Journal Issue

Forum: Lessons from two emerging giants: China and India

International Monetary Fund. External Relations Dept.
Published Date:
January 2005
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China and India are emerging as increasingly important regional and global economic powers. What can each learn from the other, and what can the world learn from both? In Beijing in late October, a conference on China’s and India’s changing economic structures—a follow-up to a 2003 conference in Delhi (see box)—examined experiences and shared views on what will be needed to sustain high growth, with a focus on how to strengthen financial sectors, ensure fiscal stability, and deepen regional cooperation.

The conference—organized by the IMF, the China Society for Finance and Banking, and the Stanford Center for International Development—drew policymakers, business people, and scholars from India, China, and the region’s emerging market countries and featured keynote addresses from the People’s Bank of China Governor Zhou Xiaochuan and Reserve Bank of India Deputy Governor Rakesh Mohan. In contrasting several major features of the two economies, Zhou paid particular attention to the contribution of the service sector to growth. He also paid tribute to the advances that India has made in its financial “ecology”—the institutions, laws, and regulations that underpin the system—adding that China had made this a priority, too. Looking ahead, he said, China’s reforms will focus on building a harmonious society, including improving living standards in the countryside, promoting energy efficiency, and protecting the environment.

In his remarks, Mohan looked beyond the two countries to highlight several conundrums confronting the global economy, notably the muted impact of higher oil prices on global growth, falling long-term bond yields at a time when the U.S. Federal Reserve has been raising short-term interest rates, and the persistence of low consumer price inflation despite abundant liquidity. These questions have implications, too, for monetary policy, Mohan said, expressing particular concern about whether price-related instruments, such as exchange rates and interest rates, may be losing some of their effectiveness.

Financing the future

In three sessions devoted to financial sector reforms, participants contrasted developments in the banking sector, securities markets, and financial liberalization in China and India. On the banking front, while both countries are moving away from their earlier, heavy reliance on state-owned banking systems, reforms have taken different routes. China has focused on modernizing operations and strengthening commercial orientation, while upgrading the regulatory and supervisory environment.

Why India and China have grown

India and China now account for nearly 20 percent of global output. A conference in Delhi in late 2003, sponsored by the IMF and India’s National Council of Applied Economic Research (NCAER), examined what led to rapid growth in both countries. A volume of the proceedings, India’s and China’s Recent Experience with Reform and Growth, coedited by Wanda Tseng (IMF Asia and Pacific Department) and David Cowen (IMF Regional Office for Asia and the Pacific), is now available.

Lord Meghnad Desai (U.K. House of Lords and London School of Economics) opens the book with a perspective on what led to China’s lead and India’s lagged growth performance over the last quarter of the 20th century. Suman Bery, Kanhaiya Singh (both NCAER), and Arvind Panagariya (Columbia University) take an in-depth look at reforms that have helped raise factor productivity and gradually accelerate growth in India since 1990. James Gordon and Poonam Gupta (both IMF) explore the role of the service sector in India’s growth, and Hu Angang, Hu Linlin (both Tsinghua University), and Chang Zhixiao (Peking University) offer valuable lessons from China’s experience in addressing urban-rural disparities and maintaining social cohesiveness.

Turning to the financial sector, Saugata Bhattacharya (Hindustan Lever) and Urjit Patel (Infrastructure Finance Development Company) weigh what India needs to do to increase the efficiency of financial intermediation. Chen Yuan (China Development Bank) highlights the challenges China faces in reforming its financial sector and increasing investment efficiency. Abhijit Banerjee, Esther Duflo (both MIT), and Sean Cole (Harvard University) consider the role of resource allocation in India’s growth—specifically whether banks underlent and what the policy response might be.

Finally, Nicholas Lardy (Institute for International Economics) looks at China’s relatively more aggressive trade liberalization, and Jonathan Anderson (Union Bank of Switzerland) and Narendra Jadhav (Reserve Bank of India) analyze China’s and India’s different reform paths on capital account liberalization. Eswar Prasad and others (IMF) explore the links between global financial integration and growth—a key interest as these two countries take center stage among emerging economies.

Copies of India’s and China’s Recent Experience with Reform and Growth are available for $105.00 each from IMF Publication Services. Please see page 364 for ordering details.

India has dealt explicitly with nonperforming loans—an issue in both countries—by moving these loans onto the government’s balance sheet. India’s experience with large-scale state and private bank ownership and the role played by different types of banks (such as community financial institutions) prompted lively discussions on the optimal degree of government involvement in the banking sector and the risks that may arise during the process of privatizing this sector.

Of the two countries, India has taken the lead in developing its securities markets. The sophisticated regulatory and market infrastructure for its capital markets is state of the art in many respects. As participants noted with some irony, this success stems in part from a crisis in the early 1990s that prompted a strengthening of oversight and regulatory bodies. China has stepped up the pace of capital market development, seeking to address nontradable government-owned shares, which have adversely affected its stock markets, and to establish an interbank market for short-term bills issued by major corporations.

As China and India become more integrated into the global financial system, the urgency of financial sector reform has increased. In particular, the need to liberalize the financial sector and make it more resilient to both internal and external shocks has become pressing. At the same time, policymakers recognized that, through transfers of technical and managerial expertise, foreign institutions can play a useful role in developing financial markets in both countries.

Fiscal choices

On the fiscal side, there was wide agreement on the overarching aim of maintaining high growth and employment rates, as well as a degree of social harmony, but there was recognition of the potential tension between other goals—notably funding human capital development and improving physical infrastructure. The former had been shifted in many instances to households, particularly in China, while the latter is seen as of increasing importance owing to ongoing urbanization, particularly in India.

Understandably for two large and populous countries, fiscal federalism was a hot topic. Of particular concern was the lack of local budgetary discipline in both countries. This indiscipline, participants pointed out, is likely to arise when local governments have to rely heavily on transfers from the central government or on various levies and charges or questionable “entrepreneurial activities” to fund their operations, rather than on the ability to raise sufficient revenue locally. Although the overall size of government has been shrinking in both countries, many were mindful of growing populism and the attendant spending pressures.

Scope for increased trade

Much of a session devoted to Sino-Indian economic cooperation focused on trade. The two countries’ economic structures were generally viewed as complementary rather than competitive—although some participants warned against taking the “China as factory, India as back office” paradigm too far. Bilateral trade has increased more than tenfold over the past decade and continues to be characterized by India’s modest but persistent deficit, a drop in tariff rates (particularly in India), and an increase in trade intensities. These trends seem likely to continue.

As for trade with the rest of Asia, China is much more integrated with northeast Asia and ASEAN than India is. However, the pattern of both countries’ trade with ASEAN, which has in part served as a gateway between them, should change as direct trade between China and India expands. Looking ahead, participants saw a relationship that has scope to mature and diversify to include services and foreign direct investment, as well as regional security and health issues.

Regional, global reverberations

What will the rise of China’s and India’s economies mean for Asia? Participants viewed this as a broadly benign development, with likely gains in living standards, poverty reduction, and intraregional trade. At the international level, the transformation of China and India into major economic forces has the potential to provide alternative sustained sources of demand and help rebalance the global economy. That rebalancing will have implications for the international financial system, too—as international organizations, including the Bretton Woods institutions, will need to adjust to the changing reality of economic power on the ground.

What’s ahead for China and India themselves? The conference concluded that the chief challenges going forward will be to achieve an orderly liberalization of capital accounts, maintain economic flexibility, and ensure sound macroeconomic and structural policies. The main risks to this benign scenario are the perceived weakness of domestic banks in both countries and the potential volatility in international financial flows.

In a wrap-up session, participants noted that while China and India are currently on a good macroeconomic path, the next phase of growth will require reforms to remove barriers to increased productivity growth in trade, investment, and financing. There is considerable scope, too, for closer cooperation on regional issues.

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