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Lecture Addresses Future of China’s and India’s Economies
Neither the Chinese nor Indian economies are headed for collapse, but it is not clear whether either can maintain its current pace of growth, according to Professor Eswar Prasad of Cornell University. Prasad spoke about the future of China’s and India’s economies during the spring semester at the Pyle Center on the UW-Madison campus. He is the Tolani Senior Professor of Trade Policy in the Department of Applied Economics and Management at Cornell and previously served at the International Monetary Fund.
China’s economy has been surging for more than two decades now, expanding by 9-10 percent over the last 15 years or so, said Prasad. Rapid investment growth, fueled by bank loans to state enterprises account for almost two-thirds of that growth between 2003 and 2005, he said. China lacks the level of private consumption that is typical of most emerging-market economies, making such investment even more important to economic growth. India’s economy has experienced more recent growth, expanding by 8-8½ percent over the last four to five years. Expansion there has been driven by both investment and private consumption, said Prasad.
The big question Prasad sought to address is whether this growth can continue. He doubts external factors would trigger a slowdown in either economy. China’s foreign assets are more than enough to cover its debts and despite India’s slightly negative international investment position, Prasad believes it, too, has enough foreign exchange reserves to make a debt-related crisis unlikely. Instead, he called attention to potential internal vulnerabilities.
What worries Prasad most about China is the effect a tightening of credit could have on “non-performing” loans accumulating in the banking system. Most loans by Chinese banks have gone to state enterprises, some of which are risky investments and in danger of default, he said. Chinese citizens continue to deposit their money in these banks, however, because of the presumption that the government would make the depositors whole in the event of a bank failure. A government bailout of the banking system would be costly, especially if accompanied by an economic slowdown, but not necessarily catastrophic, he said. Currently China runs a deficit of about 2 percent of GDP and that amount is falling; thus it could spend some resources without driving its deficit too high. A tightening of credit, however, “would make even more loans start showing up as ‘non-performing’ and it could very easily have a cascading effect,” said Prasad, who warned that such a situation “could feed into social instability, especially if the trigger turns out to be something like a further significant decline in stock market values.” Many firms and individuals, in the absence of well-developed financial markets that offer alternative investment opportunities, have invested heavily in the stock market. This is true even of average households, thus any decline in the stock market could harm a broad swath of Chinese citizens.
Potential problems in India stem from the declining availability of skilled labor, weaknesses in the education system, and a lack of investment in infrastructure, said Prasad. “India’s economy is more of a slow-burning fuse, because there are not similar huge vulnerabilities in the financial system but there are still many deep constraints to growth,” he said. These constraints make expansion in areas other than the services industry difficult. Further, the government has run up a budget deficit of about 4 percent of GDP due to its higher social spending and this diversion of funds from investment and infrastructure to short-term needs “is putting a constraint on investment in physical and human capital, which could hurt long-term growth,” said Prasad.
Prasad’s lecture was sponsored by the UW-Madison Center for World Affairs and the Global Economy (WAGE), La Follette School of Public Affairs and CIBER, and was co-sponsored by the UW-Madison Global Studies, Center for South Asia, Center for East Asian Studies, and the Wisconsin Department of Commerce, and the Wisconsin Department of Agriculture, Trade and Consumer Protection.