French Emperor Louis Bonaparte’s prophetic statement, “Let China sleep, for when it awakes it will move the world” appears to be coming true. China is on the move and what happens in China will not remain in China.
The sudden devaluation of the yuan to make it more market-determined and facilitate its inclusion in the IMF’s Special Drawing Rights (SDR) basket has conveniently come at a time when China’s exports have sharply slowed. It signals that China is struggling to rebalance its economy as it tries to internationalise its currency. The initial 2 per cent devaluation has amounted to almost 4 per cent against the dollar. It has roiled global markets — US equities and the Sensex have crashed. More turmoil could come, given its high debt and weak financial systems. The IMF has deferred the yuan’s inclusion in the SDR.
The rupee has fallen almost 4 per cent against the dollar in the last two weeks, which ensures that the rupee-yuan exchange rate remains more or less unchanged. But other BRICS currencies — the real, rouble and rand — have depreciated much more. A currency war, especially as growth in global trade has fallen, is not in anyone’s interest. If the yuan were to weaken, India would need to protect itself, as many think that the rupee is overvalued at Rs 66 to the dollar and should be at around Rs 70.
The devaluation and ensuing global turmoil has shifted attention from China’s “one belt, one road” (OBOR) strategy unveiled in the fall of 2013. That policy is a sign that China is intending an ambitious outward-oriented investment strategy to encourage new trade and connectivity throughout Asia, with road and maritime links through the Indian Ocean to Africa, the Middle East and on towards Europe. It is a revival of the ancient silk road, but even broader in scope and scale, and will help China invest abroad and relieve some of its excess capacity.
New financial institutions linked to this strategy, such as the Asian Infrastructure Investment Bank (AIIB) and the New Silk Road Fund, have been established in Beijing. The New Development Bank (NDB) and the Contingent Reserve Arrangement (CRA) have been set up in Shanghai. China has also recapitalised three banks — the China Development Bank, the China Exim Bank and the Agricultural Development Bank of China — to help finance projects linked to the new silk road strategy.
Many problems could arise in executing this strategy. Asean countries involved in the South China Sea dispute are wary of China’s intentions. The US is creating the Trans-Pacific Partnership with 12 Pacific Rim countries, which so far excludes China. Japan has increased its aid programmes and is pursuing a Japan-EU free trade deal. Concerns on past Chinese investments have surfaced in Myanmar, Sri Lanka and many parts of Africa. Russia is wary of China’s moves in Central Asia. India has not yet signed on to OBOR, as it has concerns over the China-Pakistan Economic Corridor and believes that the maritime silk road will create a “string of pearls” to encircle India. China is not happy with India’s involvement in the South China Sea. Prime Minister Narendra Modi’s trips to reignite relationships in Mongolia, Central Asia and the Pacific must have been noted in Beijing. India has countered China’s rising engagements in the Indian Ocean with its own spice route or “mausam” project.
Nevertheless, Asia’s two giants continue to engage on several fronts. Trade relations have increased substantially though India faces a huge and growing trade imbalance with China that the Chinese devaluation could further increase. Chinese investments in India remain quite small, at less than 0.5 per cent of all FDI in the country — less than even Poland, Malaysia and Canada. India needs to reduce its trade imbalance with China by attracting more FDI from China to get Chinese companies to “Make in India”. India has joined the NDB and CRA (with an Indian president) and the AIIB (as its second-largest shareholder after China). These new banks are a potential, although small, source of long-term infrastructure finance for India, and they represent a visible and tangible symbol of cooperation between India and China that can fructify and grow.
As China takes over the chairmanship of the G20 in 2016, expect more risk as well, perhaps, as more opportunity — in Chinese both mean the same. The yuan may weaken further and China may pursue more aggressive external policies to distract attention from domestic problems. But
if China becomes a riskier prospect, India could emerge as a more stable investment opportunity if it is able to pursue economic reforms and improve its business climate. India must also remain proactive on the economic and diplomatic fronts and ensure that China sees that competition with India will be costly, and cooperation will benefit both.
The writer is visiting scholar, Institute for International Economic Policy, Elliott School of International Affairs, George Washington University, US