Eurozone Crisis:Impact on Chinese & Indian Economy

The Eurozone Crisis Impact on Chinese & Indian Economies 1

The Eurozone Crisis

Impact on Chinese & Indian Economies

Author: Ashish Jude Michael Participant PGPEx2012

(OUC China +IIM Shillong )

2 The Eurozone Crisis Impact on Chinese & Indian Economies

Table of Content Executive Summary 1.1Eurozone Crisis: Brief Introduction 1.2Eurozone Crisis: Major Attributes 1.3Eurozone Crisis: Effect on European Economy 1.4Eurozone Crisis: Effect on Global Economy 2.1 Chinese Economy: Brief Introduction 2.2 Chinese Economy: Under Eurozone Crisis 2.3 Chinese Economy: Actions Taken 2.4 Chinese Economy: Suggestions 3.1 Indian Economy: Brief Introduction 3.2 Indian Economy: Under Eurozone Crisis 3.3 Indian Economy: Actions Taken 3.4 Indian Economy: Suggestions 4.1 Conclusion:

Exhibits: 1-‐18 Bibliography


Executive Summary This report is about the Eurozone crisis and how emerging economies such as India & China should deal with it and also what they should learn from this crisis. I have divided this report basically into four parts; first part gives the history, detail & analysis of Eurozone crisis. Second part I have explained briefly about Chinese economy, how Eurozone crisis has affected its economy, what are the action taken by government and suggestions. In third part I have discussed about Indian economy on similar lines and finally I have concluded in part four.

Eurozone crisis is not a single economic recession, which we have faced; in recent past but it is actually one of the event in the chain of events of what economist commonly say “ Global Financial Crisis”. The table below shows the events, which hit the global economy during last 5 years.

2007–2012 Global Financial crisis

Major Events

• 2000s energy crisis • 2008–2012 global recession • Automotive industry crisis of 2008–2010 • Dodd–Frank Wall Street Reform and

Consumer Protection Act • European sovereign-‐debt crisis • Financial Crisis Inquiry Commission • Subprime crisis impact timeline • Subprime mortgage crisis • United States housing bubble • United States housing market correction

1.1 Eurozone Crisis: Brief Introduction European union trace back its roots in 1951 with the “Treaty of Paris” with about 6 members. Now is a economic &political union of 27 countries of Europe. It having about 20% of global GDP as per PPP (Purchasing Power Parity). It introduced a common currency Euro in 2002.The 17 countries accepted Euro as their currency and these 17 countries formulate the “Eurozone” .Soon Euro became second most traded currency of the world just behind USD (United State Dollar). Year 2010 saw onset of European Sovereign Debt Crisis which is commonly referred as Euro Zone Crisis. There are four major causes for this crisis. First the rising government (public) debts. The stability of a country can be determined by the percentage of the government (public) debt to its GDP. (Exhibit 1) clearly shows that the relative position of major countries. We can see that Greece is already is in a very bad condition as its public debt is 436 billion $ which constitutes to 143% of its GDP, next to follow are Italy,Ireland ,Portugal ,&


Spain with figures of 115%, 95%,93% and 60%. Though Spain appears better in this situation but in next cause we can observe the problem faced by Spain. Second cause is the rise in trade imbalance. If we see Exhibit 2 we can see that In terms of % of GDP Portugal, Iceland, Greece, Spain and Italy are having figures of -‐9.9%, -‐7.1%, -‐6.5%, -‐4.7% and -‐3.3% respectively. Only Germany is the country which have a positive trade balance of 6.7% hence is one of the strong economy. Third cause is structure of Eurozone. The concept of Euro has structural problems. It has a monitory union but not a fiscal union. For stability of a currency system the member countries should follow same fiscal path but they have no common treasury to enforce them. Each country is free to follow its fiscal policy. It happened in the case of Greece, it was hard to control its national institutions. Lack of quick response, if any decision has to be taken by Eurozone all 17 member countries have to be unanimous and this takes lot of time. Lack of “Banking Union” common for Europe to avoid “bank runs”. Fourth cause is monitory policy inflexibility a member country cannot print the money to pay to debit holders also ECB (European Central Bank) has inflation control mandate not unemployment mandate and the Loss of confidence of Investors in affected countries is worsening the crisis. 1.2 Eurozone Crisis: Major Attributes Earlier I have already discussed the major causes for the Eurozone crisis now I will be doing a sort of microscopic analysis of the attributes, which set these causes. There are 6 attributes, which have played an important role in setting the causes, which in turn created the Eurozone Crisis. The developed economies have accumulated sizeable deficit while the developing countries have large surpluses.ie. China. This made the developing countries (China) to finance the developed ones (U.S.). Instead of blaming developing countries for saving rather than over spending developed countries should learn to manage their spending’s. Developing countries measure their creditability by the amount of foreign reserve they poses where else that is not the condition for developed countries. It appears that the general trend was that if GDP is sizeable and though a developed country is running on deficient, banks and investors took it for granted before studying the basics of investments. There were different rules for developed and developing economies and this may be one of the attributes. Second attribute is protectionism and in adequate financial help to poor countries. For example protectionism measures deeply penalize poorer countries that rely on a restricted number of export products ie. Crops and minerals. Third attribute is Loss in competitiveness, Germany had improved in competitiveness in terms of changes in unit labor cost but Greece, Portugal Ireland, Italy and Spain lost it. Fourth attribute can be the lack of cross border financial supervision and lack of fiscal policy coordination. Fifth attribute is the difference in productivity among Eurozone countries if we compare with GDP per hour worked we can see that countries like Slovakia, Slovenia, Portugal and Greeece are below 30 per hour worked and France, Belgium and Ireland have 50 Per hour worked . (Exhibit 3)


Sixth attribute is the rice in Gini index which shows the income disparity. The gap between rich and poor is increasing the top five countries where Gini index is maximum in Europe are Portugal, Greece, Italy, Spain and Ireland.(Exhibit 4) 1.3 Eurozone Crisis: Effect on European Economy The European economy has contracted by about 0.3% in 2012 and is forecasted to grow by 1% in 2013 similarly the unemployment rate is in 2012 is 11% and is expected to be 10.3% in 2013. (Source BBC).Bujt one important factor is the rise in unemployment in the young population , it is at the highest level. (Exhibit 5 & 6) 1.4 Eurozone Crisis: Effect on Global Economy Eurozone crisis is not just affecting the economies of the17 member countries or European countries but all the countries from US, China to African countries. Eurozone is a big market for US, China and India the slowdown in Eurozone will slowdown the economies or related countries too. If the Euro collapse it will not only affect 322 million Europeans but also 150million African countries whose currency is pegged to Euro. Also the world financial system will collapse as many major banks hold large amount of Euro. This may bring an economic recession worse than what world had experienced in 2007. 2.1 Chinese Economy: Brief Introduction China is currently is second largest economy of world having a GDP of 11.29 Trillion United States Dollars (USD) as per Purchasing Power Parity (PPP). Its economic reform started in 1978 and since then it is progressing with an average GDP growth rate of 10%. Its had developed it self as the factory for the world. If we consider the sector wise break up of Chinese Economy agriculture: 10.1%, industry: 46.8%, services: 43.1%. The Industry and Services are balanced but agriculture is very less.

It has become an export-‐oriented economy with surplus in terms of balance of payment. It has a foreign reserve of more than 3 trillion USD. And it is forecasted it will take over US by 2020. When we consider China economy it is keenly observed & controlled by government there are nearly all large-‐scale business and banks are SOEs (State

Sectorwise break-‐up of Chinese Economy

Agriculture

Industry

Services


Owned Enterprise) while medium to small-‐scale industry are dominated by private players. Till now china has protected its domestic companies from foreign competitors. China initially started as a location for low cost labor but with economic growth that advantage is decreasing also the rise in the older population is a concern. China is now concentrating its focus on more sustainable industries such as services & R&D. Also 11th 5 year plan has laid emphasis on environmental aspects too. Another concern for China is the rise in income disparity among earning population. We should appreciate the commitment that the Chinese political leaders have towards economic growth. Since 1978 they have achieved all major 5 year plan targets. They have industrialized, developed infrastructure and acquired skill sets for human resource for sustaining this growth weather by sending people outside for studies or by developing Chinese education system. We can say China is a much healthy economy as the government debt to GDP is about 25% (Exhibit 7), Balance of trades is always surplus (Exhibit 8) and the unemployment rate is low about 4.1%(Exhibit 9). Another major challenge, which China is facing, is the increasing disparity in income level. It has a GINI index of 45% (0.48), which can be said alarming. Initially China approached the theory of “Let some people get rich first” this has given rise to such disparity. The costal provinces are very developed as compared to the central provinces. The recent conflict arising with Japan related to Diaoyu islands may also slow down the economy further, Japan being major trading partner for China. 2.2 Chinese Economy: Impact of Eurozone Crisis As we know that China is basically an export-‐oriented economy and if we see the statistics its major export partner is Europe, it accounts of about 17% of Exports and 8% imports. We can say the Chinese economy is highly dependent on European market. Any slowdown in Eurozone will affect Chinese economy. We have seen it during Eurozone crisis when the growth rate of China felled below 8% mark in months in 2012 and Chinese government has revised real GDP growth rate at 7.5%.

If we see in above graph there is a significant slowing down of Chinese economy with the onset of Eurozone crisis. Also there is a problem of increase in inventory for goods as the demand in EU has reduced but production in China haven’t. This has created problems for stockiest and dealers. FDI in China has also reduced by 3.7% over all and 4.1% from EU this year and it is attributed to the Eurozone crisis. Yuan is appreciating but there is no problem of Unemployment though orders have reduced and industrial production has


slowed down seen due to the crisis. Also the balance of trade has taken during start of 2012 and also the unemployment rate was nearly fixed around 4% mark. 2.3 Chinese Economy: Actions Taken In order to fight the slowdown and to take advantage of Eurozone crisis China has taken following steps:

1. Focus has been diverted to Africa and development of African & Emerging economies.

2. China is investing directly or indirectly in Europe on the principle “Recession is the best time to invest”. China’s direct investment in Europe soars up in second quarter of 2012 by more than 67% as compared to last year.

3. China is ready to support or even bailout countries like Greece and bailing out Europe but surprisingly major Chinese are back away from European lenders it appears as a paradox.

4. China has cut down the interest rates in May 2012 to boost up industrial activity.

2.4 Chinese Economy: Suggestions

1. China should increase its domestic consumption for GDP growth rather than wholly dependent on exports.

2. China should diversify its exports to developed as well as emerging and underdeveloped countries so that it can reduce the risk of induced economic slowdown. China has already started this activity by focusing on Africa.

3. China should increase its investment in Europe and they are already implementing it.

4. China should try to stabilize and if possible bail out Europe so that its economic growth is not affected.

5. China should not follow the western/European model of spending on deficient.

6. China should focus more towards services rather than industry as it is slowly losing its advantage of low cost labor hub.

7. China should focus in reducing its GINI index of 48% is a bit high. Chinese government is already on action; it has stopped the special benefits & tax holidays, which were earlier given in costal provinces. Instead they are encouraging foreign companies to set-‐up their plant in central part of China by granting them special benefits and tax holidays.

3.1 Indian Economy: Brief Introduction Indian economy is fourth largest economy of World with a GDP of 4.457 Trillion USD as per PPP. After China it is Indian Economy on which on rapid growth among emerging economies. It is an economy based on services. It is also seen as a lucrative market, which is highly dynamic. If we consider the break up of Indian Economy sector wise Agriculture is 17.2%, Industry is 26.4 % and services constitute 56.4%.


We can observe that the Industry and services are not in balance. It is becoming a service hub. Especially IT & BPO (Business Processed Outsourcing) services. India is facing the problems of Government debt and maintains balance of trade. The Government debt is about 68.53% of GDP (Exhibit 13) and balance of trade has always been in deficit (Exhibit 14). Major portion of import, which India has, is crude oil. Even the foreign reserve, which India has, is not too much. Its about 328 billion USD. The major trade partners for India is EU followed by China. India has maximum trade deficit with China. The unemployment rate has sharply reduced to 3.8% from 9.4 %(2010) (Exhibit 15). This is a good sign as the period of Eurozone crisis when west is facing high unemployment rate India’s unemployment rate has reduced by one third. If we consider the industry structure the heavy industry are dominated by SOEs but they all are now opened for domestic private players so that the monopoly of SOEs can be removed and the competition will allow SOEs and private players to improve. If we compare to China, Indian government supports entrepreneurship most, and then the JVs with foreign players. The philosophy behind this is that a small or medium scale enterprise started by an entrepreneur provides much more employment, the profit earned by that is distributed to many individuals rather than in a JV where the share of profit goes out to foreign firm. India is still relatively closed to China when it comes to FDI(Foreign Direct Investments) still there are many sectors where FDI is either restricted or very less. To boost its economy India can open the sectors and this can attract foreign investors. India has a major challenge of keeping economic growth with politics. As compared to China where stern decisions can be taken by government for economic development of country in India this is not the same case. There have been major cases for example the land acquisition case for POSCO (Korean mining giant) or opening of FDI in retail. If we compare to GINI index, which is 38% (0.38) for India, which is marginally better than, China but still it should be ideally controlled below 35%(0.35). 3.2 Indian Economy: Impact of Eurozone Crisis Indian economy is much more venerable than to China to Eurozone crisis. One of the reasons is services sector (IT), which is concentrated on US and Europe. Because of the crisis many major European projects have been paused while new are not released. Though in some cases Eurozone can be considered beneficial for India, for example the reduction in unemployment rate from 9% to about 3.8 %(Exhibit 15) during Eurozone crisis is due to the factor that many European

Sectorwise break-‐up of Indian Economy

Agriculture

Industry

Services


firms are improving their bottom line by cutting down their expenses. They are outsourcing many jobs related to (BPO) to India where low cost, skilled labor is available.

From the above graph we can see that the GDP growth has fallen below 6% mark though it is increasing now. Government of India has reduced the GDP growth target for year 2012-‐13 from 7.5% to 6.5 %. This can be attributed to the slowdown caused by Eurozone crisis. Europe is biggest trading partner for India. With exports accounting to about 19% and imports about 14% . Even though the exports to EU have sill been positive Exports growth 30% & Import Growth 16 % approx., the fear of crisis deepening threatens India.

FDI investment inflow has increased by 34% this during year 2011-‐12 as compared to year 2010-‐11. Though the FDI during 2011-‐12 was about 46.48 billion USD which is nearly one fourth of China’s FDI inflow. And the FDI inflow during first few months of year 2012-‐13 is 19.5 billion USD as compared to 7.1 billion dollars last year. The FDI condition doesn’t look bad at present but if this crisis deepens then it will be tough for India to attract foreign investors. Meanwhile the FDI outflow towards Europe has increased specially Indian IT firms. But still India is not figuring among top 10 countries investing in Europe where else China is among them. The free fall of rupee against USD is a major concern for Indian Economy. This causes the Oil deficit for the country to pile up. Government has taken some stringent actions to arrest this.


3.3 Indian Economy: Actions Taken In order to avoid economic slow down Indian government has taken following steps:

1. The export focus has been shifted from western countries to emerging economies. Indian government encourages domestic companies to export to African countries. This may be one of the reasons that even during the Eurozone crisis Indian exports are not hit much.

2. Decision to open FDI upto 51% in multiband retail is the way of government to attract foreign investors in India and ensure that flow of FDI is continuous.

3. Reduction in interest rates. During February & March 2012 the industrial growth of India was at standstill to boost it government decreased the interest rates.

4. In order to reduce the government deficit it has reduced some subsidies on Oil & Gas products.

5. For boosting service sector government has encouraged foreign firms to set up their R&D facility.

3.4 Indian Economy: Suggestions

1. India should focus on emerging economies rather than developed countries for exports as recent economic crisis has proved that western economic models are not sustainable.

2. India should reduce its spending as the deficit in terms of GDP is high about 68% though it is continuously decreasing from past 5 years.

3. India should spend more on basic like primary & secondary education this will generate more skilled manpower required for service sector.

4. Competitiveness of SOEs should be improved which government has already done by allowing domestic players in many sectors such as defense production.

5. Indian firms should diversify in Europe as during recession, as it is the right time to invest and they have capital to invest.

6. India should try to reduce the balance of trade by exporting services to emerging economies as well.

7. India should make some strong laws regarding land acquisition, which is a concern for many FDI investors.

8. India should try to attract FDI in infrastructural projects. 9. India should develop some alternative such as biofuel, which can reduce

its dependency on crude oil, which at present covers about 40% of its total imports.

10. India should market its handicrafts, tourism and traditional medication more aggressively. They can earn a lot of foreign currency and improve standard of living of masses, which in turn increases domestic consumption.

11. Sustainable development should be preferred rather than the rapid and unsustainable growth.

4.1 Conclusion: In conclusion I will like to say that Eurozone crisis is the outcome of an unstable economic structure. In order to boost consumption people and


government were encouraged to spend on credit. And this credit comes as a loan from future and when it reaches its tipping point we find ourselves in recession. Bubbles are formed when virtual(fake) demands are created for short period of time these bubbles can act as a catalyst but they always burst into recessions. Hence I would say for a sustainable development should always take the middle path, which is also said as the “Mean way” according to Confucianism. Eastern economies still follow the same and now its again the west looking towards east for solutions and the sustainable structure of economy. Savings may be a new term for west but it is built in value in eastern culture. I still regard Korean model of development much better than the western model. Collectivism is any day better than individualism otherwise we will be seeing “Occupy Wall Street” movements and economic crisis very often. I think this is the right juncture to think and act, when the fast developing economies should come out from the rat race of GDP growth but focus on sustainable development. One of the reasons that India and China were not hit much in previous recession was because they had taken the “Mean way” for economic liberation.

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Exhibit 1

Exhibit 2


Exhibit 3 GDP per Hour worked 2008

Exhibit 4

Gini’s Coefficient (as %)

Exhibit 5 Unemployment in EU


Exhibit 6 Unemployment Young population

Exhibit 7

China Government Debt to GDP.

Exhibit 8 China Balance of Trade


Exhibit 9 China Unemployment rate

Exhibit 10 Trade of Goods EU with China

Exhibit 11 Trade of Services EU with China


Exhibit 12 FDI EU with China

Exhibit 13 India Government debt to GDP (%).

Exhibit 14 India Balance of Trade


Exhibit 15 India unemployment rate

Exhibit 16 Trade of Goods EU with India

Exhibit 17 Trade of Services EU with India


Exhibit 18

FDI with India by EU.


Bibliography 1. The Lessons of the Eurozone Crisis that should shape the EUs G20 Stand

by Yannos Papantoniou Former Economy & Finance Minister of Greece. 2. The Euro Debt Crisis and Its Impact on the World By Julian Knight 3. BBC Business 4. Eurostat 5. Market watch 6. Financial news 7. WTO 8. www.tradingecomomies.com 9. The Economic Times 10. www.publicserviceeurope.com 11. Wikipedia