Is the Chinese Downturn a threat to India?

A simple answer is yes, but there is more to it than that. China is a complex story that is difficult to fully comprehend as it is not a transparent economy and therefore to reach a definitive conclusion on anything involving China is not always easy. So, how is the Chinese market crash a threat to India? Let’s try and keep things simple and understand the Chinese story first, before we start to figure out how it’s going to impact the Indian story.

The China Story

When China opened up its economy in the late 70s, it offered large tracts of land at dirt cheap prices, abundant labour that was cheap but unskilled, while power, water, building materials and capital, was made available at hugely subsidized rates. All of these put together made China a very attractive destination for cheap manufacturing and this had initial investors from the Japan, Taiwan, Hong Kong and of course, the US, making a beeline for China. The Chinese economy grew at a furious pace for the last three decades, helping China build huge cash reserves that is now playing a critical role in impacting global markets. But fundamental problems remained. China still has a regulated economy which means that the government decides on how the economy will grow, which sectors will be promoted, what will be the strength of their currency, viz a viz other currencies and how the stock markets will behave.

First Realty and now Stock Bubble

To keep the economy growing at close to double digits as it had been for the last three decades, the Chinese government promoted massive investments in the infrastructure sector. After signs of a slowdown in the economy started showing up, the government promoted the realty market, encouraging investors to pour in billions into residential and commercial buildings. After the realty bubble burst, the government began encouraging first time retail investors to start pouring money into the stock market, and now the with the Chinese stock market crashing, world economy is being held ransom to the Chinese bubble. Make no mistake, it is a bubble. China’s GDP is not in the 6% region as is being made out, but could well be within the sub 4.2% region. There is no way of knowing the real picture, but let’s look at the facts through 2015.

Impact on Commodity Prices

The global economy has slowed down considerably which means it is buying less from overseas. China being the largest manufacturing country in the world has naturally been hit the most with less export orders coming in. This has led to China importing less commodities and raw materials that go into manufacturing finished goods. Countries like Australia and Brazil which are among the largest commodity suppliers to China have been majorly hit.

The Oil Impact

With excess production of global oil and lower demand from major oil importing countries like China and India, crude oil prices have been touching record lows. While this has been good news for an oil importing country like India, it is not necessarily good news for an oil importing country like China. Low prices mean low earnings for major oil producing countries in OPEC, Russia, and even the US, all of whom are also major importers of Chinese goods. Less income means less ability to import from China.

The Market Crash

As demand has dropped from these countries, factories in China have been facing the brunt, which in turn is spooking the Chinese stock markets. In the last 45 days, China has had to stop stock trading on two occasions as the market crash touched 7%, triggering a shut down. That’s not been good news for the global markets which have all reacted negatively. Sensex which has been trading between 26,500 and 27,000, dropped to sub-25,000 levels.

The Currency Play

The US economy has been showing positive signs of a slight recovery with improved jobs data coming in, along with a slight increase in home sales, all pointing to a recovery. With most economies going through a slowdown, global investors have been investing more on the US Dollar-backed assets, thereby increasing demand for the dollar. This has led to strengthening of the US Dollar against almost all currencies. In reaction to the slowdown in China, the Chinese government has resorted to devaluation of the Yuan in the hope that it will make exports from China cheaper, while discouraging imports, since imports will become that much more expensive. That’s a Catch-22 situation. If China does not import more, the developed economies of US, EU and Japan that supply to China, will suffer. With Chinese products becoming cheaper and increased dumping a growing possibility, most other economies will respond to devalue their currencies respectively, thereby triggering a currency war, which in the short to medium term is not good for the global economy.

Is the Chinese crash a threat to or an opportunity for India?

There are two perspectives here. One that says that the crash is an opportunity, the other, that it is a threat. The fact lies somewhere in between, with answers lying mostly with the Indian government and how they respond to the emerging situation. The India story is more stable and built on a more solid foundation than China. Indian democracy has evolved over time making India politically stable, at least relatively. The country has a fair and established judiciary and labour laws are more or less in place to continue to offer a stable manufacturing and services base. Global economists and investors have been speaking about how attractive the Indian market is but continuance of this is going to be based on some critical factors and include how the government pegs the Rupee, whether it can successfully implement reforms, and whether the country can continue to offer a stable political environment. The current value of the Rupee does not truly reflect the current status of the economy and must be devalued further. This will have several advantages. It will help the Rupee find its true place relative to other currencies, it will make our exports cheaper – especially in the context of cheaper Chinese products, and it will promote ‘Make in India’ versus ‘imports’, an imperative. The Indian economy does not depend too much on Chinese products, as many other emerging economies, and therefore, India is relatively insulated. But it will have a negative impact on the Indian economy to some extent but the country is well placed to absorb that. Threat or opportunity, depends on how the government handles the much delayed reforms process. Had the government been able to resolve the GST, Land Bill and labour reforms in 2015, India would have seen an accelerated inward movement of FDI and FII investment in 2016. While India has improved upon the FDI levels, it is way below its potential, thanks to government’s inability to act. If the government gets its act together in 2016, then 2017-18 could be a game changer. But then, politics in India is another story, so let’s wait and see how the government treats the emerging situation – a threat or an opportunity.