A Maze 11

“Sharpen your Perception”

It is not about the bragging rights that come with being one of

the most dynamic economies in the world or the hope of

membership at the global high table as an emerging

superpower, but transformation of ordinary lives, thanks to the

opportunities provided by economic reforms.

Average real incomes have quadrupled since 1991, providing

ordinary Indians a rare opportunity to improve their lot.

Ownership of consumer goods and basic amenities, like,

electricity and education has spread. Once accounting for about

25% of world’s out of school population, India shows higher

aspirations with this figure falling to 10%. UNDP said in its

Human Development Report 2010 that India is sixth in the list of

countries that have rapidly improved its human development

indicators since 1980. Poverty rates have dropped by at least 10

percentage points.

Indians, now, study better, eat better and live better.

We never had it so good!

China is one of the world’s fastest growing economies, with consistent growth

rates of 5% - 15% over the past 30 years. China is also the largest exporter and

second largest importer of goods in the world. China’s rapid rise as a major

economic power is often described as one of the greatest economic success

stories in modern times. From 1979 (when economic reforms began) to 2010,

China’s real gross domestic product (GDP) grew at an average annual rate of

nearly 10%. From 1980 to 2010, China’s economy grew nearly 18-fold in real

terms, real per capita GDP grew more than 13-fold, and hundreds of millions

of people were raised out of extreme poverty. China is now the world’s

second largest economy and some analysts predict it could become the

largest within a few years.

There is little doubt that China's economy will eventually surpass the U.S.,

mostly because of its sheer size -- its population is 1.3 billion, versus just 300

million in the U.S. It became more evident when China took over Japan in

2010.

China is running fast and now has new message for the world – We can help in

time of crises but can China actually save the world or more specifically

Europe from the crisis?

All eyes on

China

With slowdown is US and severe debt crisis in Europe, China rightly seems to be the only hope to give the world economy something of a boost in the coming year.

China’s rapid expansion accounted for more than half of the global economy's growth over the past couple of years and hence seems it can continue playing the

role of economic locomotive. Ironically, the biggest single risk to China's growth would not be from China, it would be a European financial crisis that could damage

credit conditions globally. Such an event could trigger a collapse in Chinese exports, with repercussions for the whole economy.

At the same time, the risk China itself is witnessing cannot be ignored. Uneven economic growth leading to public unrest, inflexible currency, unbalanced economic

development, increasing inflation and distortive banking system supporting inefficient industries are some immediate risks hampering China’s economic growth.

Uneven Economic Growth & Public Unrest

A long-term problem confronting China is the disparity in income and wealth. Every year numerous protests occur in China over a number of issues, including

pollution, government corruption, and land seizures. A number of protests in China have stemmed in part from frustrations among many Chinese (especially

peasants) that they are not benefitting from China’s economic reforms and rapid growth. Thus, income and wealth of the lower economic brackets need to be

raised to transform China from an economy dependent on investment for growth to one in which consumption is the primary driver. Overall, wages remain low,

with the average effective wage in Shanghai at $400 a month. Average GDP per head is also low at $4,300 - only 9% of the level in America. Although GDP per head

is higher in Shanghai, at $12,000, it is still lower in the central and western cities, at $1,000 to $2,000.

Unbalanced Development

China’s GDP growth still relies on capital formation or investment. In

2010, consumption and investment accounted for 37% and 54% of

China’s GDP growth. New investments can be fickle and can

evaporate in a higher interest rate environment or an increased

aversion to risk.

Growing Inflation

Though fast growth has fired up Chiana’s economic engines, but it has

also led to stubbornly high inflation, which threatens to overheat the

economy and undermine the long-running boom that the country has

experienced. From 1994-2010, the average inflation rate in China was

4.25% reaching a historical high of 27.7% in October of 1994 and a

record low of -2.2% in March of 1999. The inflation has been on the rise

since July 2009.

With inflationary pressures staying high, Beijing has been trying to

moderate growth and rein in inflation. During the past six months, the

government has tightened restrictions on bank lending, raised interest

rates, increased agricultural subsidies and even prevented Chinese

companies from raising consumer prices. China is still managing to

sustain strong growth, juggling the risks of an overheated, inflationary

economy on the one hand and too-tight policy that would trigger an

economic bust on the other. Inflation has climbed steadily despite five

interest rate hikes since October 2010 and government curbs on

lending and investment. The inflation has eased to 6.2% in August 2011

but is likely to stay above 6 percent through the September quarter.

With inflationary pressures staying high, Beijing has been trying to moderate growth and

rein in inflation. During the past six months, the government has tightened restrictions on

bank lending, raised interest rates, increased agricultural subsidies and even prevented

Chinese companies from raising consumer prices. China is still managing to sustain strong

growth, juggling the risks of an overheated, inflationary economy on the one hand and too-

tight policy that would trigger an economic bust on the other.

Inflexible Currency

China does not allow its currency to float and therefore

must make large scale purchases of dollars to keep the

exchange rate within certain target levels. Renminbi has

been appreciating since 2005 and expectations of further

gains still remain strong. China’s currency policy has

made the economy overly dependent on exports and

fixed investment for growth and has promoted easy

credit policies by the banks. These policies may

undermine long-term economic stability by causing

overproduction in various sectors, increasing the level of

non-performing loans held by the banks and boosting

inflationary pressures.

Inflation has climbed steadily despite five interest rate

hikes since October 2010 and government curbs on

lending and investment. The inflation has eased to 6.2% in

August 2011 but is likely to stay above 6 percent through

the September quarter.

Distortive Banking System - Support to Inefficient

Industries

China’s banking system is largely controlled by the central

government, which attempts to ensure that capital (credit)

flows to industries deemed by the government to be

essential to China’s economic development, especially

SOEs (State Owned Enterprises). It is believed that

oftentimes, SOEs do not repay their loans. In addition, the

government sets interest rates for depositors at a very low

rate, often below the rate of inflation, which decreases

household income. On the other hand, low Chinese

interest rates greatly benefit Chinese industries. Some

economists claim that this system constitutes a transfer of

wealth from Chinese households to Chinese companies,

which, it is claimed suppresses Chinese consumer demand

and encourages over-production in various Chinese

industries. Such policies are believed to have contributed

to widespread economic distortions in China.

Chinese government is trying to address each risk as it seeks to achieve sustainable economic growth,

which should better combat inflation risks and maintain social stability. Also despite daring predictions

of an imminent China bust by some bearish commentators over the past two years, the economy has

proven incredibly resilient amid significantly tightened domestic monetary policy and escalated global

risks.

However, in spite of all the positives placing any hope on China helping the world economy seems

unrealistic and flawed at this point of time. China is in the same situation as the rest of the world,

weighted down by overproduction, export dependency, overexposed banks, and compressed

consumption. Its success lies on an artificially overvalued yuan and a cheap and un-free workforce.

China can pull off great shows—the Olympics, Shanghai Expo, Asia Games—but it cannot solve the

problems of its people: the chaotic traffic in its megacities, pollution, quality of life and justice for its

workers and farmers. The only reason China is invests its foreign exchange reserves is for iquidity,

security and decent returns. It isn’t trying to save the world. China’s leaders lack a creative sense of

responsibility. They have cautious, incremental and narrowly focused interests. It’s high time China

starts adopting a broader concept of its interests and become a ‘responsible stakeholder’ in the global

system.

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