China slowdown opens avenues for India's economy

Analysis

Jaitley sees the Chinese slowdown as an opportunity for India's economy.

Identifying new opportunities

Prime Minister Narendra Modi has targeted Indian manufacturing -- which currently provides only 15% of GDP -- to lead India's future growth and job creation (see INDIA: Job deficit may stymie demographic dividend - August 31, 2015). As rising wages and re-structuring of the Chinese economy undercut its competitiveness in the production of mass manufactured goods, Modi hopes for India to fill the gap.

There are some positive signs:

• After a long slump, Indian manufacturing grew 4% year-on-year in the first four months of the April 2015-March 2016 fiscal year, compared to 2.8% last year.
• The auto sector -- which has strong links to global supply-chains -- has grown 6.7% over the last ten months.

Relative bright spot

Among emerging markets, India is proving a relative bright spot in terms of its GDP growth (of around 7%) and of attracting FDI.

FDI rose 27% to 30.9 billion dollars in the year ending March 2015 compared with the previous year and several leading global manufacturing companies have pledged new investments -- with, for example, FoxConn (Taiwan) committing 5 billion dollars to telecoms assembly plants in Maharashtra alone.

India is a major beneficiary of the commodity slump, especially oil prices, to which the Chinese slowdown has contributed. India imports 70% of its oil needs -- which, during periods of high international oil prices, has eroded consumption and growth, and fiscal and current account balances.

India's current account deficit (CAD) swelled towards 6% of GDP in 2013, putting it in the frontline of currency volatility during the 'taper trauma' of 2013. However, with the fall of oil prices, the CAD has fallen to just 1.2% of GDP.

Moreover, depreciation of the rupee is lower than that of other EM currencies such as the Indonesian rupiah despite the strengthening of the dollar, the expected rise in US interest rates and the Chinese stock market crash (see CHINA: Stock crash shows cracks in 'China model' - August 26, 2015).

The rupee depreciated only 3% in the last quarter, compared with the rupiah's decline to a 17-year low.

Constraints facing India

However, that India will take full advantage of these (temporary) global conditions is not a foregone conclusion.

Structural problems

The barriers to sustained industrial growth in India are formidable, stretching to labour relations, land acquisition, power provision and lack of appropriate skills. Modi has advanced plans for reform in all these areas but made limited progress due to political challenges.

Also, the full impact of the impending interest rate rises on global balances has yet to be felt.

Slackening Chinese demand

Moreover, China's difficulties could rebound back on India.

In the last 15 years, China has become by far India's fastest-growing trade partner, bilateral trade rising from negligible amounts in 2000 to 74 billion dollars (second to the United States) in 2014-15.

India currently faces a sharp slowdown in its own exports, which have fallen 20% over the last eight months as traditional industries, such as textiles and gemstones, have struggled. Slackening Chinese demand is likely to make matters worse for Indian exporters, directly and indirectly, since the purchasing power of other Asian buyers of Indian exports also depends on Chinese demand.

China's closed markets

The pattern of trade is unbalanced with India running a deficit of 34 billion dollars in 2014-15, raising concerns about its value. In order for India to benefit from China's move away from cheap manufacturing, China would need to open its markets.

However, here the signs are not promising.

Exports of iron ore to China, which used to act as a counter-balance in India's favour, have largely ceased for political and legal reasons since 2009. Attention is now drawn to how far imports from China consist of cheap manufactured goods, which India might make for itself.

India has more 'anti-dumping' cases against China before the WTO than any other country and, most recently, has imposed a 20% penalty duty on Chinese steel.

India has also launched a major diplomatic effort to widen the access of its own exports to Chinese markets and to rebalance the trade through expansion rather than contraction. It has enjoyed some success in some areas where, for example, Infosys and Tata have a significant presence in the Chinese IT sector. However, trade in merchandise remains a critical problem.

Risk of trade war and infrastructure deficit

To address the trade imbalance, India could adopt protectionist restrictions such as import duties, thereby contracting trade. If so, and if China retaliated, the costs could be considerable since China has come to play a key part in the growth of sectors such as heavy industry and infrastructure where India most struggles.

Although India does import cheap manufactured goods from China (especially in telecoms), the largest single item of trade (25%) consists of imports of capital goods, especially in the power sector where India is notably deficient.

Chinese power engineering companies have played a large part in the rapid rise of power generating capacity within India itself -- which has grown by 60% since 2007. Chinese capital goods companies are also heavily involved in the railways and roads sectors -- and would be in ports and airports if Indian government restrictions on their activities were lifted.

These connections have also led to new possibilities for investment. In September 2014, Chinese President Xi Jinping committed 20 billion dollars of Chinese investment in India, mainly in much-needed infrastructure.

Widening geostrategic rift

Tensions over trade and investment have the potential to expand into strategic relations, where competition between India and China is intensifying.

While China is intensifying its economic and diplomatic relations with India's smaller neighbours in South Asia, especially Pakistan, India has now started to engage with China's disputed claims in the South and East China Seas, and its presence in the Indian Ocean (see CHINA/INDIA: Competition over Indian Ocean will deepen - September 17, 2015).

It is also developing closer security ties with the United States, Japan and Australia. For India, the potential costs must surely outweigh the gain of alienating China.