In a recent contribution to these pages ("The age of cheap capital"), Sanjeev Sanyal has argued that the rebalancing of the Chinese economy will entrench China's role as a large-scale structural exporter of capital in the coming decades. The sheer scale of the Chinese economy, even as its growth slows, will carry global significance for both the pattern of financial intermediation as also global economic activity.
I find Mr Sanyal's analysis persuasive as one possible scenario for the evolution of global finance. I note, however, that it is at variance with views expressed earlier by the McKinsey Global Institute, who, as I recall, had argued that China's external surpluses would decline as its population aged. Based on his reading of the experiences of Germany and Japan as those societies have aged, Mr Sanyal believes that China's towering investment rate will decline faster than does its saving rate, leading to a savings surplus that will express itself as a current-account surplus. Mr Sanyal apparently believes that this will remain the case even if the Chinese authorities are successful in boosting household personal incomes and personal consumption, while McKinsey seems to look forward to a later era when aging households have started to dissave.
Given my belief in the value of scenario thinking, this divergence does not particularly bother me; indeed I positively welcome it. In the remainder of this article, I take the "Sanyal view" as one plausible view of how the global financial system might evolve. But where Mr Sanyal's focus is on the implications for the global economy, I use his analysis to reflect on some implications for India's policies: domestic, bilateral and global.
As Mr Sanyal correctly points out, the sheer logic of national accounting means that a surplus of saving over investment must express itself as a current-account surplus in the balance of payments. Even if both saving and investment reflect deeper structural trends, this does not mean that they are insensitive either to policy, or to the business cycle. Indeed the rapid deterioration in the Indian balance of payments, followed by an equally rapid recovery, provides confirmation that this is the case. Even for China there has been a significant reduction in its current account deficit since the start of the global financial crisis in 2008.
Although I am not personally familiar with the analysis of the adjustment in the Chinese external accounts seen from a saving-investment perspective, in general, the most volatile elements tend to be public saving and public investment, followed by the corporate sector. The household sector is the primary source of net saving in most economies. It is this sector's behaviour that is the most sluggish, and is most influenced by such considerations as aging and demographics.
Despite these caveats let us accept that for some time to come China will continue to opt for a policy mix that renders it unlikely that it absorbs its savings domestically. Will this benefit or harm India, and if so, by what means?
Let us first consider the trade channel, both bilateral and in third markets. With respect to the latter, while there remain important areas where Chinese manufactures compete with those from India, China - like Japan and South Korea before it - is fast moving up the value chain, and will increasingly be competing with those countries rather than with us. This should result in an improvement in the terms of trade for India in these goods, which is good for India, although not so good for those domestic manufacturers (telecoms and power equipment; solar panels) who wish to compete in the local market. Given that India is a fast-growing market for imports overall, and for China in particular, a further implication is that we are unlikely to succeed in reducing the bilateral trade imbalance with China, a cherished goal of our trade diplomats.
A second potential channel is via the nominal exchange rate and the currency. Here it is the differences rather than the similarities between China on the one hand, and Japan and Germany on the other that are relevant. Both of the latter two have had open capital accounts, and well-developed financial and foreign exchange markets for a considerable period of time. China is only hesitantly taking steps both to liberalise exchange rate determination and to open its capital account, even as it seeks to increase the use of the Chinese yuan in trade-related transactions. This in due course will increase overseas demand for the currency. If my earlier supposition on diminishing competition between Chinese and Indian manufacturers is correct, then the impact of Chinese exchange market intervention on Indian exports should become less relevant, although it may have some effect on exports to our domestic market.
This then brings us to the third channel, the impact of China on global financial markets and on global imbalances, with a particular focus on what former United States Federal Reserve chairman Ben Bernanke called the problem of the "savings glut". At the time that the argument was first put forward by him the focus was on the evaporation of investment demand in the Association of Southeast Asian Nations following the Asian financial crisis of the late 1990s. After the brief but torrid boom in the last decade the issue has returned, this time because of the collapse in investment demand in the economies of the North Atlantic. Mr Sanyal's concern is that a structural current-account surplus in China without compensating deficits elsewhere will be an additional deflationary force in the global economy.
India's long-term interests are clear: to import capital within prudent limits to finance viable investment projects, preferably in sectors subject to market tests and implemented efficiently by the private sector in a non-distorted price environment. Even though our demographics are favourable for an increase in household saving, our weak fiscal position and the enormous investment requirements of our forthcoming urban expansion mean that our need for capital is structural and long-term. Ideally, such capital should find its way to us intermediated through competitive international markets rather than through purely bilateral or regional mechanisms. We should seek to use the G20 to ensure that a robust global financial architecture is recreated from the ashes of the ongoing financial crisis and that it endures.
The writer is group chief economist, Royal Dutch Shell. These views are his own