Chinese bubble may burst: US pressure on China in India’s interest

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by Ashwani Mahajan

on 03 May 2010

Today China is the world's fastest growing country in the world. 25 percent of the total world production comes from China, and its share in world trade is 6 percent. From consumer goods to power plants, China today is producing all in large quantities, and world markets are dominated by Chinese products.

India has a huge trade deficit with China and it has been growing fast for several years as India's exports are less than the value of imports coming from China. By the year 2008-09, India's imports from China had reached US$ 32.5 billion. Since Indian exports to China were only US$ 9.4 billion, so our trade deficit with China had reached US$ 23.1 billion.

But recently, the value of imports from China has started declining and in the first nine months of financial year 2009-10 i.e. April-December, the value of India's imports from China was only US$ 21.4 billion, while in the corresponding period of 2008-09 China's import bill was US$ 24.9 billion. This implies that imports from China have come down by 21 percent, as compared to last year. Though India's exports to China are also down by 21 percent, India's trade deficit with China this year is expected to be lower than last year.

The reason is that the Chinese government under domestic economic pressures was compelled to reduce subsidies to its industry and exports. As a result imports coming from China became expensive and their demand was reduced accordingly. It is well known that China's bulging exports to India were due to their extraordinarily lower prices. Cuts in subsidy by the Chinese government have resulted in reduced demand for Chinese goods.

China's heavy surplus in trade has been mainly for two reasons - one, the Chinese Yuan is kept artificially weak. It may be noted that China’s currency's value is not decided by market forces but by the force of government. In fact Chinese Government determines the value of Yuan and has been keeping it artificially low. As a result prices of Chinese products in the international market remain low. This helps Chinese products to dominate international markets.

Secondly, the Chinese government grants direct and indirect subsidies to its industry and exports. Though Chinese public sector enterprises are running huge losses, heavy subsidies help them to dump Chinese products in world markets. During 2010, the Chinese Government was compelled to reduce subsidies, thanks to rising budgetary and fiscal deficits. This had a significant impact on Chinese exports. For the past few months the American President has constantly been making statements that the Chinese Yuan is being artificially kept weak and its revaluation is required.

US and European countries have been creating pressure on China for appreciating its currency so that adverse impact on the industries of those countries could be reduced. So far, bypassing all such pressures from different quarters, Beijing has been keeping Yuan's value low. But in the last few weeks China seems to be budging a little bit under US pressure and has made statements indicating appreciating the yuan. Though the Chinese Premier has made a statement that they will not bow down to US pressure, the People's Bank of China has indicated possible appreciation of Yuan. The Chinese central bank has also indicated a more flexible currency regime, meaning thereby the possibility of a market determined value of its currency.

Between 2005 and 2008, China increased the value of Yuan by 21 percent. But after the global meltdown since 2008, Beijing chose to stick to the exchange rate of Yuan vis-à-vis the US dollar at 6.83 Yuan per US dollar. This was perhaps done to stall any fall in their exports in the post global economic crisis. The USA, India and many more countries suffered heavy losses in trade with China. China's central bank has increased the value of Yuan by 1 percent recently.

In the long run, China's decision to revaluate the Yuan would relieve the United States and European countries; India also is likely to be benefitted from this decision. Most of the exports from India to China are raw materials like iron minerals. The revaluation of the yuan will not affect exports of India to China. Rather India may get more in terms of dollars, looking at lower price elasticity of exports to China. On the other hand, Chinese exports to India will become expensive and looking at price sensitivity of imports from China, India's trade deficit with China may also come down.

The deteriorating financial discipline in China's public sector enterprises, the growing fiscal deficit of Chinese government, and dwindling conditions in provincial governments, have been creating problems for the Chinese economy. The spurt in prices of essential commodities in recent months has given alarm signals to policy makers in China. The recent spurt in prices has been said to be due to 27 percent money supply growth and a credit growth of 34 percent.

Fearing possible inflation, Beijing’s efforts to curb business cycles are likely to curb growth as well, because these efforts may have far reaching impact on internal demand. On the one hand, Chinese central bank has started curbing credit and on the other hand Chinese government has started cutting subsidies, which has caused a dip in Chinese products exports to the rest of the world. It may be noted that China has faced its first ever trade deficit to the tune of US$ 7.24 billion in the month of March 2010, after a gap of 6 years.

Now the revaluation of the Yuan may further make Chinese products costlier in international markets, and India which has been facing huge deficit in her trade with China, is likely to be benefitted from this move.

The author teaches Economics in the University of Delhi

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