In the same boat

By Prem Shankar Jha

Last week, only hours after he had successfully piloted a bill through the U.S. Congress giving China permanent most favoured nation trading status in America, the President, Mr. Bill Clinton, sent the U.S. Trade Representative, Ms. Charlene Barshefsky, to Beijing to warn the Chinese government against trying to wriggle out of some of the obligations it is accepting by becoming a member of the World Trade Organisation. The warning became necessary because signs were multiplying that China was having second thoughts about several of the commitments it had made to get into the WTO, including lowering tariffs to open its domestic markets to imports, and reducing subsidies to its state owned enterprises as well as on infrastructural inputs provided by them to industry.

China has been wanting to slow down the pace at which it meets these obligations, and is arguing that as a poor developing country it is entitled to some latitude in its observance of the WTO norms. The U.S. will have none of it, and has been quietly warning China that attempts to backtrack on opening its economy will jeopardise its entry into the WTO.

To those who have watched the growing apprehension in India as April 1, 2001 draws near, the Chinese jitters will look familiar. On April 1 India will be forced to remove import restrictions and ban on the remaining 700 imports, most of them consumer goods, and rely solely on tariffs to protect Indian industry. No one knows just how much of what consumer goods will be imported, what the impact will be on the domestic market, how much they will affect the profitability of domestic manufacturers and therefore how many of them will survive and how many go under.

There is an uneasy feeling that the tariffs to which India had bound itself in past years (when they were only notional since no imports were allowed anyway), will not suffice to protect local manufacturers now. Even where they are sufficient, no one really knows what foreign manufacturers will do to get under them and which products and industries will be the most affected. This is one reason, although by no means the only one, why there has been a continuing hiatus in investment in new capacity in the last 18 months despite signs of a mild industrial recovery.

The main reason why both countries are getting cold feet is that both are facing the compulsion to open their markets at a time when their domestic economies are virtually stagnant. China's growth rate last year was officially 7.1 per cent, but most China watchers know that this was greatly exaggerated and that the real growth rate was not more than 4 to 5 per cent. The Indian economy too has been growing at a supposedly healthy rate of 6.1 per cent in the last three years, but as the latest Economic Survey pointed out, 0.7 per cent of this is a statistical illusion created by the increase in government employees' salaries and pensions, and the payment of arrears.

What is more important, industrial production is growing slowly. The growth was only 5.4 per cent in the first quarter of 2000-01. Chinese figures are subject to the same overestimation as their GDP, but what no one is denying is that around 60 per cent of its industry is working at half to two thirds of capacity and that overproduction has been so great that it has caused a steep fall of the general price level, that began at the end of 1997 and had still not ended at the beginning of this year.

The forced opening of markets could not therefore have come at a worse time. Had India been experiencing the 12.8 per cent growth of industry it knew in 1995-96, and had China had the hectic growth of 1992 and 1993, both would have been able to absorb the impact of larger imports easily within an expanding market. Today there is an all-pervasive fear that higher imports will only worsen the plight of domestic manufacturers. In one respect, however, China's plight is more serious than India's. While India can afford to push its exchange rate down in order to offer additional protection to its manufacturers, China does not really have this option. The reason is that while India's economy is broadly in balance, China's is not. Much of China's reported $140 billion of foreign direct investment is locked up in the excess capacity that now plagues the economy.

What is worse, an equally large amount there is locked up in a vast real estate and construction bubble, which could burst anytime because around 70 per cent of new residential and office space is lying vacant. This is investment in dollars that can only yield returns in yuan.

As a result, devaluation would increase the debt servicing liabilities of the borrowers in yuan at a time when they are in any case finding it difficult to remain solvent. This would lead to a spate of defaults in debt servicing payments that China simply cannot afford.

India , by contrast, has everything to gain from a mild devaluation in the coming six months. The seven per cent devaluation since May has only offset the appreciation of the dollar against all other currencies. So another small dose to add a measure of protection against imports, and encouragement to exports would help keep the external sector in balance after April 1.

What is still better to bring down the rupee the Reserve Bank of India will have to buy dollars aggressively. This will boost India's foreign exchange reserves. Increasing these is in any case urgently needed because most of the so-called reserves are actually borrowed money and could leave the country if the economy began to look shaky. India's true foreign exchange reserves, that is, its balances minus its vulnerable liabilities amount to barely $5 billion. Lastly, devaluation would increase revenue from customs duties and help bridge the fiscal deficit. India could thus kill three birds with one stone.

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