China Crisis & India

Things are falling apart, the centre cannot hold. In the world  political scenario, USA has established its image of a centre, but in economic scenario, alas, we do not see any centre to keep tight the things in an atomic form. First, 2008 sub-prime crisis, then Greece default, now Chinese crisis. Who will take the lead of  stabilising the world economic platform.

China which so far has been exporting all kinds of goods  is now exporting uncertainties around the world. A national daily came out with headlines "Global Crash, Made in China".

Over a period of four weeks, Chinese companies lost some $3.9 trillion in value, i.e., 40% drop since June this year.  The Chinese government has employed a range of strategies to halt the slide --- relaxing restrictions on how much investors could borrow to buy stocks; putting restrictions on new company IPOs -- else it would prevent investors  putting their money into companies already selling shares on stock market; putting bar on selling stakes for the next six months if an individual is owning stocks worth more than 5 percent in an  individual  company.

Let us now try to understand what are the weak links in the Chinese economy and to what extent could these  affect India.

China has a population of 1.3 billion people as well as the world's second largest economy, deeply connected to world market.  China's rapid growth over last decade reshaped  the world economy, creating powerful driver of corporate strategies, financial markets and geopolitical decisions; with the sole objective of creating a momentum that would provide a steady source of profit and capital.

In China, interest rates are low as compared to India; mostly under six per cent. Whenever interest rates are too low, bank deposits look unattractive. Housing becomes favourite  proposition; for living and as an investment opportunity. Financed by generous bank loans, this eventually leads to a massive supply of unsold houses. The second attraction is stock market. People tend to save less and invest more. In China, on an average, every household invest 15% of its income in stock market. The exchange rate of Chinese currency  is not market driven. Unlike Indian Rupee which is floating currency in FX market, Chinese Yuan is more or less a fixed currency. In short, Chinese housing sector, stock market and currency never transmitted it's true strength and/or weakness. When the bubble burst, all this storm is witnessed.

To maintain the social stability, China responded  by making aggressive moves to devalue its currency,  prop up the stock market, inject money into the financial system, and generally stimulate the economy. But these are all knee-jerk decisions that may do more harm than good in the long run.

The global reaction to China's devaluation of currency was greater than expected. However, if it leads to currency war among nations, it may  result  affecting China's own economy --undermine its exports and investment.

Indian financial system, with its own strength and shortcomings, is well regulated and robust to bear these jerks. In 2008, it passed through unscathed.   Despite our huge private sector, India is still a hybrid economy, dominated by public sector banks and state owned corporations. That means our financial system is shielded from the impact that a stock market crash would have in a western style private banking system. Wall Street Journal reports, "India hasn't been rattled as badly as Brazil, Russia or South Africa. Its international reserves are ample, and it isn't highly dependent on foreign capital to fund imports".

(The views expressed in the article are merely for academic purpose and are not subscribed by the organisation where the author is working)

Tilak Gulati is Assistant General Manager at UCO Bank. 
Author:  www.itstrgulati.blogspot.in