China Research

It seems obvious that the Fed in 2022 will have a couple of interest rate hikes which have been almost officially announced in recent weeks by Chairman Powell. This probable development may be necessary to be started in the U.S. for the attempt to re-balance the globally economy, both when it comes to the fight against the ongoing high inflation and to the deflation of unpleasant asset price bubbles in quite a number of countries (real estate, bond and stock markets).

However, welcoming higher interest rates in the U.S. – and at a somewhat later stage in Europe and other parts of the world – is really not an easy call, particularly since such a development also will dampen GDP growth somewhat in the global economy. Some kind of getting back to a realistic “new normal” for short-term rates has no alternative. But how can a “new normal” be found and defined? A safe answer cannot be given these days. Different markets (financial and labor markets, technological competition, etc.) will gradually lead us to more insight in this conundrum.

Higher U.S. rates bad news for (many) emerging markets

For emerging markets, tightening monetary policy of the U.S. is bad news in several respects. Matters of concern for emerging and less developed countries are, for example (at least theoretically and according to textbooks):

¤ Lower growth in OECD countries dampens imports from emerging countries
Higher interest rates have a negative impact on investors and consumers in advanced countries – followed by a similar reaction in emerging countries. However, in this case some new hope may arise from declining global bottlenecks on the supply side. Many emerging countries may benefit from weakening commodity prices in the case of slower growth in mainly the U.S.

¤ Many emerging countries are highly indebted in U.S. dollars
Higher short-term rates in the U.S. mean also ceteris paribus higher costs for the borrowing in USD by emerging countries. Reactions on bond markets are not really predictable.

¤ Higher U.S. rates will probably strengthen the dollar
Higher short-term rates in the U.S. make the USD stronger – and for emerging countries the costs for changing into USD more expensive. The open question is for how long time the dollar will surge.

¤ Declining foreign propensity to invest in emerging countries
Here we have really a high risk. We have seen such reactions in the past. Portfolio investors prefer often less risky strategies in (very) uncertain times. They wait for signs of recovery. Greenfield investors also tend to cut or delay their planned projects when uncertainty is increasing.

¤ Economically vulnerable countries are less resilient
Countries with healthy economic conditions and limited foreign debt are certainly more resilient against rising U.S. rates than the weak and vulnerable emerging and developing countries. Analysts should consider this distinction.

¤ How much will China be hit – and how much hits China emerging countries?
This question is not easy to answer. China stands now for 17 percent of the global economy. This is why China cannot isolate itself from developments in the U.S. and the global economy.

But how much will China be hit by the American hikes? Financially certainly to some extent, probably also (temporarily) by weakening exports to mainly the U.S. and other emerging countries. However, most of China’s problems are made at home by the worrisome conditions on the bubbling real estate market, the enormous domestic debt credit bubbles and all the well-known structural growth impediments -> see my previous article in this blog (chinaresearch.se). It is not a secret that China is overly dependent on the real estate market – even more than the U.S.

Altogether, developments in China will be very important to other emerging countries in 2022 and beyond – but not basically due to the interest rate hikes by the Fed. The main Chinese economic problems are purely made at home.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

 

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Presentation by Hubert Fromlet at LNU’s
Baltic Sea Region & Emerging Markets / China Day
Kalmar, October 14, 2021

About 15 years ago, I published a paper trying to answer the question whether China or India will be the economic winner in the long run¹. I concluded then:

“India and China have very much in common. But both countries are also characterized by major differences. At present, the Chinese economy seems to be in the lead. This analysis shows, however, that it is far from certain that China will maintain the lead 15 or 20 years from now…”

In this paper from 2005, I also made a qualitative analysis of different growth factors. In 2021, I landed at the following confirmed or revised judgments:

My judgments on GDP-growth factors in 2005 and 2021 – China and India compared*

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*Own judgements: ++ substantial lead, + some lead, 0 roughly equal positions.

¹Source for 2005:
Fromlet, Hubert, “India versus China – who will be the winner in the long run?”
Economic & Financial Review: a journal of the European Economic and Financial Centre, London, ISSN 1351-3621, ZDB-ID 12001399. – Vol. 12.2005, 3, p. 111-143
²sources for 2021:
own studies of papers, (country)reports, newspapers, statistics.  

 

What will decide – democracy, demography or deregulation?

Looking at growth factors in the table above, the impression seems to be logical that it still remains an unanswered question whether China or India will become the long-term economic winner. India seems having improved its relative position a little bit more than China in the past 15 years. Both countries have achieved improvements of certain factor contributions to GDP growth – but face still also lagging developments. However – when summing up developments – it seems to be impossible to give the different economic growth factors really correct weights for enabling to add up to a total change. How should, for example, the growth indicator “democracy” be weighted?

Obviously, there are also three more growth-driving factors which have not been discussed (enough) in my article from 2005. But they are now mentioned below with the need to be considered more deeply. Here they are:

 

 

 

In my view, the three now emphasized  “D”-growth contributors can play an important role when designing the growth perspectives for the next 15-year- period. But we should be aware of the fact that the obvious relationship between democracy and economic growth is not shared by all economists. I myself believe in this relationship and join therefore the related research by, for example, the famous institutional economists D. North and D. Acemoglu. It also should be relevant for India to maintain what I call “Western political sympathy points”. In a Chinese perspective, choosing realistic positions for meeting future protectionism, presidential changes in the U.S., and the global environment commitments will remain very important issues.

India’s favorable outlook for demography can be seen as a strong growth factor which, however, should be accompanied by enough focus on education – a must if India ever shall manage to pass by China economically.

Summarizing questions: Will China’s supremacy of the Communist Party continue to dominate over Chinese commercial needs? Will the market economy lose further momentum compared to the objective of the Third Plenum in 2013? What will happen to what then was envisaged as “the decisive role of markets in the economy” (chapter 1, 2 in the list of goals)? This goal was, by the way, mainly set by the still ruling strong President Xi Jinping and Prime Minister Li Keqiang. And how much will more deregulation and/or marketization be accepted by the societies in China and India? How big is the future risk for social unrest (which, for instance, may be caused by painful or badly planned deregulation)? We simply don’t know.

But I feel relatively sure that the answer to the questions above and, finally, as regards the long-term economic winner of the two most populated countries in the world – will be decided in Beijing and not in Delhi. However, this does not mean that India can afford underestimating the urgent need of structural domestic reforms – with institutions, education, innovation, infrastructure, digitalization, productivity, and health issues in the first place.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

 

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