The Hindu Business Line : A place for India in `Asian' Century

China revising its GDP growth rates and the launch of SAFTA mark the arrival of Asia on the world scene. Both have implications for India. The first demanding a re-visit to the national income statistics to factor in the contribution of the services sector, and the second, New Delhi's leadership. Will India take up the challenge, wonders A. Vasudevan.

TWO INTERESTING developments await India Inc. to seize opportunities to grow to be a part of the dream of making this an Asian Century. The present official thinking is favourable for the Indian business to get its act together. We shall at the outset deal with the developments and then discuss the implications thereof for India.

First is the news, dated December 20, 2005, concerning China's upward revision of its estimates of gross domestic product (GDP) for 2004. The upward revision places the GDP to be higher over the earlier estimate by about 17 per cent, driven largely by the growth of the services sector whose share in GDP has moved up to about 41 per cent.

News reports also suggest that China has not made revisions of GDP for the preceding years but would gradually bring out revisions beginning 1993. The revisions are based on the new methodology, presumably corresponding closely to what was suggested by the UN System of National Accounts, 1993. But the revision effected for 2004 does not mean that it is the same as the growth rate. In view of the lack of revised data for 2003, one would presume that the growth rate during the year has not changed.

Ahead of Italy

The implications of the revision and the timing of the announcement immediately after the Hong Kong meet on trade negotiations are of relevance for India. The revision places China ahead of Italy — the sixth largest in the world — in terms of economy size.

Some academics in China, however, believe that the latest revision of GDP for 2004 does not capture fully the reality. In their view, the values of transactions of the private sector are sharply under-reported. If this view is correct, China could well edge out or equal the UK or France in terms of economy size. Industrialised countries can no longer afford to ignore China and will have to seriously consider giving it a place in their elite club. The summit of the Group of Eight countries (G-8) that normally takes place around May/June could well see a new member in China. This could mean that either the member now occupying the eighth position would have to be left out or the G-8 would have to be extended to become G-9.

The concept of symmetry of treatment that plays a critical role in international finance can, however, be ignored by the summiteers if China does not come out with its national account statistics for some of the years preceding 2004. One should not be surprised if data for at least 2003 are released in the next few months.

What does the GDP revision mean in US dollar terms? As the exchange rate is given, China's GDP in US dollar terms would be higher than what was believed to be the case before the data revision. Could this be interpreted as China's way of saying that its currency is not overvalued, given the inherent strength of the economy?

Product of technology

Another significant implication is that China's high growth rates are secured not by large investments implying wastage of capital resources as Paul Krugman had argued some years ago but by higher productivity.

Since this productivity would be regarded mainly as a product of technology shock (what economists call the total factor productivity) rather than of labour productivity growth, one should consider China as being positioned at the new frontiers of science and technology.

But reality suggests otherwise — China is not a technology leader but an emulator. The gap between China and the US in the fields of science and technology is still very large.

Once the technology shock is discounted, a curious question arises as to why productivity should be so high in China and not in other countries. Is it because workers' productivity is high due to sound work ethics and factory discipline? Or, is there an incentive system unnoticed by outsiders?

The upward revision of GDP would also imply a high income velocity of money, given its stock. In other words, the demand for money in China would have been low. Real money demand in China would have been less positively responsive to income and negatively related with short-term interest rates. The yield curve should have been higher than what was the position before data revision. From the policy viewpoint, interest elasticity of demand for money would signal scope for further financial sector diversification and deepening of financial markets. China's financial reforms and practices so far have been not as transparent as they should be with the result that questions of financial vulnerability are often aired.

Relevance for India

The above discussion has relevance for India in more ways than one. First is the need to re-look at India's national income statistics. India has adopted the UN system of national income and made revisions in relevant data some years ago. But as these revisions have not been marked in India, it would be useful to revisit the methodology, particularly in respect of compilation of data of the contribution of the services sector and of the unorganised sector within the commodity-producing vector, as also the price deflators that are deployed.

Second, the case for accelerating investment rate in order to post higher growth would be less relevant than the case for enhancing productivity. It would be necessary to work out strategies for improving work ethics, labour contract laws, and incentives for application of new or innovative technologies. Third, with only 41 per cent services sector share in GDP, China could post higher growth rates than India with 52 per cent services sector share in GDP. It is difficult to know as to what should be the right share of the services sector to optimise the overall growth but it is becoming increasingly clear that securing a better balance between the growth in the services sector and commodity-producing activities would be necessary for India to address the problem of large-scale unemployment.

Finally, the large market size of China should be exploited for the trading opportunities it affords. To make inroads into the markets of China, Indian goods (and services) would have to be price competitive with those that export goods to China, besides being qualitatively as good with sound after-sale servicing and other business practices. Will India take up the challenge?

SAFTA is real

The second development relates to setting in place the South Asia Free Trade Agreement (SAFTA) from January 1, 2006. Enormous useful work has been carried out on the operational procedures by the Committee of Experts of the seven nations forming the SAARC — Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. SAFTA envisages reduction of tariffs for intra-regional trade among the seven countries along with concessions covering tariffs, para-tariffs and non-tariffs for the least developed countries of the region.

While some issues like the negative lists in respect of high value goods for purposes of trade have to be still sorted out, it is necessary to use the opportunity thrown up by the Agreement to make large-scale investments in the region as also to improve the volume of trade. The Prime Minister's suggested estimate that the volume of trade could increase from the present level of $6 billion to $14 billion in two years from January 1, 2006 should be within reach provided the Indian business community and exporters of the rest of the countries of SAARC ensure that intra-regional trade is price competitive.

It is also possible to extend financial services and technical collaborations including knowledge management, educational and information technology services rendering it possible to ultimately realise a full-fledged South Asia Economic Union as a stepping stone to making the century truly Asian.

(The author, a former Executive Director of the Reserve Bank of India, can be contacted at asurivasudevan@hotmail.com)