India and China: Not so decoupled from the global downturn

C.P. Chandrasekhar

With growth recovering significantly in China and India, these countries are once again being presented as decoupled giants who can revive the world economy. Advocates of “decoupling” argue that, despite the force of globalisation, some economies are relatively unaffected by the economic cycles characterising the rest of the world because the factors driving their growth are sui generis. However, this view has been discredited in recent years for two reasons. First, there appears to be a high degree of synchronisation of booms and busts in stock and housing markets across the world. If the appetite for investment among wealth holders or even wealth seekers was stoked anywhere in the world, such investment found its way across the globe, reviving diverse markets simultaneously, even if to differing degrees. The reverse was true when bearish sentiments prevailed.

The second challenge to the decoupling theory came from the depressive impact that the slowing of global trade had on growth in China and India. According to the World Bank’s World Development Indicators, before the onset of the crisis (2007) exports of goods and services amounted to 43 per cent of GDP in the case of China and 21 per cent in the case of India. This level of export dependence would imply that a trade downturn would adversely affect these economies. It did, and challenged the notion of decoupling.

But the recent revival in stock markets and in GDP has led to a revival of the decoupling theory. This is surprising because liberalisation leads to “coupling” not just through increased dependence on global markets, but through the restructuring of the financial sector that homogenises regimes of accumulation across countries. Specifically, financial liberalisation and the reliance on monetary as opposed to fiscal levers to promote growth result in the displacement of deficit-financed state expenditure by debt-financed private expenditure (on housing, automobiles and general consumption) as important stimuli to growth. When monetary policy is lax, credit is easy to obtain, and interest rates are low, one also witnesses enhanced credit-financed consumption and an acceleration of growth. When banks and financial institutions are less willing to lend, and households are less willing to borrow because of economic uncertainty, one sees a cutback in debt-financed private expenditures and a downturn.

This disease now seems to afflict most countries pursuing market-friendly growth strategies. Consider China for example. A recent report from the OECD points to the growing role of debt-financed housing investment and consumption in driving demand, even when the state remains an important player. It has been known that consumption demand from China’s new rich and well-to-do urban professionals has been rising rapidly in recent times. Housing investment is on the rise, triggering a boom. The highest decile of urban households numbering 50 million people earned an average household income of $30,000 in purchasing power parity terms in 2007. More than a third of these households had already acquired a car. These households also bought consumer durables ranging from air conditioners to flat screen televisions. Consumption of this kind was also percolating downwards. The ownership rate for cars in the 8th decile was similar to that in the highest decile four years earlier.

The point to note is that not all of this consumption was financed out of current income or past savings. Debt played an increasingly important role. In 2000, consumer loans totalled RMB 426.5 billion, of which RMB 337.7 billion financed housing purchases and RMB 18.8 billion financed automobiles. By 2008 the corresponding figures were RMB 3723.5 billion, RMB 2980 billion and RMB 158.3 billion respectively. That points to a scorching pace of growth of credit, which has taken outstanding consumer credit to 12.4 percent of China’s GDP in 2008. This is not, however, just a Chinese syndrome. The same OECD report quotes a McKinsey Global Institute study which places consumer loans at 18 percent of total advances in India and nearly 50 percent in Malaysia.

These trends point to the homogenisation of the regime of accumulation across countries. This sets up another route through which booms and downturns can be synchronised. In a globalised financial world the state of liquidity, interest rates and the monetary policy stance of central banks in different countries are interdependent and similar. Periods of easy money are generalised through cross-border flows of capital. So are periods of credit stringency. This generalises credit-financed booms and credit constrained downturns. In the event domestic stimuli rather than just trade dependence tend to be coupled. So does growth.