The past
week saw a significant shock to world financial
markets, thanks in part to egregious mishandling
of financial-market regulation by Chinese
authorities.
Already reeling from the
problem of falling US house prices and rising
defaults among poor Americans, global financial
markets took an extremely negative view of the
measures introduced by China, which were
ostensibly to cool down speculation in its stock
markets but have only served to increase confusion
for all investors. The best description I heard
all week of Chinese officials came from a
colleague who asked about China's stock market
regulator, "Is Jessica Simpson in charge?" [1]
referring to
a
stereotypical blonde and reportedly ditzy pop
singer.
In sharp contrast, and against the
expectations of pessimists such as myself, India's
finance minister this week released a "steady as
it goes" national budget that hopes to expand on
recent economic successes. Amid recently concluded
rambunctious state elections that saw the ruling
Congress party losing power in two key states and
reports of increased sops for various
constituents, including farmers, the result proved
more palatable.
To be sure, there is much
to disagree about regarding the state of India's
financial management, including the government's
excessive reliance on borrowings to fund its
expenses. Still, some reforms on tax rates and
collection did make it, and the government did not
expand on its ill-thought-out plans for rural
assistance in this budget, nor did it unveil any
price controls aimed at curbing inflation.
Chinese whispers From many
viewpoints, China appears to be two economies
rather than one, incompatible entities that are
finding it increasingly difficult to co-exist,
much like a mismatched couple. The inside track is
the elite wing filled with "Communist" Party
officials, bureaucrats, business people and local
and foreign bankers. On the outside track lies
everyone else. The inside track is relatively
efficient and often produces phenomenally
well-thought-out and well-executed plans. The
outside track, on the other hand, is almost always
filled with corrupt, incompetent or plain
amateurish officials who are tasked with
implementing policies made by the inside track but
not always accompanied by either clear
instructions or achievable objectives.
The
most egregious example of this trend was on parade
in the past few weeks. In a previous article, [2]
I wrote about China's plans for converting its
management approach on its foreign-exchange
reserve from a traditional "IMF" (International
Monetary Fund) model to a robust resource-based
model that better suits the country's expanding
needs. This will have significant implications on
global financial markets, which has been handled
by Beijing quite discreetly. Indeed, a number of
prominent economists and think tanks have been
consulted by China in advance of its
decision-making on changes to reserves management.
This has provided outsiders such as the US
government with good insight on proposed changes
and their implications.
The contrast with
the management of domestic situations could not be
more stark. [3] For one thing, China's effective
subsidy to its exporters by keeping its currency
stable has generated billions of yuan for these
companies and business people to use within the
economy. Being business people, many have invested
in "hot" areas such as property and stocks. Hoping
to ride the bandwagon, China's middle classes
joined in the mania, but funded through bank
borrowings in addition to their own savings. The
combination helped to push Chinese stock markets
to unsustainable multiples, particularly with
respect to the valuation of untested firms that
simply benefited from listings.
Attempting
to curb these excesses one by one produces a
"whack the mole" kind of game; indeed, an
intelligent approach would start at the root of
the problem, namely the country's undervalued
currency. Instead, regulators first tried to trim
bank lending and, when banks protested about
potential lost income, switched to trying scare
stories. Over the past month alone, Chinese market
regulators have made announcements, and then
contradicted themselves, no fewer than three times
with respect to the stock market. In each case,
announcements that led to sharp declines in market
values immediately were countermanded. Thus the
impression of a blind man feeling his way through
a tin shop has been created for the entire world
to see.
Such shenanigans are usually
associated with officials in small banana
republics - for example, the senior politicians in
The Gambia, who promised a cure for AIDS. That
China is even mentioned in such company is bad
enough, but the fact that another part of the
government functions very effectively in sharp
contrast provides a lesson regarding priorities.
India to the fore Regular
readers of this column are undoubtedly aware of my
lack of respect for India's current Congress-led
government. My main issues relate to the
government's clueless pursuit of income
redistribution without focusing on generation. The
idea of cutting revenue expenses to focus on
deficits purely for capital spending is lost on
the party, which is keener on winning the next
election than providing the basis for sustainable
growth.
In the above context, this week's
budget satisfied merely by failing to make things
worse. In the convoluted logic of modern India,
that actually counts as progress. Cuts in tax
rates must be welcomed, as are advances in
collection efficiency. It would still take a
master spender to turn an economy growing at more
than 8% to generate a budget deficit, and the
Congress always manages that feat. The inability
to expand supply has perpetuated the demand-supply
gap, in turn increasing both bottlenecks in
distribution and providing inflationary pressures.
Still, the good news came from elsewhere -
two places, in fact. First, voters showed that
they had seen through the government's fragile
economic logic, which has caused inflation to rise
on key products including vegetables. Their
disenchantment, combined with the experience of
corrupt local chieftains, has produced adverse
election verdicts in two key states for the
Congress.
The second piece of good news is
that the corporate sector really doesn't appear
constrained by the government's lack of ambition.
Many industrialists are pushing the boundaries of
innovation, and creating significantly more
aggressive expansion plans for both the domestic
and the export markets. Examples of this trend can
be found in sectors as varied as textiles and
electronics.
Long journey ahead for
both China's command economy is still
strong, but appears increasingly incapable of
managing excesses. Indeed, government officials
appear increasingly desperate to provide stability
ahead of planned liberalization. I am not
surprised by their lack of progress [4] but note
that investors are increasingly wary of the lack
of transparency.
India in contrast has
proved its system of internal checks and balances.
While they produce increased instability in
politics, they are also pushing the government to
gradual irrelevance. Therein lies the good news
for future generations of Indian business people.
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