The Asian Overhang

The advantages enjoyed by emerging economies when capital fled the recession-hit US market in search of higher returns are finally petering out. With new stirrings of growth in America and hints by Federal Reserve chairman Ben Bernanke about paring stimulus, the outflow of capital back to the US has begun. While such a turnaround could have been anticipated, the weak performance of emerging markets, especially China and India, was not. China’s failure to come to grips with its debt overhang and India’s fatal attraction to populist economic policies could combine to drag the world economy down.

In its mid-year estimate, the International Monetary Fund (IMF) pared its earlier projection of global growth. “While old risks remain,” the IMF warns, “new risks have emerged, including the possibility of a longer growth slowdown in emerging market economies” due to sustained capital flow reversals. The old risks are lacklustre growth in the developed world, with continued recession in Europe creating weak demand for exports from emerging economies. Falling commodity prices add to these woes. The IMF calls for policy action to reverse the trend, but judging by developments in two of the largest emerging market countries, China and India, concerns over regime stability and short-term political considerations, respectively, take priority over reforms. 

Recent trade data from China (after the IMF forecast China’s growth falling to 7.7 per cent ) shows clear signs of a slowdown. With exports down by 3.1 per cent compared to last year and the government attempting to curb investment in property, the two key drivers of Chinese growth are losing steam. Meanwhile, low wages and high housing costs are acting as a drag on private consumption — which China hopes to harness for stimulating growth. To revitalise the economy, Beijing needs to clamp down on shadow banking, which has created a huge overhang of hidden debt. As the government jostles with these problems, Prof. Michael Pettis, from Peking University, says that China’s long-term growth rate could average a decidedly humdrum 3-4 per cent. 

India, too, stands on the precipice of squandered opportunities. Despite successive years of good agricultural harvests, which have given India a cushion, the sinking rupee, rising inflation and woefully inadequate infrastructure, with corruption and policy paralysis, have dampened India’s growth prospects. Poor management of the public food distribution system has already caused substantial waste and loss, which could be further aggravated by a fiscally irresponsible Right to Food programme. While mass malnutrition in a country with surplus foodgrain is shameful, the Centre’s populist programme could raise the total cost of subsidy to $25 billion, adding to a burgeoning current account deficit. India’s reserves now cover less than six months’ worth of imports. 

Ever since Bernanke hinted at a possible stimulus slowdown, paving the way for a rise in long-term interest rates, capital outflows from emerging countries have increased. Already, some $7 billion has flowed out of India. The knowledge that more than $170 billion of the country’s $390 billion foreign debt will be due for repayment this year would not make it easy to raise more debt.


The attempt to find a short-term solution to the current account problem by allowing foreign investors to own 100 per cent of a telecom company, up from 74 per cent, and raising the foreign direct investment (FDI) ceiling in defence-related companies to 49 per cent from 26 per cent may be a bit too late. The regulatory environment remains highly unpredictable and a high-powered cabinet committee set up to expedite the launch of FDI projects has been able to clear only a tiny part. 

For a long-term solution, India will have to first set its policy house in order and that may have to wait till the general elections next spring. Meanwhile, sputtering Asian economies can only add to the gloom about the global economy.