Tuesday, 22 June 2010

Damned if you do; damned if you don't


The financial markets have gone gaga over the Chinese central bank’s announcement over the weekend that they would allow the Yuan to rise gradually. There has been almost unanimous international pressure on Beijing to let this happen for sometime. But then Beijing does not like others telling it what to do (after all, who does ?). It will do what it wants, when it wants. But Chinese reluctance has little to do with foot dragging in international diplomacy. It is caught in an almighty quandary.

If the Chinese central bank does not intervene as it does daily, the Yuan would have surely risen a fair bit by now. And probably suddenly. That would be disastrous for China. China is an export led economy. It’s export operating model is huge scale, low costs and wafer thin margins. Costs are under pressure as wage costs rise and general inflation bites. It can only be partly offset by moving factories to the interior where costs are lower than the coastal provinces. Firstly factories are not so easy to shift. Secondly it is a fair disruption to start all over again somewhere else. Thirdly, costs are rising in the interiors too and might only buy 3-4 years time. This blogger has been stating repeatedly in this blog – China is no longer the lowest wage country for manufacturing – pound for pound, India is cheaper, let alone even cheaper countries such as Vietnam.

Therefore if the Yuan were to rise, and rise fast, the export led economy would massively lose its competitiveness. And the specter of unemployment looms. China’s political and social model is centred around providing jobs and big scale economic improvement to its population. Every year, China adds to its workforce numbers that are equivalent to the population of most countries. Any threat of unemployment is even more disastrous to China than anywhere else in the world.

Every company I know , is already factoring in a much stronger Yuan to its future plans. And that means looking elsewhere for manufacturing. Not shifting factories, as yet, but looking to expand elsewhere outside China. Growth of manufacturing in China is now already a huge challenge – people have started to factor currency appreciation and China is not looking as rosy.

But the option of not letting the Yuan rise is worse for China. That’s what is happening today. The Central Bank intervenes buy buying dollars and selling the yuan. This has caused a mountain of yuan sloshing around China. One obvious danger is inflation. The second serious threat, which has already happened, is massive asset bubbles. Both the stock market and property market have gone crazy. The Chinese suffer from the same universal delusion that property prices will go only one way. We all know what happens when property prices fall; as they surely will.

All this is a massive opportunity for India – the only other country in the world with the scale to take on China in manufacturing. And, India is doing its very best to ensure that it can never compete. Low costs alone cannot win. You need infrastructure, sensible land policy, power, government will. Faced with an open goal, an injured goalie and preoccupied defenders, the Indians are busy trying to dribble in the opposite direction and score an own goal.

Back to China. You have to have some soft corner for a country facing a problem because it has succeeded wildly. It is faced with a piquant situation. Damned if you do. Damned if you don’t.

11 comments:

Sandhya Sriram said...

me first

Sandhya Sriram said...

I tend to think as a layman. I feel that India should not build an economy in the model of China. the model is successful but it is built on people blood and not just on sweat.

The other perspective is that while China can afford owing to the huge availability of land on mass farming, India is still faced with food crisis and if at all we want mass scale labour most of it would migrate out of agriculture which is not we want

I feel, India should try to find ways of retaining the existing mix of Agri-Industry-service, make agriculture more remunerative, incentivise Industry automation to make out better yield and keep widening the service base to absorb the educated manforce which the country is churning out

I know, this is stupid economics but stupid people are allowed to think stupid - isnt it :-)

Adeshsidhu said...

Now I understand why Sensex rose yesterday. All analysts were saying it is because of rise Yuan. But I could not understand the relation between happiness of Indian stock markets and Yuan.

Anonymous said...

//Faced with an open goal, an injured goalie and preoccupied defenders, the Indians are busy trying to dribble in the opposite direction and score an own goal///


waka waka waka waka waka waka :))))) awesome comparison

ambulisamma said...

Husband has a soft corner for China,since they export to Chinese customers, and the market is very dull these days,hence less job for him.And need i say am happy about it?

Deepa said...

"A perfect world"... Requiem for this dream!

zeno said...

Perfect Catch-22?
Sometimes scoring an own goal may not be that bad!
Check this out
http://mindyourdecisions.com/blog/2010/06/16/the-weirdest-soccer-match-and-game-theory/

KC said...

If India wants to capture this godzillian opportunity, it has to put the nail on the head. There has to be more intelligent people in the political system, we should not end up creating a china like situation.

In my opinion, when big corporates from the developed world established their giant manufacturing operations in China, assuming a developing economy with revolutionary and inviting policies will never change, it was just not business-like assumption. Dare to dream in the evolving world. It had to happen but happened pretty much very quick in case of China.

The world should be ready to buy expensive chinese stuff, it's time to end the dream.

Ramesh said...

@Sandhya - Don't agree. Agriculture does not need as much labour to be productive. Labour exists there simply because there's no option and is massively underefficient. Its manufacturing that can create large number of jobs, especially at the bottom of the pyramid. We should embrace manufacturing wholeheartedly, for that's the only way to do poverty alleviation on a large scale. Some 300 million people in India can safely move from agriculture to manufacturing without a dent on agricultural output. India has one of the highest percentages of cultivable land in the world. And its a large country. Land availability for industry is not an issue.

@Adesh - Stock markets don't need a reason to go up or down; its just the herd moving one way or the other. They could very well move up because you came back to blogging after a brief absence !

@Gils - You are sounding like an African :) Waka Waka

@Ambulisamma - Oh does he ? Say Ni hao to DD

@Deepa - Indeed so

@zeno - Catch 22 indeed. I am sure India will use your link to justify why own goals must be scored !!

@Kapil - China still has huge competitive advantages and is still the premier manufacturing destination of the world. It will still be an important destination in the future , for there is no other country bar India, which can absorb the scale. And India getting its act together is a long way away. These are early dark clouds in the China horizon - the storm is still far far away.

Vishal said...

Both the situations seem dangerous from China's future perspective. Still I think the position of Yuan rising looks more dangerous. While damages due to not letting Yuan rise may be managed somehow, but at this stage of their industrial evolution, they cannot afford to lose the competitiveness. As the time passes, I hope they will attain an equilibrium in their economic model.

As far as India is concerned, I think they are trying their very best to ensure that their own players get few red/ yellow cards while on course to score own goals.

Ramesh said...

@Vishal - Yes, that's why China is really dragging its feet on allowing the yuan to rise considering an undervalued yuan as the lesser of the two evils. Yes, lots of cards flashed in India, but somethings are changing. For eg in the automobile industry; especially in auto components, India is making serious inroads globally.

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