Decoding China’s Growth
Can a major country’s economy grow at 24 per cent a year? The answer: no – not if it’s a normal country. But China isn’t a normal country so in the five years between 2006 and 2011 its GDP grew at an astonishing average of 24 per cent a year.
In 2006, China’s GDP was $2.75 trillion. In 2011 it had miraculously nearly tripled to $7.55 trillion in five years. Work the math backwards: that’s equivalent to an average nominal GDP (real plus inflation) growth rate of just over 24 per cent a year.
This was the take-off point for China’s economy. It catapulted from being the fourth largest economy in the world behind the United States, Japan and Germany to the second largest in five years. In 2006, the GDP of the United States was $13.81 trillion, five times China’s. By 2011, US GDP had risen to $15.54 trillion, just twice China’s. Thus between 2006 and 2011, China’s economy had grown from being one-fifth ($2.75 trillion) of America’s to half ($7.55 trillion) of America’s.
The reason for this modern version of Mao Zedong’s Great Leap Forward is difficult to pin down. China had never grown for five continuous years at an average of 24 per cent a year before 2006 and hasn’t done so after 2011. Indeed, the rise over the past decade in China’s GDP from $7.55 trillion in 2011 to $16 trillion in 2021 reflects an average annual growth rate of a more normal 7.5 per cent. It therefore took China 10 years to double its GDP between 2011 and 2021 compared to just five years it took to nearly triple GDP between 2006 and 2011.
Look for clues to explain this anamoly at the yuan-dollar rate. In 2021, it averaged 6.46 yuan to the dollar. The exchange rate ten years ago in 2011, remarkably, was exactly the same: 6.46 yuan to the dollar. Through the decade, the rate fluctuated very little.
But rewind to 2005-06. The yuan-dollar rate was over 8.1 yuan to the dollar. Thus between 2006 and 2011, the Chinese currency had strengthened against the US dollar by up to 25 per cent.
Since GDP is measured in US dollars, the appreciating yuan helped bump up China’s economy by at least 25 per cent. Had the yuan remained steady during 2006-11, China’s GDP in 2011 would have been nearer $6 trillion instead of $7.55 trillion. That would have reduced the average annual growth rate of the Chinese economy in 2006-11 from a miraculous 24 per cent to a more credible 14 per cent. Without fudging, the annual growth figure would have been even lower.
In stark contrast, the Indian rupee has over the same period weakened significantly. In 2011, the exchange rate was Rs. 45 to a dollar. In 2021 it is Rs. 75. If like the yuan, the rupee had remained steady through 2011-21 at 45 to the dollar, India’s GDP in 2021, measured in dollars, would already be $5 trillion.
India has an ecosystem that constantly seeks a weak rupee. The export lobby is for obvious reasons a fierce votary of a weak rupee. India’s merchandise trade deficit and an inflation differential with the US are why the rupee has historically depreciated at an average of between three and five per cent a year.
Exports, despite a constantly weakening rupee over the past ten years, have risen only this year, belying the argument that a weak rupee is essential for export growth. Quality of merchandise, cost of logistics and timely shipping are as important. India needs to improve on these instead of focusing only on a weak rupee to boost exports.
According to V. Anantha Nageshwaran, a professor of economics at Krea University, “Of all the economic fundamentals that influence exchange rates, the one enduring factor is the inflation differential. In other words, relative purchasing power parity (PPP) holds over long horizons. Nearly a decade ago, in their annual investment returns yearbook for Credit Suisse, financial historians Dilroy, Marsh and Staunton noted that the pound sterling had depreciated by about 1 per cent on average per annum between 1904 and 2004. The annual inflation differential between the UK and the US was also around 1 per cent. So, assuming that inflation differentials will do a better job of explaining the dollar-rupee exchange rate over a 5-year horizon is not an unrealistic assumption.
“But even the US Federal Reserve concedes that the high inflation rate in America that was considered transient is now deemed more permanent. Consumer-price inflation rate has been stubbornly at or above 5 per cent for the last five months. So, for any USD-INR forecast, higher inflation rates in India over the US that have been the default factor for the past few decades cannot form the basis (of depreciation any longer).”
A more accurate comparison between major economies is to examine GDP as measured by purchasing power parity (PPP). When economies are quantified at current exchange rates tied to the US dollar, the local value of goods and services in developing, low-cost countries is skewed. PPP calculations equalise these cost differentials. They also give a correct sense of relative living standards, factoring in costs and wages.
By PPP, China’s and India’s GDPs in 2021-22 are estimated to be, respectively, $26 trillion and $11 trillion. This GDP gap of 2.5x is far lower than the 5x differential suggested by comparisons using nominal GDP based on current exchange rates.
Similarly, if by current exchange rate calculations, China’s per capita income of $10,000 is five times larger than India’s ($2,000), the gap in PPP-based per capita income between the two countries is much lower. According to the latest International Monetary Fund (IMF) estimates, China’s per capita income by PPP in 2020 was $16,216. India’s per capita income was $6,172. This gap in thus a more realistic reflection of living standards in the two economies. The IMF calculation narrows the gap in per capita incomes between China and India from 5x to 2.5x.
With India entering a decade of high economic growth and China’s economy slowing to 4.5 per cent a year, the gulf in per capita income is set to narrow further. To achieve consistent real (excluding inflation) annual GDP growth above 7 per cent, India needs to continue with strong structural reforms. That should be the Narendra Modi government’s overriding priority in the second half of its second term.
