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iCHINDIA
A tale of two giants

ABN AMRO
Emerging Market Analysis & Multilateral Organisations
Serdar Küçükakın Swe Thant

May 2006

Emerging Market Analysis & Multilateral Organisations

Table of contents

Introduction Chapter 1: Chapter 2: Chapter 3: Chapter 4: Chapter 5: China and India in the global economy Competitive issues Infrastructure International relations Trade and FDIopportunities for the Netherlands

3 5 10 13 16 22

2

May 2006

Emerging Market Analysis & Multilateral Organisations

Introduction
After decades of self-inflicted isolation, China and India have made a grand entrance on the world stage. Markets have been forced to pay attention to the two neighbouring Asian giants because of their growing influence on global economic trends. The twocountries have had an enormous impact on commodity prices and on global economic growth. Their competitive labour costs mean that they are expanding their global market share in a number of industries. The low prices of Chinese and Indian exports remain a powerful force for global disinflation. The importance of the two countries extends far beyond the current business cycle. However, it must beremembered that they still have a long way to go when it comes to the living standards of their populations, which are still very low compared to those of the Western world. Furthermore, growth in the two countries, and especially in China, has so far benefited mainly urban populations, laying the ground for social unrest in rural areas. Looking at the economic dynamics of the two countries, interms of demographics, education, labour market flexibility, capital formation and infrastructure, the two economies diverge considerably. Because of its one-child-policy China will experience the effects of ageing much faster than India. According to projections, growth of the working age population in China will halt in 2020 and decrease thereafter. This will have an adverse effect on the potentialgrowth of the country. However, India will face the challenge of creating jobs for its growing working age population. So far, it has not succeeded in delivering the jobs it needs, partly because of the very small amounts of foreign direct investment (FDI) in manufacturing (the sector which can absorb large amounts of low skilled labour readily available in India). China, on the other hand isexperiencing large FDI inflows. FDI played an important role in capital formation in China, especially in the beginning of the reform process (‘opening up’), which was set in motion after 1978. Given its enormous savings rate, the importance of FDI is declining in China. Now it looks like India is the next hot spot when it comes to attracting FDI. However, to become a really attractive location forforeign investors India needs to upgrade its physical infrastructure, which is more and more perceived as an impediment to growth rather than supporting it. Since China started reforming, it has made an enormous effort to upgrade its physical infrastructure and it is therefore way ahead of India. Unfortunately, China neglected to apply the same zeal to its banking system. The Chinese banking sectorcontinues to be dominated by large state owned banks. State owned banks also play a major role in India, but there is more competition from private sector (including foreign) banks. This, combined with a better risk appraisal system, makes the Indian banking system more robust than China’s. Apart form such economic differences a major difference between the two countries is of course in theirpolitical systems: China is a one-party state whereas Indian is a parliamentary democracy. In China, internal policy is strongly focused on maintaining the political stability of the country. In India, the largest democracy of the world, policy making for any government can be seen as a balancing act, given the very fractious setting of the parliament. In international affairs, China, as a permanent...
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