A bipolar economic world is emerging. At least if markets in China are to be believed, they reacted quite differently from most of the world on Fed. interest rate cut by half-a-percent.


At the time of writing this article on 19th September, China’s Shanghai Composite index was down by 1.09%, BSE Sensex in India was up by 2.36%. And last night Dow Jones Index in NYSE closed up by 2.51%, cheering the much anticipated rate cut with positive surprise (by the 0.5% value against 0.25% -0.5% anticipated range). 

China showed that it indeed has decoupled from financial developments in the US, at least if last couple of months of acid test is to be believed. Back in May-June this year, media in the west were beating the drums that a correction in Chinese markets looked imminent. Markets in China, around 4300-4400 levels then were up by closed to 90% this year; and almost three times since last year. And price-earning measure, the sole valuation parameter applied by many analysts could not maintain same momentum; resulting in stratospheric PEs resembling the dot-com boom days.  

However financial developments since then was rather the opposite. The US was hit harder by the sub-prime issue, and in August it led to a situation where risky instruments found no-takers, resembling an apparent dearth of liquidity though liquidity was ample by any measure. And a Chinese market was up by closed to another 1000 points (or 25% in 3 months, annualized growth of 100% again since May-June’07). 

Things were not smooth either for China. Inflation there went up by more than 6% as per last report; sort of highest in decades from closed to 3%; prompting Chinese central banks to raise interest rates quite often and also capping liquidity for investments.  

India in between looked like an extension of the US markets (and like most of the other world) in-spite of lots of euphoria in India local media about the decoupling story. August 2007 was horrible for India like the summer of 2006, as it was in the US and in Europe.  

So it essentially poses a question – why Chinese markets move independently (or even in reverse gear in comparison to the US, though evidence for this hypothesis is inadequate) where India follows the US, sort of blindly? I said blindly, because a market with 1.1 billion people can’t dance to the tunes played by US Federal Reserves that’s primarily entrusted with monetary policy for the US, with 1/4th of the Indian population. Many analysts in local Indian media started reading the Wall Street Journal for last couple of months to know what’s happening, throwing away the local pink dailies. The fever went up so high! And local media definitely gave more coverage to US Fed decision than they usually give to similar credit policy decision done by the Indian central bank, the Reserve Bank of India. 

Again complex questions don’t have any easy answer. But the reasons can be one of many, or rather part of many. Indian markets lack the local money that China has aplenty. For China, the problem is the quantum of local money and 50% savings rate that generate more than $ 1 trillion every year, that can either get returns at bank savings rate (less than 4%, much lower than prevailing inflation rate). And India generates hardly $300 billion local savings; however due to the ups and downs of global tide that flood the narrow channels of Indian markets in regular tsunamis; local people put hardly 2% of their savings with stocks.  

Though I don’t have firm figures; but it won’t be wrong to state that Indians own a fraction of firms listed in Indian bourses compared to what Chinese people own in Chinese bourses. Convertibility, flexible exchange rates and easy norms for foreign capitals of any forms to move in and out have seen higher FII investments in India in comparison to much higher FDI flows in China.  

Following pure text book theories of isolated economies and ignoring geopolitics probably should have led to more concerns in both India and China over the Fed. rate cut. Both countries have significant exposure to US bonds, and fall in dollar reduces the reserves value. The rate cut has resulted in higher oil and commodity prices and both these two countries rely on imports for a majority of their oil consumption. China is more export-driven economy compared with India, which is more of a domestic growth story. Therefore slowdown in US economy should affect China more than India, and the rate cut should have led to more euphoria in China; but we see the opposite. True, it’s only expected from global financial markets because financial markets following logic are more of an exception than a norm. 

Interest rate in India is already one of the highest now amongst major global economies (true, many won’t reckon India to be a major global economy and I myself belong to that group), impact of which can be felt with slowing growth rates over investments and even in manufacturing growths in India over last couple of months. And China now looks forward to growing almost 10% more than at what rate US is expected to grow. 

As the single super-power; US policies influence most other nations; barring China, Russia and a few others like Iran, Venezuela for obvious reasons. US Federal Reserves is no exception. However time will only tell which of these two nations (China and India) is on the right path – one following its own policies ignoring any leads from the super-power whereas the other desperately trying to integrate with the global economy by dancing with every cues from the super-power. The only caution India should follow is ants are better off to stay away from where elephants dance.

Ranjit Goswami is a research scholar with the Indian Institute of Technology (IIT), Kharagpur, India; and is the author of the book “Wondering Man, Money & Go(l)d”. 

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