India and China - Synergies

I am including here my entry to an essay contest (held on the same topic) by the Wharton Business School. I know most of the people would be uninterested in reading it but since I put in the effort to write it, why not post it!!!! So, here it goes ....

"What Can India and China Learn from One Another?"

The global business landscape is set to be galvanized by the inherent potential of a synergy between China and India with their combined GDP to account for up to 20 per cent of the world’s total by 2025 if the two Asian giants agree on free trade, a study has said. This is but one of the many voices coming out in support of these two Asian economies. What is most amazing is that both these economies have grown on entirely different policies and have charted entirely different paths. It would thus be interesting to see if these two economies could learn from each other and enhance their own capabilities further. In this paper, I am attempting to put together some of the things that I think that these two vibrant economies can learn from each other.

I will begin with an analysis of the Chinese story. China’s achievements are often cited as the gradual approach against the big bang approach, the reason being the absence of shock therapy elements in China’s case. Thus China’s reforms delivered the benefits of the big bang approach while effectively immunizing the economy from its costs.

There were many pillars on which the Chinese story has been scripted. One of them was the emphasis on growth of small & medium enterprises. Special thrust was given to light & medium enterprises where investments required are limited. It led to rapid economic growth & production of consumer goods increased. A consequent rise in exports and foreign currency earnings led to a general rise in personal incomes.

The real force behind China’s economic development appears to be the country’s ability to take the industry to rural China as against the common model of industry concentration in urban cities. Another major source was the non – resident Chinese who began acting as venture capitalists for their counterparts back home, who were offering good returns. They not only funded these businesses but also acted as buyback agents of the production.

How ever, for sustained growth the industry needs to go up the value chain. In China, the emphasis is now shifting from low value added products to more sophisticated ones such as semiconductors and IT hardware. Infrastructure is a key ingredient for the economic growth of any country and China needs to be complimented for this. China improved its infrastructure vastly and that helped it in sustaining the economic growth delivered by reforms.

The second key ingredient or pillar of economic success was Foreign Direct Investment (FDI). China is next to only the US in receiving FDI. More importantly, these FDI funded firms are now contributing 40% of China’s exports. To achieve this, a range of reforms were required. These included rules on foreign ownership of companies, repatriation of earnings, et cetera. There are still many roadblocks but the overall picture looked rosy once most of the restrictions were lifted (that were in place since the Tiananmen Square incident). A major segment of the FDI going into China actually came from Hong Kong. Even Taiwanese businessmen channeled their funds into mainland China, despite their political differences. That means business – sense scored over political relationships. This mindset is a precondition for a free market.

Above all, the overseas Chinese whose investment in China has been a major accelerator of China's growth have shown more interest in China's economic development and rise as a major world power rather than in her democratic transformation.

India today is probably where China was 10 to 15 years ago. Much has been achieved since 1991 when economic reforms first began under the then Prime Minister, Mr. P V Narasimha Rao (with Dr. Manmohan Singh as Finance Minister). A lot of reforms have been pushed through despite unstable governments at the Centre. The country is now firmly on the path of economic liberalization.

There were four consistent themes in the Chinese approach to reform: gradualism, partial reform, decentralization and self-reinforcement of reforms. The Indian approach has been much the same. The only difference being the 1991 push which was more akin to shock therapy. But progress there on has followed the gradual mantra.

One area where India failed miserably and China achieved immensely is the area of labor reform. India succeeded in overprotecting the interests of workmen making the restructuring of industry impossible. In China workers have a say and in some cases even ownership, but the terms of employment are flexible enough to inculcate discipline. This one reform is crucial to allowing Indian industry to make the transition to the next level.

The other area is infrastructure. India has woefully under invested in its infrastructure. The Golden Quadrilateral was a good start but it now needs to be expanded to all other segments of the country. This would include fast development of ports, airports, railroads, power and large scale up gradation of roads. This will require India to allow easier access to these sectors to the private sector. The third segment is cutting down on state participation in industries. Disinvestment of state enterprises has been slow to take off and needs to be pushed ahead.

The Indian growth story is supposed to be more widespread and most areas of the country are benefiting from it (except some laggard states). This is in contrast to the Chinese experience. In China, economic growth has caused serious social inequalities. If the proportion of income disparity in villages was 1: 10 in 1979, it was 1: 10,000 in 1993. In addition to inter-household inequality the disparity between regions has grown further. Coastal provinces such as Jiangsu and Guangdong are prospering very fast while inland areas such as Shaanxi and Ningxia remain far behind even though they too are developing steadily.

A major area in which India vastly outperforms China and where China has a lot to learn is financial sector reforms. The financial sector in India is extremely stable and is in line with world standards. It has a healthy banking system (albeit far smaller than China) and an extremely vibrant stock market. A large number of venture capitalists are now eager to invest in India because a vibrant stock market is a pre – requisite exit strategy from their investments. A notable example in this regard is Bharti Tele, where its US investor Warburg Pincus (initial investment $292 million) exited with a kitty of $1.616 Billion. This included an open market sale of 6% stake sale at $560 million (the largest ever single equity deal on an Indian stock exchange).

In contrast, while stock markets have been developed in China as a result of the reform efforts, it is as yet being used by the government to secure additional funding for its moribund state enterprises. All the ills of a bad financial market seem to be rampant here. Insider trading, price manipulation and corporate opacity are rampant.

The Indian banking sector is extremely robust and already plays host to multiple multinational banks. Even government owned banks are performing well and have efficiencies at the level of their US counterparts (the highest being Andhra Bank). The level of NPA’s is low and is a miniscule fraction of India’s GDP.

In contrast, the China’s state banks are infamous for their overstaffing, low efficiency and poor internal management. Acting as agents of the state, China’s four largest state – owned, commercial banks are technically insolvent after years of directed lending to loss making State enterprises. Non – performing loans are estimated to be as high as 40%, though the official ratio is just 25%. This is a fairly large proportion of China’s GDP.

They remain afloat mainly because of rapidly growing private deposits channeled into the system through discriminatory state policies as well as explicit state guarantees. Having transferred bad loans of 1.3 trillion Yuan ($150 billion) at an unorthodox par value to the four newly established asset management companies – which may have 30% recovery rate at best – the four state banks are still under – capitalized.

How ever, it hardly solves the problem. It merely transfers the burden from one to the other. The bottom line is that the system has to bear the load of these NPA’s. With lack of alternate avenues of investment, banks are still flush with deposits. With the entry of foreign mutual funds and public issues, much of this money is likely to flow out of the banking system. The need of the hour is to totally liberate the banking system from the shackles of the government. Banks in turn have to reorient themselves to function in the free market mode. Recently, officials from some of the Indian banks were invited to China to help them out in solving their burgeoning NPA problem.

A major reason for the vast difference in the paths taken by the by the two economies is the fact that while Chinese labor is a great deal more productive than Indian due to pro – labor policies in India (China’s GDP per worker was about 55 % higher than that in India), capital efficiency in India is estimated to be around 45% higher than that of China.
One reason is that China still has a planned economy. Much investment is still not really rational. Second, India is at a different stage. India is maybe like China 10 or 15 years ago. In the early stages of opening up, efficiency is higher because capital goes to the most efficient, most productive sectors. But later, the returns gradually slow down. The first dollar is usually the most productive, and the second is less productive. How ever, there is still a lot that can be done to improve the capital efficiency of Chinese companies.
Recently, Indian manufacturing has also picked up. Evidently, the efforts put in by the corporate sector — at restructuring, cost cutting, improving productivity and technology up gradation — over the last five difficult years appear to be finally yielding results. Over the last two years, Indian manufacturing has not only done well domestically but globally as well. How ever, much needs to be done by the government by way of allowing FDI in all sectors so as to jumpstart the Indian manufacturing story.

After all this, it is worthwhile to note that there exists tremendous synergies between the economies and if successfully exploited can propel both the economies to the next level of growth. Rather than viewing Chinese and Indian economies as competing, it is much more important to understand their potential business synergy.

China’s manufacturing prowess is unrivalled and it is the world’s factory. Juxtaposed against this, are India’s strengths in R&D and high-tech services. While China is a manufacturing powerhouse, India is a knowledge-driven power with services accounting for half its economy. The dragon has the hardware while the elephant has the software.

It remains to be seen how this partnership progresses. Much depends on how the bureaucrats & businessmen of the two countries take up the issue.