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Shanghai's little secret

June 30, 2003

Take a cruise down the Huangpu river in Shanghai, and it doesn't take long to feel humbled. On your left, as you head out towards the sea, are beautiful and well-lit Victorian-style buildings, of the type you see in Mumbai (so there's no problem, so far!).

But on your right, in the Pudong Special Zone, is the most amazing array of gigantic skyscrapers (the MOFTEC building has 88 storeys), often with the most curious designs, that make even the Manhattan skyline pale in comparison. A wistful sigh escapes your lips, and it's natural to think India's been left far behind.

Add to this, the huge highways (by the way, all Communist countries, including Russia, build huge roads to display their power, even to facilitate the tanks rolling in!), the massive exports, the high economic growth, and it is difficult to see how a country like ours can even begin to compare herself with China.

That said, and one has to be both blind, and stupid, not to recognise China's stupendous strides, it is useful to get some perspective, if only to understand what parts of the China story can be replicated.

First, most of us think the glitzy buildings have been built by private sector entrepreneurs who see great economic prospects, in the same way that builders like DLF are constructing those huge shopping malls in Haryana's Gurgaon area, to meet the shopping needs of all those call-centre and BPO-type professionals.

While it is true that private-sector entrepreneurs are building these 'skycutters' ('scrapers' doesn't quite do them justice), most of the funds really come from the Chinese government -- state-owned banks are asked to give loans at sub-Libor rates, and given the fifty per cent or so level of occupancies in most buildings, even the principal very often doesn't get repaid.

In other words, this is classic government-expenditure led growth, and funded in a manner that it doesn't look like the money is coming from the budget -- but in the bargain, banks have got saddled with huge non-performing loans, believed to be equal to half their total lending, and eventually it is the government that will have to pay for this.

Between 1998 and 2000, for instance, the government spent $55 billion on infrastructure projects and encouraged banks to lend without restraint to loss-making state owned enterprises. As any economist will tell you, such huge and mounting bad loans are a sure-fire recipe for disaster.

Even the most outrageous China-lover recognises that China's banking sector's health remains very touch-and-go. When nobel laureate Milton Friedman, a great supporter of the early reforms, came to China in the late 1990s, he said of Shanghai's Pudong Special Zone, "The city is not a manifestation of the market economy, but a statist monument for a dead pharaoh (Deng) on the level of the pyramids."

Another point worth keeping in mind while discussing the huge foreign investments that continue to pour into China, is that few of them are making any money. A survey of 229 foreign-owned businesses by management consultants A.T. Kearney in 1998 showed only 38 per cent were able to cover even operating costs.

In 2002, to cite just one example, General Motors had invested $2 billion in auto parts and vehicle manufacturing, but according to Joe Studwell in 'The China Dream', the management was, after extensive re-tooling, hoping to raise sales of three cars to just 60,000 units a year -- the company's Shenyang plant, in fact, remained closed for six years till 2001 for a variety of reasons.

China, of course, will deal with its problems in its own way. And if its focused approach in the software sector is any indication -- tens of thousands of English-language teachers were imported, and scores of universities/institutes were set up overnight to create software engineers -- it may, just may, find a way out of the current crisis.

The question, however, is whether, and how, India can catch up. Though this looks near impossible when you're mesmerised by the pace at which buildings come up in Pudong, the path ahead may not actually be that tough.

Take manufacturing, which is seen as China's strength, and India's Achilles heel -- according to a CII-McKinsey study, average Chinese manufacturing prices are around 30 per cent lower than Indian prices.

Well, according to the study, highertaxes (such as import and excise duties) account for about half the difference between Indian and Chinese prices. Higher costs of capital add to another 5 to 6 per cent.

Reducing tax levels and interest costs isn't something that should be too difficult to do, indeed fairly good progress is already being made in both areas. This, and very aggressive restructuring by India Inc., in fact, has resulted in a situation where Ficci-CII no longer cry wolf each time they see a dragon, something they were doing till two years ago.

Equally encouraging, some state governments, such as the one in Karnataka, are aggressively engaged in computerising land records -- once the question of land title is settled, since the majority of Indians will then be able to get loans against the land they own, you can imagine how this will stimulate the economy.

Other states are lowering and rationalising stamp duties on real estate transactions -- together, both moves are expected to give a big fillip to the real estate market, and maybe add a vital percentage point to GDP growth.

Of course, even getting these small things done will take a lot of effort -- the comparatively simple VAT legislation has been put off three times already, lowering of interest rates also appears to have hit a roadblock with the government unwilling to increase the pressure on the banking sector, and considering waffling is taking place on labour reforms for three years now.

But the path ahead is clear: India can move up with a bit of effort, while China has lost a fair amount of its growth momentum

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