policies towards global participation in their economy. China is the world’s largest recipient of FDI’s for over two decades and continues to be. India has opened its market to the world much later and that too not in all sectors. In 2009, China attracted $95 billion FDI inflows, accounting for 1.9 percent of its GDP compared with India’s $36.6 billion inflows, equivalent to 2.7 percent of its gross domestic product. China attracted 2.5 % more FDI’s than India in the year 2009.India’s FDI inflow dropped by 14 percent in 2009 and that of China by 12 percent. India should improve its infrastructure as well credibility of the government to attract FDI’s. India is a vast country with many natural resources including metals, minerals and oil deposits. English speaking ability gives edge over China to improve its service sector. India should sustainably increase it’s invest on infrastructure to attract more FDI’s. Foreign investors, who could invest their money anywhere, find more opportunities and fewer obstacles in China. (Zhou Siyu, 2010)

FDI, Net inflows (BoP, Current US$)

2005

2006

2007

2008

2009

China

79,126,731,413

78,094,665,751

138,413,000,000

147,791,000,000

78,192,727,413

India

7,606,425,242

20,335,947,448

25,127,155,852

41,168,605,242

34,577,000,000

(Adapted from: The World Bank Group, 2010)

Foreign Exchange Reserves and Exchange Rate Policy:

China: Policy on Exchange Rate

China’s exchange rate policy in 1950s and 1960s was mostly determined by the nation’s geo-political, security, and strategic interests. China revised its currency reforms on January 1, 1970, by substituting 10,000 renminpiao for one renminbi (RMB) and it fixed an official rate of 2.46 yuan to a dollar. Since July 2005, China has been implementing the managed exchange rate policy, i.e. the RMB is pegged to a basket of foreign currencies, notably the US dollar. Many argue that Chinese RMB is undervalued and it gives an unfair advantage for the Chinese exporters and this result in a large trade surplus and accumulation of Foreign Exchange reserves. Main reasons which favoured to maintain Chinese exchange rate are the government policies and the term “Four Bulwarks.” (Abdol S.Soofi.2007)

The Four Bulwarks:

China had adopted an internally fixed exchange rate policy. It has pegged the RMB at a predetermined rate against the dollar. During the Asian financial crisis in 1997 four factors worked as bulwarks to preserve the RMB’s fixed exchange rate: (1) substantial foreign exchange reserves, (2) huge current and capital account surpluses, (3) a high ratio of foreign direct investment (FDI) to short- term foreign capital inflows, and (4) inconvertibility of the yuan on capital account. These in turn were strengthened by sound macroeconomic restraints implemented since 1993. (Xiao-Ming Li.2000)

These policies had helped China to hold the largest official foreign currency reserves in the world currently estimated to be $2.4 trillion an increase of nearly $500 billion in the course of 2009.China was the second largest holder of US Treasury Securities at the end of December 2009 with $755.4 billion next to Japan.

India: Foreign Exchange Reserves and Exchange Rate Policy

India also followed a very traditional reform process in exchange rate policy. Indian rupee was devalued by 19 percent. The exchange rate was unified in 1993.The government had an option of either allowing the Indian rupee to float in the open market and find its equilibrium rate or fix the nominal rate and maintain that rate by selling or buying foreign exchange. The Indian government opted to buy and sell foreign exchange and pegged the exchange rate. Rather than reforming the real exchange rate due to appreciation, the Indian government decided to accept risk of inflation and came up with some amount sterilization and fiscal control. The real exchange rate exceeded 10 percent in the last two years. An appreciation in exchange rate helped to keep the inflation low in 2007. A more flexible exchange rate supports a counter-cyclical interest rate. China is about $2.2 trillion at current exchange rates and India is about $700 billion. China’s foreign exchange reserves are about 5-1/2 times more than India. (Debasish.Chakraborty. 1999)

Inflation in China and India:

China:

In recent years inflation in China has been considerably lower. Consumer price inflation in China varied year by year. At a point of time, it fell back to – 4 percent in July 2005, and increased to 5 percent in May 2007. Since then it was around 5 percent for over a period of time. Even under very low inflation China managed very high GDP growth rates. Inflation in China remains low because its demand is not facing supply bottlenecks. China managed lower food inflation than India despite lower production growth, while per capita incomes were growing much faster. Consumer price inflation hit a 23 month high of 3.6 percent during September. Chinese inflation has been largely driven by food costs, which account for about a third of the country’s consumer price index. The increase in global commodity prices and relatively loose domestic monetary environment was also adding to inflation risk.

China-Inflation-Rate-Chart-000002.png

Source: http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=CNY

India:

India does not have an official consumer price index. Unlike most countries India calculates inflation on wholesale price index over a basket of 435 basic goods. Food prices constitute a big share in India’s most likely representative consumer price basket. India has not suffered particularly from dramatic inflation; it is currently experiencing a rise in inflation as in other emerging economies. The wholesale price index in May 2010 rose to 10.16 percent, the highest since 2008.Rise in food and fuel costs was the reason behind the rise in inflation. With economy growing at a brisk pace rising in prices remains a key concern. On a measuring note to control inflation government raised its interest rates hoping that it would bring down inflation.

Source: http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=INR

Unemployment in China and India:

China:

China is the highest populated country in the world. About 22 percent of China’s labour force is without employment. Chinese society had undergone a meaningful reform in the past three decades. They were allowed to work in any part of the country or start a business of their own. Young Chinese had watched their country to emerge as an economic superpower and they wanted to be a part of it. Chinese unemployment rate is about 4.3 percent (September 2009 est., according to Central Intelligence Agency (CIA)) .It’s major labour force is in agriculture and services followed by industries. Education system in China needs to be changed. China should ensure a steady transition from its low cost manufacturing to a service oriented economy. Some of the reasons for China facing unemployment were due to frequent natural disasters and economic uncertainties.

India:

India is the second largest populated country in the world where about 60 percent of the population lives in rural areas. Many people in India work in the agriculture sector or are self – employed. With global economic reforms in place, India is also moving into the manufacturing sector as well as service sector which are providing some employment to its vast population. Low literacy percentage is a major setback for India and it does not possess marketable skills necessary for the job market. India had an unemployment rate of 10.7 percent in 2009(est.) the major labour force are in agricultural sector, services and industry. Indian government had taken major steps in providing employment to its rural population. Schemes like National Rural Employment Guarantee Scheme (NGRES), Swarnjayanthi Gram Swarozgar Yojana(SGSY), Swarna Jayanti Shahari Rozgar Yojana(SJSRY), were introduced by the government to provide employment for the rural people. Employment in the current situation was affected by the global financial crisis and economic slowdown in India.( Annual Final Report-2010)

Effect of Recession on China and India: Measures Taken By the Governments

The global economic crisis had a greater impact on the emerging economies of the world. But they were not the worst affected ones. Even during recession China put up a good economic growth, but it affected India to a certain effect. The Chinese social structure, market dynamics and political system helped China to resist the recession. The decrease in exports, lead to a stall in domestic production. Factories were closed in Southern China. In order to minimise the recession affect China government announced a US$ 586 billion stimulus package. This was aimed at encouraging growth and domestic consumption in ten areas of Chinese society. China had also instituted cuts in interest rates; greater rebates were given on taxes charged to exporters.

India was badly affected by recession because US is India’s largest market for exports. In order to neutralize the recession government of India came out with an economic package which encompassed interest rate cuts, indirect taxation, monetary policy measures and duty cuts. Prime lending rates of the commercial banks were reduced.

Conclusions:

China and India are rapidly growing. The growth of China and India had created enomorous opportunities for their trading partners. China is more integrated into global production sharing for manufactures, while service exports are more important for India. However, one of the current differences between China as the ‘factory of the world’ and India as the ‘world’s back office’ in global trade may be changing in the coming decade, China aiming to develop its service sectors whereas India hopes to strengthen its manufacturing sector. Globally India’s economic growth was surpassed only by China. The continuing economic growth is not assured.

China should improve its quality of exports, education should be improved privatization should be encouraged with less government intervention and improve its agricultural productivity which helps in reducing inflation.

India needs to improve its basic educational standards, governance, control inflation, liberalise financial markets, introduce credible fiscal policy and increase trade with its neighbours. India needs to improve its infrastructure and as well as agricultural productivity. India needs to attract more of FDI’s and improve its manufacturing sector.

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