Inflation in India and China—comparison

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Manas Chakravarty

The government’s Economic Survey is important not so much for its remembrance of things past, but for the signs and portents it provides for the future. Seen from that perspective, the recent survey can only be described as extremely gung-ho. Liberated from the constraints of the old Hindu rate of growth, the economy has soared into a trajectory so high that only the metaphors of space travel are adequate to describe it. Hence, the talk of having achieved “escape velocity”.



The issues that remain are the problems of plenty: how to ensure that the growth is sustained without inflation, and how to ensure more inclusive growth. Sustainability is apparently not an issue, since the demographic dividend from a growing proportion of the population in the working-age group will boost savings, which will boost investment and growth, in turn leading to more savings and a virtuous cycle. What’s more, the economy is also getting more efficient in the utilisation of resources — another impetus to growth.

What about inflation? There lies the rub. The survey frankly says inflation is a problem and finding immediate answers to supply shortages is difficult. The challenge is of “carefully calibrating inflation without taming growth”. Even the short-term prospects for agriculture appear to be bright, although the survey pulls out the laundry list of measures badly needed in the medium-term, such as irrigation, more high-yielding crops et al. Investment prospects are bright, with high savings ratios and higher FDI. The stockmarkets too are expected to do well, fuelled by foreign investors seeing India as “one of the preferred destinations”.

This rosy portrait of the economy is marred by factors such as the power constraint, shrinking employment and the inability to curb government expenditure. The crux of the issue is simple. For sustainable growth, productivity must improve. For that to happen, infrastructure, from the power situation to the congestion in ports, has to get better. Training programmes to correct the skill shortage need to be put in place. And faster growth in the services and industry sectors must draw surplus and underemployed labour from agriculture. Also, industry is now operating at close to its maximum capacity. It is unclear, therefore, how high levels of growth can be sustained without overheating, so long as the supply problems are not addressed.

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Jehangir S. Pocha in Beijing

New Delhi has long touted its superior capital markets and banking system as a major competitive advantage over China, where real commercial banking is only two decades old and the central bank self-confessedly ill-equipped to independently handle the vagaries of a modern economy. Yet, the People’s Bank of China has adroitly kept the nation’s inflation rate well within the global average of 2.5 per cent while India’s inflation rate is currently more than double that, standing at about 6.5 per cent.

More embarrassingly for India, the bulk of China’s inflation is rooted in surging oil prices and a sudden spurt in the domestic cost of food oil, eggs, meat and grain, which have all logged double-digit increases in recent months. Once these costs are stripped out, core inflation in China can be seen to have held steady at less than 1 per cent over the past five years, Jonathan Anderson, chief Asian economist with UBS bank in Hong Kong, said recently. That is an astonishing fact, given China is enjoying record international trade surpluses ($177 billion in 2006) and has a raging hot domestic economy that grew at close to 10 per cent last year. Massive export earnings, helped by China’s under-valued renminbi, have also been flooding the financial system and creating asset bubbles in various areas such as real estate and the stockmarket (one of the world’s best-performing in 2006). Wages are also rising in the boom towns along China’s eastern coast and spiralling demand for raw materials are pushing commodity prices to record levels.

Yet, a retiree in Beijing can pick up his usual monthly supplies for pretty much the same price as he paid two years ago largely because of two reasons: an inflation-wary governor at the helm of the central bank, and an investment-crazy corporate sector whose current investments are running at about 45 per cent of the total gross domestic product, according to official reports.

Zhou Xiaochuan, the professorial head of the People’s Bank of China, has repeatedly stated inflation is China’s financial public enemy No. 1, and his actions have left no one in doubt of how seriously he means that. Over the past nine months, Zhou has raised interest rates twice and acted to curb bank lending a record four times in the same period, mostly by increasing the national credit reserve ratio. As a result, inflation is currently down to 2.2 per cent after climbing to 2.8 per cent in December 2006. China’s money supply (M2) also rose only 15.9 per cent in January 2007, less than the 16.9 per cent it climbed to in December 2006.

More significantly, Stephen Green, chief economist with Standard Chartered Bank, Shanghai, says the keystone factor in China’s low inflation is that companies here have been utilising their cash to make huge investments in building new capacities in numerous industries — from steel to TVs to computers. The resulting glut in products and services is holding down prices, says Green, as companies struggle to win customers and fend off ever-increasing competition. In contrast, India is still a supply-driven economy, where sellers can command sky-high prices from consumers aching to satiate years, if not decades, of their pent-up demand for products and services. While this applies across the board, it is especially true for those semi-luxury and luxury goods and services that more and more people now consume, but which are still not a significant part of India’s consumer price index (CPI). The cost of these items is substantially higher in India than China, both because of India’s high and compounding taxes, and because of the differing overall cost structures in both countries. Consider this: a 19-inch colour TV from Haier costs about Rs 3,000 in China and twice that in India, a Thai meal for two at a restaurant in Beijing costs about Rs 1,000, while in Delhi it would cost at least twice as much.



Part of the reason for the high price of such goods in India is that consumers here are more willing to pay for their new toys than their counterparts in China. “In developing economies, producers charge high prices just because they can,” says Edward Bell, head (planning), Ogilvy & Mather, Beijing. “Consumers are not sophisticated and unwittingly pay premiums for ordinary products.”

China’s inflation is also low because unlike India, the retail market is very crowded and competitive, making stores wary of consumer ire over rising prices. “If I raise my prices, people will just buy from someone else,” says Li He, a vegetable vendor in Beijing. “There is a supermarket down the road, where things are really cheap.” In India, vendors and stores raise prices more readily because real estate and capital shortages, regulatory and administrative difficulties with starting businesses, not to mention the necessity of dealing with local political hoodlums, have inhibited natural competition in retailing.

In some respects, these differences underline the gap in the economic maturity of the Chinese and Indian economies. But they also hint at the different political economy forming in both nations. Policy makers consistently have to choose between pleasing industry and consumers, and in China, authorities have learned to strike an awkward but effective balance between the two. While Communist Party oligarchs and powerful businessmen certainly extract their pound of economic flesh from self-serving policies, the government is also watchful of how much pain citizens are able to bear. Since the Communist Party’s fraying legitimacy is based in large part on its ability to provide economic benefits to its people, the government is at pains to keep inflation under control. Price rises could quickly alienate large parts of the population and further stoke the already deep disillusionment with the Communist Party across the country, says a professor of economics in Beijing who asked not to be identified.

In India, an analysis of recent industrial regulations and tax incidence shows that policy makers have been handing out sops to industries, and often specific industrialists, without an equal concern for protecting the economic interests of consumers. For example, the top effective tax rate for individuals is about 35 per cent, while for numerous booming industries, such as telecom, it is just about 17 per cent.

More significantly, China, like India, is also experiencing massive increases in the stockmarket and the price of real estate. But Beijing has acted fast to clamp down on speculative demand for housing by starting to enforce a land appreciation tax and increasing the amount of money buyers need to put down on purchases. Chinese authorities have also defended the stockmarket from speculators by suspending the launch of new mutual funds, telling investors to be wary of entering the stockmarket at this stage, and ordering banks to ensure that commercial loans are not used for punting on stocks.

India’s responses have been much meeker, says a commercial banker in Mumbai. “There is a view now in Delhi that the focus should be on allowing people and companies to make money and drive growth,” he says. “People think that will solve all economic problems and consumer issues aren’t really on the table.” Of course, the Congress Party could pay a price for that in the coming elections, and to avoid that, it might come up with some populist measures. “But the core issue, the basic way policy is being formulated, will not change,” says the banker.

The Chinese professor says it is not fair to blame India’s political economy alone for the differences in the way China is managing its inflation. The Chinese government, he says, has the advantage of being in direct control of a much larger part of its national economy. “Here, the government, central bank, commercial banks and state-owned enterprises (which collectively account for 60 per cent of the economy) can move in step,” he says. “In India, policy is less efficient. It is already a high-cost economy. High inflation will make India economically unattractive to investors.” Then he chuckles. China’s amusement with India’s monetary policy appears to be spreading.