China doesn146;t show the way

Various commentators have reiterated that policies that work for China should work for India because both countries are poor and have large labour surplus economies. In managing the currency and prices, the Chinese policy of sterilised intervention was described as the perfect recipe for achieving high exports and low inflation. It has been argued that government only needed to allow the RBI to sterilise and the RBI would be able to keep the rupee weak and exports high. When the Chinese central bank, People8217;s Bank of China PBOC, created bonds meant for sterilisation of its currency intervention, massively sold them to Chinese public sector banks and raised the Cash Reserve Ratio CRR, the RBI followed.

Today, when Chinese inflation has hit 8.5 per cent and the PBOC has raised the CRR to 16.5 per cent, India is still following. Indian policy makers have not woken up to the fact that this is a disaster for India. They completely ignore the fact that public sector enterprises in China can keep investing despite the credit constraints and keep China8217;s investment rate high, but Indian firms that function in a market economy cannot do so. The higher cost of capital is pinching industry, and can easily push the economy into another 1996-97 kind of recession when the RBI had repeatedly raised the CRR to sterilise its intervention. Policy makers need only to look back at the consequences of monetary policy in India in the 1990s.

Instead, they continue to look towards the Chinese model.

Another important difference between India and China as well as other East Asian economies who followed the Chinese path that policy makers seem to forget is the difference in the political regimes. Perhaps in China the government could ignore the impact of its yuan policy on domestic industry and the mass of the population for a long time, even though it could see that its currency policy had costs. The question that the Congress government needs to ask itself is whether it can blindly follow in the footsteps of a single-party state. The Congress cannot but turn to industry for political funding, and towards the people for votes, when it seeks re-election. Having pushed industry into a slowdown and voters into high inflation, it will be interesting to watch how the Chinese model will save the Congress.

As the figure shows, the RBI has pumped huge amounts of rupees into the economy. Money supply has been growing at rates above 20 per cent. This was bound to pull up prices. At the same time, the global prices have gone up. This has led to a big jump in inflation. This was hardly the best policy to follow in a democracy, especially in a pre-election year.

If the Congress continues with the false fight against inflation without a genuine change in its policies, then unlike the Communist Party of China, it can be thrown out of power. It may be fashionable to follow East Asia and China in high export growth. But unlike in India, the autocratic governments in these countries did not have to consider domestic political constraints as seriously as a ruling party in India needs to.

The writer is senior fellow, National Institute of Public Finance and Policy