<div>All of the above have raised expectations on the Indian side to a fever pitch. But a reality check is in order. While reduction of its widening trade deficit with China — India’s imports from China were to the tune of $51.05 billion, and exports a meagre $14.83 billion, resulting in a $36.22 billion trade deficit in 2013-14 — is high on New Delhi’s agenda, from China’s perspective, the Sitharaman-Gao agreement is merely reflective of the country’s changing economic growth priorities in the wake of the recent slowdown in its gross domestic product (GDP) growth. <br /><br />In fact, China’s current five-year plan gives more importance to raising household income and boosting consumption than to pure export-oriented growth to sustain and grow its national wealth or GDP. In this connection, it wants to move some of its manufacturing activities out of the country — hence an assurance to invest in Gujarat and Maharashtra to set up industrial parks — even as it boosts domestic consumption and household income through growth in its services sector. <br /><br />While many see China’s outreach as an effort to counter India’s growing cosiness with Japan and the US, the fact is that the engagement is largely driven by the changes taking place within the Chinese economy. <br /><br /><strong>Shrinking Trade</strong><br />“There was an opportunity, but unfortunately, we made ourselves inconsequential,” says Basant Poddar, vice-chairman, Federation of Indian Mineral Industries, the largest miners’ representative body in India. <br /><br />Poddar is referring to the Supreme Court decision — to lift the ban on iron ore mining and allow mining companies to export ores —that came after two long years. The China connection to this development is that most of the pre-ban ore exports were to it. India, in fact, was the second largest exporter of iron ore to China. Two years on, it is out of the reckoning. Mining companies from other countries have ramped up production to fill the gap left by India. “The confidence of the Chinese buyer has been shaken. It is extremely difficult to re-establish it,” says a Kolkata-based miner.<br /><br />While the mining industry is keen to regain a slice of the Chinese market, the government is even more so, as was evident from the recurring theme of “trade deficit” in the talks between Prime Minister Narendra Modi and Xi. <br /><br /><img width="631" height="200" align="middle" src="/image/image_gallery?uuid=c80a96a0-7e42-45ce-acf2-4f42c67b5048&groupId=520986&t=1412055459878" alt="" /><br /><br />Deficit apart, the overall volume of trade between India and China has also seen a sharp fall. According to commerce ministry data, the total trade between the two was $65.9 billion in 2013-14, compared to $73.4 billion in 2011-12. Experts see the decline as an early indicator of the policy shift that has begun to take effect in China. <br /><br />China has embarked on a correction in its economic growth pattern — skewed due to mass exports (resulting in a glut of made-in-China products) and massive infrastructure development — to generate a more sustained, albeit slower, growth. Whether India will lose, gain, or only be marginally impacted by the changes in the Chinese economy are questions that remain unanswered at the moment. Even the $20-billion commitment and the promise of industrial parks are inconclusive steps.<br /><br /><strong>Time To Slow Down</strong><br />Why did China need a course correction? Experts believe it was brought on by the need to correct serious anomalies associated with its fast-paced economic growth in recent times. “The slowdown in China is occurring for the same reasons that caused sharp slowdowns, even crises, in every country that has had a growth miracle driven by very sharp investment growth,” says Michael Pettis, a professor of finance at Peking University, Beijing.<br /><br />According to him, in every such case, the early years of rapid growth are transformed into growth driven by investments that are increasingly and systematically misallocated to create manufacturing overcapacity, overly expensive infrastructure, excess commercial and residential real estate, trophy projects, etc. — all driven by credit expansion and excessively low interest rates. <br /><br /><a href="/image/image_gallery?uuid=e656296b-7bbf-4a18-9c7d-6666cb4d1800&groupId=520986&t=1412055595874" target="_blank"><img width="627" height="455" align="middle" src="/image/image_gallery?uuid=048f4855-b860-4823-97cf-582a01fe32e9&groupId=520986&t=1412055558098" alt="" /></a><br /><br />“When this happens, debt begins to rise much faster than debt-servicing capacity and, at some point, the country is saddled with far too much debt and must rein in credit growth. China has long passed that stage, and debt levels have become among the worst in the developing world,” notes Pettis. The problem is that China’s economic activity is very dependent on rapid credit growth. “Beijing must continue to rein in credit growth over the next three to four years and, as it does so, economic growth will continue to drop sharply. I don’t expect (China’s) GDP growth to exceed 4 per cent on average during 2012-22,” he says.<br /><br />“Tight lending meant that hitherto sprawling infrastructure investments (in China) saw a slowdown,” says Joe Thomas Karackattu, assistant professor, China Studies Centre, Indian Institute of Technology, Madras. This hit Indian exports to China as it resulted in a slump in the demand for iron ore, minerals and metals. In 2012-13, India’s exports to China saw a 9.4 per cent fall from the previous year, to $17.03 billion. Anne Stevenson-Yang, managing principal at Beijing-based J. Capital Research, says Indian exports to China will remain affected by the slowdown. “India is more of a commodity supplier to China than a competitor for manufacturing contracts so, in this sense, the slowdown is bad for India.”<br /> </div><div>break-page-break</div><div><br />In the same period, China’s exports to India, mostly machinery, did not slip into the negative territory, though the growth was nominal (1.6 per cent). This, because India is trying hard to push infrastructure growth through investment in roads, energy, manufacturing, etc. <br /><br />While India’s infrastructure push will continue, what remains to be seen is whether China will continue to ramp up exports to India or choose to set up manufacturing hubs here to cater to the demand.<br /><strong><br />Losing Edge </strong><br />Karackattu notes that China’s manufacturing sector has been witnessing rising production costs (land and labour), a reduced preference for the east coast for setting up new units (re-balancing economic prosperity between provinces) and an increased demand to move up the technology ladder in recent times. This has resulted in Chinese products losing their cost competitiveness in some segments. </div><div><br />“One of the consequences of the rebalancing is an erosion of China’s export competitiveness as wages, currency and interest rates continue to rise in real terms,” says Pettis. “These factors were at the heart of China’s rapid growth, and are also the main reason for China’s huge economic imbalances and enormous overcapacity. So they must and will be reversed over the rest of this decade. China’s manufacturing exports to India, in other words, will see a rise in prices. This is bad for Indian consumers but good for Indian producers.”<br /><br />For instance, the second-biggest component of India-China trade after ores, namely, intermediates and final bulk drugs, will witness the fallout of rising production costs, impacting consumers here.<br /><br />Nipun Jain, managing director of Pharmchem, says the competitiveness of Indian formulation (final medicine) manufacturers who use Chinese intermediates will be affected. “Prices are already rising. China was the only source for several fermentation-based raw materials. We cannot, overnight, set up drug manufacturing facilities to produce them more effectively,” he explains. <br /><br /><strong>The $20-billion Opportunity </strong><br />The impact of the economic rebalancing in China is not limited to trade. It will alter the investment climate in the country and change China’s priorities for outbound investments as well. Seen in this context, the country’s $20-billion investment commitment turns significant. <br /><br />China’s current 12th Five-Year Plan is aimed at raising household income, boosting consumption and facilitating expansion of services. However, it is not an easy task, says Karackattu. “As for consumption, China accounts for only 3 per cent of the world’s imports of consumer goods and, therefore, has to undertake long-drawn internal reforms to achieve a rebalancing. Hence, in the short to medium term, the role of large consumer markets and investment sites such as India cannot be ignored,” he says.<br /><br />So far, Chinese investments in India have been in areas such as telecom and electronics (Huawei, ZTE, TCL, Haier, etc.), power (Mingyang Wind Power Industry Group, Shanghai Electric, China Datang Corp, etc.) and transport (Shanghai Automotive Industry Corporation, China CNR Corp, CSR Corp, etc.). Indian corporates known for their Chinese investments and joint ventures include the Tatas, Mahindra & Mahindra and Bharat Forge. IT majors such as Infosys Technologies, HCL Technologies and Genpact also have a presence in China. <br /><br /><a href="/image/image_gallery?uuid=b25aff3c-f371-4372-a5d4-a0d4acffc62e&groupId=520986&t=1412055690496" target="_blank"><img width="640" height="421" align="middle" src="/image/image_gallery?uuid=9ca4d5ba-f074-412b-86b1-3af705bcd0d9&groupId=520986&t=1412055662732" alt="" /></a><br /><strong><br />Room For All</strong><br />Another dimension to the Chinese slowdown is its potential impact on global markets and its possible consequences for India. Jabin T. Jacob, assistant director, Institute of Chinese Studies, New Delhi, says the growth opportunities for India and China are complementary and not competitive. Karackattu agrees: “The benefits from any slowdown in China will be reaped by countries that directly compete with it. (Based on the corelation) India doesn’t really stand to gain from a slowdown in China. The loss also is too early to speculate upon”. <br /><br />The logic behind this argument is that India and China are competing in the global market with different skill sets and products. “India’s key advantages are in services and the manufacture of precision engineering goods (unlike China’s, whose advantage lies in low-cost, low-tech manufacturing),” says Karackattu.<br /><br />According to him, China should focus on horizontal investments and disaggregated production with an India focus. “China should prepare the ground for its companies to shift from export of equipment to India to an ‘integrated service model’ with a strong investment component that serves the additional purpose of job creation in India,” he says.<br /><br />Karackattu also proposes that India and China be part of a South Asian value chain. “China’s trade with South Asia is less than 5 per cent of its trade with the Asia-Pacific; thus, South Asia remains on the periphery of China’s active economic engagement.”<br /><br />China could be India’s biggest trading partner, but the converse is not true. In 2012, India ranked 15th among China’s trading partners, with a 1.72 per cent share of its overall trade, recording a decline of almost 10 per cent year on year. In terms of exports to China, India stood 19th, with a share of 1.1 per cent. The negligible share of trade is one reason why India doesn’t figure in China’s economic strategies the same way as China figures in India’s. “One problem in China, and I see this even among my Peking University students, is that they do not seem to take India seriously enough,” says Pettis. “I have told my students that this is a serious mistake, and that they must remember that China has far more in common with India and the developing world than with the developed world, but not too many are eager to hear this. Anyway, it is a widely and deeply held system of belief,” he adds.<br /><br />The success of the Modi-Xi engagement will largely hinge on the extent to which the two countries can find a commonality of interest amid differing priorities and national interests. It matters little that Xi finally did not commit to the much-talked-about $100-billion investment. The $20-billion that he’s promised could be the start of a beautiful romance.<br /> <br />joe@businessword <br />twitter: @joecmathew<br /><br />(This story was published in BW | Businessworld Issue Dated 20-10-2014)</div>
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