Impact of China Slowdown

on India

Geetima Das Krishna

Senior Researcher
Centre for Policy Research

Sakshi Bhardwaj
Research Associate
Centre for Policy Research

February 2016

WWW.CPRINDIA.ORG

India-China

Introduction
After three decades of double-digit growth, China is slowing as it is rebalancing its economy from export-driven
to less-volatile domestic consumption driven economy. The impact of China slowdown on India has been a topic
of debate since last year. According to the Finance Minister Arun Jaitley, slowdown in the Chinese economy will
not impact India as it is not part of Chinese supply chain and India could become the "additional shoulder" the
global economy needs to stand on. Niti Ayog Vice Chairman Arvind Panagariya commented that India will not be
impacted as long as the reform initiatives continue: As China reorients its domestic demand and starts exporting less, it
will give India the opportunity to take part in the market space China currently occupies. However, RBI governor
Raghuram Rajan contradicted the government's recent assertions and stated that China's pain of economic
slowdown can be India's pain too.
In Section I, the paper examines whether India can indeed provide the additional shoulder for global growth.
Section II studies the impact of China slowdown on India through different channels. The econometric analysis for
both direct and indirect impact of China slowdown on India is given in Section III with the conclusion in Section IV.

Section I: Can India replace China as Global growth engine

Chinas share in global GDP tripled from 3.6% in 2000 to 15.5% in 2015 as it grew at a breakneck speed for three
decades. During the same period Indias share in global GDP also doubled from 1.4% to still low 3%.
However, recently, Chinas GDP growth slowed, from nearly 10% annual growth rate observed in last three
decades after it started its reforms in 1979, to a more sustainable 6.8% yoy in 2015 - lowest in 25 years. On the other
hand, India has emerged as the fastest growing economy among the major countries in the world with an
expected growth rate of 7.6% in FY 2015-16. But the expectation that India will take up the position from China as
worlds growth engine is erroneous.
According to World Bank, the GDP of US, the largest

Chart 1: China and Indias share in Global GDP

economy, is over $17 trillion while that of China is just

over $10 trillion. In comparison, Indias GDP is just over
$2 trillion, one fifth of that of China. So, even if India
grows faster than China, the magnitude of the impact
on world GDP will be much smaller. A significantly
bigger but marginally slower China will continue to
contribute more to global output compared to a much

Source: IMF Data

smaller but faster growing India.

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China contributes more than 1% to global growth while India contributes a mere 0.2%. Even if India grows faster
in coming years, its contribution to global growth will remain miniscule and slower China will continue to
contribute more than 1%.
Stronger growth, higher industrial production and increased investment in infrastructure have made China the
largest consumer of commodities in the world, particularly metals. The share of infrastructure investment in
China has been more than 20% of GDP while that in India remained in single digits with annual spending on
infrastructure in China reported to be ten times that in India in USD terms. So, obviously, Chinas demand for
metals has been almost 15 times that of India in 2014 as seen in the chart below. India consumed around 80 million
tons of steel in 2014 as against China's 800 million tons.
Chart 2: Chinas consumption of key commodities Chart 3: Indias consumption of key commodities

Source: World Bank, BP Statistical Review of World Energy, World Bureau of Metals Statistics, U.S. Department of Agriculture.
Note: IP denotes Industrial production.

As China slows down and its growth model shifts from industry-led towards more services-based growth, the
demand for commodities, both metal and oil, has softened. According to some estimates, one percentage point
(pp) decrease in Chinese GDP is equivalent to 0.3 pp fall in global growth while 5% fall in Chinas fixed investment
can translate to 0.3% to 0.5% fall in global GDP growth. So, a slowdown in Chinese economy has led to a sharp fall
in commodity prices. At the same time, India continues to remain a service led economy with no significant change
in growth drivers and hence demand for global commodities.
As a result, even though India is usurping China as the fastest growing major economy in the world, it is impractical
to expect India to take the place of China as a major contributor to growth or consumer for industrial commodities
in the short term. Indian economy being a fifth of the Chinese economy and also less material intensive can hardly
substitute for China as a global growth driver.
Few studies have explicitly compared China with India using a directly comparable framework giving adequate
attention to the measurement issues. Broader multi-country studies such as Wilson and Purushothaman (2003),
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Bosworth and Collins (2003), Jorgenson and Vu (2005) and Fan and Felipe (2005) have made useful comparisons
but do not predict the impact of one on another. Bosworth and Collins (2007) have made a growth decomposition
focussing on the productivity impact of sectoral reallocation of labour. Fan and Felipe examine China and Indias
growth performance from the income side, looking at the sustainability of investment through an analysis of
profit rates using a classical (Marx-inspired) approach. The results question the sustainability of the much higher
rate of capital accumulation in China as compared with India, given an apparent ongoing fall in the economy-wide
profit rate.
The primary difference between the performance of the Indian and Chinese economy has been faster growth of
the capital stock in China. Moreover, Chinese growth has been built on infrastructure, investment and
manufacturing, while India lags far behind China on all these dimensions and its growth has been primarily
service sector driven. Manufacturing is about 17% of the Indian economy, compared to China's about 30%. China
has arguably the best physical infrastructure outside the western world. India's looks more like the poor country
that it still is. Therefore it is difficult to say that India could take the position of China in near future.
However India could surpass the growth rate of China, according to many Researchers. World Economic Outlook
(WEO) report from the International Monetary Fund (IMF) stated that Indias growth rate is set to further outstrip
Chinas in 2016 with the gap between the two economies expected to widen to over 1%. The Financial Times report
said that Indias Growth rate has surpassed both China and the U.S. as the worlds top destination for greenfield
foreign investment, and a simultaneous 16-place jump in the World Economic Forums global rankings for
competitiveness. However few researchers doubt the impressive India's headline growth rate and say that it is
partly the result of changes to statistical methods that seek to capture more evidence of economic activity.
Few reports on Global economy warn that instability and slowdown in the world economy can also affect India.
IMF warned that downside risks such as a sharper-than-expected slowdown in Chinas growth, tighter global
financial conditions as the US exits from an easy monetary policy, a sudden rise in global risk aversion and an
escalation of current geo-political tensions could derail the slow global economic recovery.
Dr. Raghuram rajan says that the Chinese slowdown is a concern for the whole world. There is a lower demand for
some of our exports to China. But indirectly too, many of the countries are not exporting to China as much as they
did and they are buying less from us, But India being a commodity importer, has been helped a bit by cheaper
commodities. Chinas slowdown has impacted global growth and India is very well integrated into the global
economy.
Commerce Minister Nirmala Sitharaman rightly points out, "It is a worrying development as it will make imports
from China cheaper and our products more expensive." Slowing down of economy in China will also create excess
capacities, leading to increased dumping of cheap products from China.
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Section II: Impact of China slowdown on India

Chinese slowdown can impact India through various direct channels like trade, investment and indirect channels
like lower commodity prices, financial volatility and higher economic uncertainty.
Trade with China
Indias trade with China has increased over the years as China emerged as its largest trade partner replacing US
since 2008. Total trade (Export plus Import) with China has increased 5.7 times to $72.4 billion in FY 2014-15 from
$12.7 billion in FY 2004-05. Interestingly while India maintains a trade surplus with USA, its trade deficit with
China has been widening significantly over the years (table 1). Its trade deficit with China has reached an
unsustainable level of $48.5 billion in FY 2014-15, with imports from China being more nearly five times of Indias
exports to China.
Table 1: Trend in trade with China

Source: CMIE database, CPR research

Indias export basket to China consists of primarily resource based products including chemicals, raw cotton,
petroleum products and spices. Considering slowdown in Chinese growth rate, the demand for such products may
decline as had already started in FY 2014-15 when Indian exports to China fell by 20%. They are also down by a
whopping 25% in the current fiscal year (April to December 2015). In contrast, Indias imports from China grew at
healthy 18% in FY 2014-15 and remain in positive territory even during the current year. This divergent behaviour
has brought the trade deficit with China in sharper focus.
Indias trade still remains less vulnerable to Chinese slowdown as first, Indias services exports remains at 50% of
overall exports (merchandise and services) to the world and Chinas presence in $235 billion (inflows plus outflows)
services trade is miniscule. Second, Indias exports to China represents only 3.9% of total exports to the world while
its import from China has a higher share of 13.5% in its total imports of $447 billion in FY 2014-15.
Investments from China

Chart 4: Chinas FDI investment in India

China has been slow in investing in India.

Its cumulative investment by end 2014 stood at mere
$500 million over a period of 14 years, even less that
invested by Poland, Malaysia or Canada. Chinese
President Xi Jinping, in his last visit, announced an
investment of $20 billion over next five years.
Source: DIPP, CPR Research
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Since then, its cumulative investment till September 2015 has increased to $1.2 billion still very minimal in total
stock of $392 billion cumulative FDI inflows into India.
Unlike its investment history in India, China has been

Chart 5: Chinas trend of FDI investment

investing significantly in other countries. It has been

reported by UNCTAD (United Nations Conference on
Trade and Development) that China was the third biggest
source of foreign direct investment in 2013, having
invested more than $100 billion in other countries. In the
eleven years to 2015, it invested more than $683 billion in
different countries in the world including India.

Source: China Global Investment Tracker, CPR

Research

There are many reasons for low FDI flows from China to India. First, the political trust deficit between the two
countries, with some Chinese companies under government scanner, has hampered easy flow of investments
from China. Second, Chinese investment in other countries has been traditionally focused on acquiring natural
resources to boost its economic growth like its investment in oil, natural gas and coal sectors in Africa, Australia,
Indonesia etc. These investments were part of its strategic priority. India, being a major importer of these
resources, did not attract Chinese investments. Third, China has been slow in recognising the importance of Indias
market while India too has been slow in attracting Chinese investors. Fourth, Chinese firms do not have the
adequate support networks.
Indias infrastructure sector, with its massive investment needs, can be the natural destination for Chinese
investments. China has excess capital along with the expertise for developing large infrastructure projects both at
home and abroad. On the other hand, India is infrastructure deficient. Investment in Indias infrastructure can be
the basis of stronger relationship between the two major neighbouring economies.
Impact of lower commodity prices
The slowdown in China has resulted in a sharp fall in commodity prices. India, being the major importer of oil and
other minerals, has benefited from softer oil and commodity prices. First, lower oil price has helped in reducing
Indias import bill that narrowed the trade deficit. This has brought the current account deficit (-1.6% of GDP as on
September 2015) much lower than sustainable level of 2.5% reducing external vulnerability. Second, fiscal deficit
target of 3.9% of GDP for FY 2015-16 will be met as lower oil prices have reduced the oil subsidy payment (with oil
price deregulated) and higher excise duties on petrol and diesel have significantly increased indirect tax collection
that will more than offset any shortfalls in direct tax and disinvestment target. Third, lower commodity prices
helped bring retail inflation (CPI) within the RBI target of 6% by March 2016 and central bank responded by
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slashing policy rate by 125 bps since last year. Overall, softer commodity prices have helped improve macro
stability of India. Fourth, lower raw material and oil price helped corporates to improve their profit margins.
However, lower oil prices have slowed the growth of remittance flows to India. The World Bank reported that
India, the largest recipient of remittances, received an estimated $70.3 billion or nearly Rs. 4.5 lakh crore in 2014.
According to the Reserve Bank of India, about 35% of these remittances to India originate in in the GCC countries.
Lower oil prices along with real appreciation of the rupee, has resulted in slower growth of 0.6% in 2014 as
compared to 1.7% in 2013. Going forward, continued low oil prices could further reduce remittance flows from the
GCC countries. This can be a major impact as in the past, remittances have surpassed foreign direct investment
(FDI) flows over the years, financing about 47 percent of the merchandise trade deficit in FY 2013-14.

Section III: Empirical Evidence of the Impact of China on India

We tried to look at the impact of China slowdown on global trade, growth, financial volatility (vix index), bond
spread, oil price etc. We found significant direct impact of China slowdown on these indicators.
We estimated that the long-run elasticity of Indias GDP growth to Chinas GDP growth is about 0.4, meaning that
a 0.5pp decline in Chinese performance could shave off 0.2pp from Indias growth. The same elasticity is slightly
higher for industrial production. However, in the short-run, the effect could be amplified by the interaction of
many factors. One way to take into account these is to estimate an extended single-equation regression as follows:
log(GDPt_India) = c + a1 log(GDPt_China)+ a2 log(Oilt_basket)+ a3 log(IPt_World)+ a4 log(ERt_(INR,USD) )+ a5
Dummyt_(2008-09) + e
Where all variables are taken at quarterly frequency between 2000 and 2015 and are expressed in terms of their
YoY growth rates. Variables used are Indias GDP, Chinas GDP, Indian oil basket, World industrial production,
Exchange rate (INR and USD). The dummy has been introduced to take into account the financial crisis period.
As expected, we found that Chinas GDP and global industrial production have significant positive co-relation with
Indias GDP growth whereas crude oil prices and the exchange rate have significant negative co-relation.
Using this simplified setting, we empirically conducted a scenario analysis and found that a 50bp (permanent)
decrease in Chinas growth (which we termed as soft landing) will cut Indias growth by 30bp at first while the
effects vanish over the long run. In case China slows down by 150 bp (termed as hard landing), Indias GDP growth
could fall as much as 80bp. However, things could get much worse for India if the rupee devalues to above 80
INR/USD at the same time. (Note: tables of the regression will be published in forthcoming paper)
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Section IV: Conclusion

India cannot replace China as global growth engine in the short run as Indias GDP is just over $2 trillion, mere
one fifth of that of China. So, even if India grows faster than China, the magnitude of the impact on world
GDP will be much smaller.
China has emerged as the largest trading partner of India since 2008. However, Indias trade still remains less
vulnerable to Chinese slowdown directly because Indias services exports account for as much as 50% of
Indias overall exports (merchandise and services).
Chinas total FDI investment in India has been miniscule - $1.2 billion till September 2015. But Indias
infrastructure sector can be the natural destination for Chinese investments.
India reaped the indirect benefit of lower commodity prices in terms of narrower CAD, softening inflation,
lower interest rate, increased government fiscal bonanza, all of which contributed to greater macro-stability
in India.
Any financial stress due to Chinese Renminbi depreciation would also negatively impact Indias capital
markets and could result in capital outflows as investors confidence in emerging markets takes a knock
A 50bp declinein Chinas growth rate is likely to lower Indias growth by 30bp in the short run. In case China
slows down by 150 bp (hard landing), Indias GDP growth could fall as much as 80bp.

We acknowledge the contribution of Mr. Andrea Furgeri, Financial attach, Bank of Italy and Embassy of Italy in New Delhi.

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