India and the death of free trade

India and China are facing the consequences of a global decline in trade. Their resilience in the face of this adversity is more likely to be a function of their political systems than their economies. In particular, India’s long economic isolationism and only partial embrace of free trade could become a template that other emerging markets begin to follow.

Similarities

It is often assumed that similarities between China and India are superficial. Their size is an obvious point of comparison, level-pegging as the world’s most populous states with around 1.3 billion inhabitants apiece. But there, the conventional wisdom goes, the similarity mostly ends. China’s command economy and ethnically homogenous Han Chinese population have allowed it to pursue a transformative process of state-led development, whereas India’s enormous diversity and complex democracy have hindered its pursuit of the same goal.

For a brief period between 1979 and1991, it was arguably true to say that China pursued export-led growth whereas India favoured near autarky, until India liberalised its economy to some extent as a result of a balance-of-payments crisis in the early 1990s. It remains true to say that China specialises in the export of manufactured goods, while India is more focused on exporting services, reflecting its success in business-process outsourcing and its very large English-speaking workforce.

However, the economic parallels between the two are converging in some surprising ways. Openness to trade and investment is one. Neither India nor China makes life easy for foreign companies trying to access their domestic markets. Tariff barriers are high. The World Economic Forum’s Competitiveness Rankings, filtered for trade tariffs, places India and China in 124th and 117th positions respectively, out of 140.

Foreign direct investment (FDI) faces significant hurdles in both countries. The Heritage Foundation, a conservative U.S. think tank, ranks India near the bottom of its Index of Economic Freedom, in 143rd place, with particularly poor scores for what it calls ‘Labour Freedom’ (the ease with which a business can lay off workers), government integrity and judicial effectiveness. India scored in 130th place in the World Bank’s latest Doing Business rankings, out of 190.

Despite these barriers, the giant consumer markets of China and India are nevertheless two of the world’s largest magnets for FDI. India’s FDI reached USD46.4 billion in 2016, an increase of 18 per cent on the previous year and amid the context of a 12 per cent fall in FDI logged by the world as a whole. China attracted FDI worth USD118 billion in 2016. In both cases, a good chunk of this is domestic investment that is ‘round-tripped’ via friendly tax jurisdictions.

Although FDI has held up, portfolio investment is fleeing in anticipation of further U.S. interest rate rises this year that will improve returns on investment in lower-risk developed economies. As in China, where the central People’s Bank of China is burning through its foreign exchange reserves in an attempt to support the value of the renminbi, there is some evidence that the central Reserve Bank of India is likewise expending foreign exchange reserves to support the values of the rupee, which fell sharply against the U.S. currency following the U.S. Federal Reserve’s first interest rate cut in December.

‘The economic parallels between the two [China and India] are converging in some surprising ways. Openness to trade and investment is one.’

Dark clouds

Perhaps most surprisingly, today China and India have similar exposures to global trade. Exports represent roughly a fifth of the overall economy of each. With signs that globalisation is in retreat, both need to confront the implications for their economic models. While India and China are each experiencing overall GDP growth of around 7 per cent annually at the present time, in both cases this in the context of their exports declining. China’s exports fell by 7.7 per cent in 2016 from the previous year, the second consecutive annual decline. India’s exports were down by 13.6 per cent in January 2017 on the same month of the previous year – the 14th consecutive monthly fall.

How this will impact them in the medium-term is where the real differences between the countries begin to manifest themselves…

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