ABN AMRO - Chindia

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CHINDIAA tale of two giants

ABN AMRO

Emerging Market Analysis & Multilateral Organisations

Serdar Kkakn

Swe Thant

May 2006


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May 20062

Table of contents

Introduction 3

Chapter 1: China and India in the global economy 5

Chapter 2: Competitive issues 10

Chapter 3: Infrastructure 13

Chapter 4: International relations 16

Chapter 5: Trade and FDI opportunit ies for the Netherlands 22


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May 20063

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 two countries 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 be remembered 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, in terms of demographics,

education, labour market flexibility, capital formation and infrastructure, the twoeconomies 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 potential growth 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 is experiencing 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 inChina. Now it looks like India is the next hot spot when it comes to attracting FDI.

However, to become a really attractive location for foreign 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 sector continues 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 Chinas.

Apart form such economic differences a major difference between the two

countries is of course in their political 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 member of the UN Security Council, traditionally has had a hand in

world politics. India, on the other hand, lost its traditional role in the international

political arena when it lost its position as a leader of the movement of non-aligned


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May 20064

nations at the end of the cold war. It is redefining itself as a regional power with

global aspirations.

Last but surely not least, the economic development of the two countries, which is

set to go on for the foreseeable future, offers enormous possibilities for the

Netherlands in terms of FDI and trade. Looking at past trends and extrapolatingthese to the future it seems that India is the more promising of the two emerging

markets offering better opportunities for trade and investment for Dutch

companies.


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May 20065

Chapter 1: China and India in the global economy

This chapter looks at the impact of China and India on the global economy. The

two countries have made a grand entrance on the world stage.

Contribution to trade and global growth

In the last two decades, foreign trade of China and India has grown at a

considerably higher pace than the world average of 7.3%: 17.3% and 10.9%,

respectively. Especially so for China, whose trade has grown at more than twice

the global rate since the country embarked on economic reforms in 1978. Indias

foreign trade jumped to an average of 13% after the country started its reform

process in 1991.

The composition of China's exports has changed significantly over the past

decade. Despite the public attention last year following the end of the Multi-Fibre

Agreement on Textiles and Clothing, the share of textiles in Chinas total exports

has fallen from nearly 24% in 1997 to 15% in 2004. Conversely, exports of 'highand new technology products' have risen from less than 15% of the total in 2000

(the first year for which data on this category are available) to nearly 28% in 2004.

China's trade balance in these products has changed from a deficit of USD 17

billion in 2001 to a surplus of USD 4 billion in 2004.

The composition of India's merchandise trade has changed much less than that of

China. Textiles and garments still account for 22% of total goods exports, and

gems and jewellery for nearly 18%. These proportions are virtually unchanged

from a decade ago. High-tech products account for just 5% of India's

manufactured exports, compared with 28% for China. For all the world-wide

attention that the sector has attracted in India, it is worth noting that China's

exports of commercial services, other than transport, travel, finance and insurance

(the residual in which IT services are included in internationally comparable

statistics), totalled USD 20.6 billion in 2003, compared with India's USD 18.9

billion.

Meanwhile, on a purchasing power parity basis (PPP), GDP for China and for India

has climbed to around 65% and 30%, respectively, of US GDP in 2005. In

comparison, both countries registered around 15% in 1980. Although China

accounts for only 14% of world GDP it has directly accounted for 28% of the

growth in global GDP during the past 15 years, a figure which is significantly higher

than the 19% contribution of the US Since India started its reform process at the

beginning of the last decade, it contributed 6.5% to world GDP growth.

During 1980-2005, growth rates for China and India comfortably outpaced theworld average. Since 1991, Chinas growth rate never dropped below 7.6%.

Furthermore, since the beginning of this millennium, the difference between the

world average and that of the two countries even increased, with the gap between

Chinas and global GDP growth peaking in the first half of the 1990s. During 1991-

1995, Chinese GDP growth averaged almost 13% a year, nearly 10 percentage

points above the global average.

India, and, especially, China are typically viewed as powerful export machines,

taking growing market share and acting as deflationary forces on global activity.

Foreign trade

% global trade

0

1

2

3

4

5

6

7

1982 1988 1994 2000

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

China (l.a.) India (r.a.)

Total GDP

% US GDP

0

10

20

30

40

50

60

70

1980 1986 1992 1998 2004

15

18

21

24

27

30

33

36


The calculations are based on the PPP standard


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May 20066

However, these countries are also huge importers, to the benefit of many

countries. For example, although Chinese commodity imports have attracted much

attention recently, the value of imports of machinery and electrical equipment was

about twice the size of that of imported primary products in the first half of 2005.

China is, in fact, a very open economy with foreign trade accounting for 68% of

GDP compared with 28% for the US. By comparison, the Indian economy is stillrelatively closed, being driven more by internal demand. Nevertheless, Indian

foreign trade also increased considerably since the start of the reform process in

1991, especially after the boost from trade liberalisation at the start of this

decennium.

The industrialization of the two Asian giants will continue to generate growing

domestic prosperity and, thus, increased demand for a growing range of goods

and services, from automobiles to tourism. Moreover, this trend is still at a very

early stage. The strong growth in India and, especially, China is having a

particularly large impact on the Asia region. For example, China's imports from the

rest of Asia have increased at a considerably faster pace than imports from other

areas, leading to growing intra-regional trade dependence.

Thus, the development of China and India may be seen as a positive force for the

world economy. The rapid growth of the two Asian countries has provided an

important stimulus to the global output at a time when the industrialized countries

were experiencing difficulties.

However, there is a powerful body of opinion that sees India and, especially, China

as threats rather than as benefits to the global economy. This is particularly so

from the perspective of industries which are at the sharp end of Chinese

competition. The pressures of Chinese competition became apparent when the

global multi-fiber agreement ended at the start of 2005, thereby removing quotas

on trade in textiles and clothing. India is somewhat of a different story. So far,

Indian competition is felt, not through the exports of goods, but rather through the

IT sector. Because of its high quality and low prices, the sector is attracting many

foreign companies, which outsource their IT activities to India.

It is easy to identify lost jobs from displaced local production due to Chinese

imports, but it is hard to measure increased consumer purchasing power due to

lower-priced goods. However, it should be recognized that this purchasing power

gives consumers more money to spend on other goods and services, some of

which will benefit domestic companies. The bottom line is that free trade raises

real incomes and growth and, therefore, China's membership in the global

economy is a positive force.

Where are China and India on the development curve?

It is important not to confuse the growth in the size of the two economies with their

relative living standards. China's GDP may well overtake that of the US in overall

size in the next 10 to 15 years and Indias GDP will reach half the size of the US

economy in the same period. However, the GDP per capita is still very low by

global standards: around USD 6.270 last year on a PPP basis in China and USD

3.420 in India (or around USD 1.577 and 677 before adjusting for PPP). In other

words, it will be a very long time before per capita incomes catch up with those of

the developed countries.

Foreign trade

% GDP

10

15

20

25

30

1990 1994 1998 2002

20

35

50

65

80

India (l.a.) China (r.a.)

Chinese imports

USD billion

0

100

200

300

400

500

600

1985 1989 1993 1997 2001

Indian imports

USD billion

0

25

50

75

100

1985 1989 1993 1997 2001

GDP per capita

% US GDP per capita

3

6

9

12

15

1980 1986 1992 1998 2004

5

6

7

8

9


The calculations are based on the PPP standard


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May 20067

Real per capita incomes in China and India are growing at broadly the same speed

as occurred in Japan and Korea during their take-off phases, but the starting point

for incomes is much lower. Both countries have made huge strides in developing

their economies, but in both countries more than half of the population still lives in

rural areas, and agriculture still accounts for around half of the jobs. Especially in

China, the disparity between urban and rural incomes is growing rapidly, so themigration into cities will continue, as will the decline in agricultural employment,

which goes hand in hand with economic development.

On the plus side, the low starting point for per capita incomes creates a huge

upside potential. There is a massive pent-up demand for consumer goods and

infrastructure development. India, in particular, badly needs infrastructure

investment, the poor state of its infrastructure being perceived actually as an

impediment to economic growth. However, it is a mistake to worry about

infrastructure over-investment in China. There is a huge productivity payoff in

China as new roads and bridges are built. It is not like Japan in the 1980s and

1990s, when wasteful expenditure on public infrastructure projects yielded little or

no return. An apt comparison would be with the US in the late nineteenth century,

when the expansion of railroads and other infrastructure projects fuelled rapid

growth and development.

The development of both countries should continue at a rapid pace, not least

because of the widespread use of new technologies. Major companies from

around the world are expanding operations in China and India to take advantage

of both cheap labour costs and attractive long-term prospects for demand. For

China, this shows up in the continued strong inflows of foreign direct investment

(FDI). While the influx of FDI in India is quite low by comparison, the countrys

bright economic prospects are starting to attract the attention of foreign

companies.

China's and Indias impact on commodity prices

Energy commodities

The impact of India and, especially, China on raw material prices has been

highlighted by explosive gains in a broad range of hard and soft commodities

during the past couple of years. On a per capita basis China and India use very

small amounts of commodities, reflecting the fact that most people still live in rural

areas with a relatively simple lifestyle. For example, China consumes less than 2

barrels of oil a year per person, compared with more than 15 barrels in Japan and

25.5 barrels in the US Similarly, Chinese per capita consumption of copper and

aluminium is a fraction of that of industrialized countries. However, even low per

capita consumption times 1.3 billion people translates into a large number, and

one that is growing strongly.

Because of strong economic performance and inefficient use of resources, Chinas

impact on global energy markets has been substantial. In fact, China has become

the worlds second largest consumer of primary energy (after the US) since 1994.

In the period 2000-2004, China's primary energy consumption rose at an average

annual rate of 12.5%, compared with a world average of around 3%. In other

words, Chinas energy consumption was more than four times the world average.

Furthermore, China has accounted for 46% of the increase in global primary

energy consumption over this period

Oil priceUSD per barrel

20

40

60

80

2003 2004 2005 2006

Gas price

USD per MT

200

300

400

500

600

700

2003 2004 2005 2006


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May 20068

The fact that China's energy consumption has risen at a more rapid pace than the

level of economic activity implies that China's energy efficiency is low. In fact, the

whole Asian region is a least efficient user of oil and other forms of energy in the

world. Over the past decade, the developing economies of Asia accounted for

about 40% of the total increase in world oil demand, larger than the 35% share of

increase going to the OECD countries. Not surprisingly, about three-fourths ofdeveloping Asias increase in oil consumption was concentrated in China and

India. Both countries have extremely high oil intensities: in 2004 these were twice

as high as the world average and far higher than those of developed countries like

the US, Japan and Germany.

China's impact on the global coal trade has been even more striking. China is the

world's largest coal user, by a wide margin. Although China also exports thermal

coal, its imports (mainly of higher-quality coal) have increased more than four-fold

in the same period. Because of the rapidly increasing electricity generation,

consumption of coal has risen at an average annual rate of 14.2% in the period

2000-2004, accounting for 70% of the increase in global consumption in this

period. It thus seems almost unarguable that the demand for energy, to fuel

China's rapid industrialization and growth, has been an important, if not the most

important contributor, to the sharp rise in energy prices over the past few years.

India's economy is considerably less energy-intensive than China's, in part

reflecting its much smaller manufacturing sector. India has been the fifth largest

consumer of primary energy since 2001, when it moved past Germany. Its energy

consumption has risen at an average annual rate of 4.3% over the past five years,

accounting for 5.4% of the increase in total world primary energy consumption

over this period, similar to the share of the US

India is the sixth largest consumer of oil, and has accounted for 7.1% of the

increase in global oil consumption in the period 2000-2004. India is the world's

third largest consumer of coal, and the growth in its consumption over the five

years to 2004 represented 6.9% of the increase in total global consumption, a

proportion exceeded only by China.

Other mineral commodities

Chinas rapid industrialization has also had a significant impact on the markets for

metals and minerals. In 2004 China produced around 300Mt of steel, twice the

amount produced in 2001. China has thus emerged as a major source of demand

for iron ore and coal.

Although China is the world's largest producer of iron ore, the quality of Chinese

iron ore is low. Therefore, the country also imports an enormous quantity of iron.

Chinas iron ore imports have risen at an average annual rate of 30% over thepast five years, accounting for over 85% of the increase in global iron ore trade.

Similarly, although China is a large producer of coking coal, the quality is poor, and

Chinese imports of coking coal have jumped sharply from less than 0.5Mt per year

prior to 2003 to 6.8Mt in 2004. Although this represents only 3% of total world

trade in coking coal, China has accounted for one-third of the increase in coking

coal trade over the past two years. India overtook Brazil in 2004 as the world's

third largest importer of coking coal (behind Japan and Korea); and has accounted

for a further 16% of the increase in global imports over the past two years. Against

Coal price

USD / MT

20

3040

50

60

70

80

90

1997 2000 2003 2006

Oil intensity index*

0

1

2

3

China India World

Av erage

US Japan Germany

* Oil intensity index measures the quantity of oil required to produceone USD billion of GDP


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May 20069

a background of very tight supplies, Chinese and Indian demand has been a key

contributor to the rapid increase in coal prices during the past few years.

China's demand for copper has risen 75% over the past five years, accounting for

the entire increase in global demand. In the US, which was the world's largest user

until overtaken by China in 2001, copper usage has fallen by more than 12% overthis period. With production of refined copper disrupted by maintenance programs

at a number of smelters around the world over the past year, copper prices have

more than doubled over the past two years.

In 2004, China overtook the US as the world's largest primary consumer of

aluminium, and growth in Chinese demand has accounted for half the increase in

global primary aluminium consumption during 2000-2004. However, in this same

period Chinese aluminium production has risen at an average annual rate of 20%,

faster even than its rate of consumption (16% pa). In other words China, has

become a net exporter of aluminium. Therefore the rise in aluminium prices has

been much less pronounced than that of other metals where China is not a

significant net exporter, such as copper, nickel and zinc.

Over the medium term, continued rapid growth and industrialization in China, and

to a lesser extent, India, is likely to underpin demand for and the prices of those

mineral ores and metals which these two countries are unable to produce for

themselves, a prospect of considerable benefits to commodity suppliers.

Agricultural commodities

The impact of rapid Chinese and Indian economic growth on markets for

agricultural commodities has been less pronounced than on markets for minerals

and energy. This largely reflects the fact that world markets for agricultural

commodities continue to be highly distorted by trade barriers and subsidies

(including those of China and India themselves). Like the EU, Japan and the US,

China and India attach great importance to 'food security' and are willing to force

their consumers to pay higher prices for food in order to ensure this, and to

subsidize the production of commodities such as wheat. However, China has

reduced its weighted mean import tariffs from 14.1% in 1992 to 5.6%. On the

contrary India's weighted mean tariff on agricultural imports has risen by nearly

three percentage points, to 36.9%, since the early 1990s.

Aluminium price

USD per MT

1000

1500

2000

2500

3000

2003 2004 2005 2006

Copper cathode

USD cents C / LB

0.5

1.5

2.5

3.5

4.5

2003 2004 2005 2006

Corn price

USD cents per bushel

150

200

250

300

2003 2004 2005 2006


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May 200610

Chapter 2: Competitive issues

In this chapter we look at the competitiveness of China and India. By doing so, we

analyse the developments in demographics, education and capital formation.

Labour

Demographics

The big and growing importance of the two countries to the world and their

astonishing rates of growth is further underscored by their sheer size. In 2005, the

two countries accounted for more than one third of the global population and

around 40% of the working-age population between 15-64 (years of age). By 2010,

India and China will contribute an additional 83 million and 56 million people,

respectively, to the global labour pool. In comparison, the US will contribute 13

million people and Europe just 0.1 million during this timeframe.

The substantial reduction in the size-difference in population between the two

countries can, of course, be attributed to Chinas one-child policy, which led to asignificant reduction in population growth in the past decades. India also

experienced a reduction in population growth, but in the absence of a policy like

Chinas, the reduction was far less pronounced, resulting in a higher population

growth. India's population is growing at a rate of 1.6%, compared to China's rate of

0.8%. In other words, India is quickly closing the population gap.

As a consequence of its one-child policy, China has also benefited from a

considerable fall in its dependency ratio1. This ratio has fallen from 79% in 1970 to

43% in 2003. During the same period, the decline of the ratio was far less

pronounced for India, from 79% to 61%. In fact, China's age dependency ratio will

continue to be lower than that of India until 2025 even though it is likely to bottom

out at 40% in 2010. However, from 2025 onwards China will suffer from a sharp

rise in its age dependency ratio.

China has managed to convert the advantage of a growing work force into a

virtuous loop of creating productive jobs that lead to higher savings, investment

and growth. This growing working population has been able to find productive

employment opportunities and, in turn, generate adequate savings to finance

higher physical capital accumulation. China's savings rate has increased from 34%

in 1980 to 50% in 20052. In turn, this has financed the acceleration in growth of

physical capital accumulation and GDP.

Measured in terms of age dependency ratio trends, India is about 15 years behind

China. India's age dependency ratio should improve, albeit gradually, over the next

20 years. Whether this will translate into higher savings, investments and growthfor India remains a question. This will depend on the reform success of the

1A measure of the portion of dependents in a population (people who are too young or too old towork). The dependency ratio is equal to the number of individuals aged below 15 or above 64 divided

by the number of individuals aged 15 to 64, expressed as a percentage. A rising dependency ratio is a

concern in many countries that are facing an ageing population, since it becomes difficult for pension

and social security systems to provide for a significantly older, non-working population.2The flip side of the coin of why the savings have grown so substantially is the lack of a social

security system in the country. People need to save to make up for this. Furthermore, since the

financial system is not functioning optimally, many private companies do not have access to bank

funding. Therefore, these companies are forced to have high savings in order to be able to invest.

Additional working age population by 20010

Million

83 7356

41 3820 13

0.04

-3-20

0

20

40

60

80

100

India

Africa*

China

SouthEastAsia

LatinAmerica

WesternAsia

US

WesternEurope

Japan

* Africa includes a group of 56 countries

Working population age

Million

0

200

400

600

800

1000

1200

1950 1970 1990 2010 2030 2050

India China

Age dependency ratio*

%

40

50

60

70

80

1950 1970 1990 2010 2030 2050

China India

* Proportion of non-working population to working population


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May 200611

government. In this regard, the trend over the past 13 years is a case in point. In

this period Indias dependency ratio, as stated above, improved considerably.

However, there has been a negligible improvement in the savings and investment

rates in this period. Although household savings did rise during this period,

aggregate savings remained relatively stagnant, because of government

overspending due to poor management of public finances and the slow pace ofreforms. Over the next 10 years, there should be further improvement in India's

age dependency trend, in turn improving its savings and growth potential. As

mentioned, however, a comprehensive set of reforms will be necessary to achieve

this growth potential. Compared to the past, the Indian economy today is more

integrated with the global economy. This process will most probably continue in the

years ahead. This in turn will have a positive impact on the reform process of the

country.

Education

One of the primary indicators of competitiveness is the primary school enrolment

ratio of a country. The basic assumption is that, in the long run, an educated

population will have a positive impact on the competitiveness of a country. Both

China and India have an gross enrolment ratio of around 100%. However, the

percentage of children reaching grade five shows India is lagging behind China:

61% against 99%. Furthermore, India is behind China in comparisons of the

conditions of education. The pupil-teacher ratio (the number of students per

teacher) for primary education in China was 21:1, compared to 40:1 in India in

2002.

China also scores better in comparisons of secondary education (entrance age 10

years) between the two countries. The percentage of the relevant age group

receiving full-time education in China is 70%, compared to 52% in India. The

pupil-teacher ratio for secondary schooling in India is 34:1 versus 19:1 in China.

As a result of these observations, the Indian government has initiated a greater

focus on schooling in recent years. But the size of the problem suggests it will take

decades, if not longer, before the problem is resolved. India has about 200 million

children in the 6-14-year age group, but only 120 million are enrolled in schools,

while net attendance at the primary level is just 66% of the enrolled portion.

According to World Bank estimates, male youth illiteracy in India is 20% compared

to 1% in China.

However, India is ahead of China in terms of the proportion of the population that

has finished tertiary education. According to the IMD World Competitiveness Year

Book (IMD), in 2002 about 8% of the population in India between the age of 25-34

had attained some tertiary education, compared with 5% in China.

Another edge for India is that a majority of the tertiary programs use English as the

main medium of instruction. This is not the case in China. India adds about 2.3

million graduates with a bachelors degree and about 300,000 engineers, annually.

In terms of the degrees that are awarded, the university education system meets

the competitive needs of the economy. IMD ranks India as 6th among 60 nations

with a score of 6.44 out 10, compared to a ranking of 58 for China with a score of

3.38.

Because of its higher enrolment ratio in tertiary education, India has a larger pool

of skilled workers, especially engineers, than China. According to IMD, in 2002

Illiteracy rate

%

0

10

20

30

40

50

60

1980 1990 2000

China India


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May 200612

India ranked first among 60 nations in terms of availability of skilled labour,

especially qualified engineers, while China was in 57th

place.

Labour flexibility

The competitiveness of a countrys labour market is not only determined by the

education level of its labour force, but also by the flexibility of its labour market. Agreater flexibility of the labour market enables the economy to respond better to

cyclical as well structural changes.

Since the reforms began, the Chinese labour market has become considerably

more flexible in the process of hiring and firing employees. While the reform

process initially aimed at the private sector labour market, at the start of the last

decade China began implementing changes that touched public sector

employment as well. From 1990, China started implementing a lay-off program for

state-owned enterprises. According to an IMF study on China's labour market, an

estimated 25 million workers were laid off from state-owned enterprises and

collectives during 1998-2002.

In comparison, India's labour laws remain restrictive. Indeed, the World Economic

Forum's global competitiveness report (2003-04) ranks India 96th

out of 102

countries on hiring-and-firing policies, compared with a 26th

for China. The labour

market is especially rigid for companies with 100 or more employees. Dismissing

employees from such companies is only possible after a lengthy and time

consuming approval process. However, this law is only applicable to employees

working in the formal economy, which accounts for only a fraction of the work

force.

Capital

Looking at the growth differences between China and India, one can only conclude

that the difference in capital accumulation has played a major role. The growth in

India, like in many other emerging economies, is constrained by insufficient

availability of capital. A corresponding weakness is the low level of savings,

especially savings by the government, which can be converted into investment.

Furthermore, poor access to foreign direct investment also plays a role in the

equation.

China has a huge savings rate that has increased significantly since the start of its

reform process in the late 1970s. The high savings rate, together with an

enormous influx of FDI, resulted in a very high investment rate. China is actually

experiencing over-investment which has led to declining returns. China needs to

tackle this problem by broadening the growth-base of the economy. It is

disproportionably dependent on investment and export, while the proportion ofprivate consumption in the GDP has been declining since reforms began.

By comparison, the most important cause of a poor public savings trend in India is

the government deficit. The general government deficit for the fiscal year

2004/2005 was 7.5%, while public debt stood at about 86% of GDP. Because of

the sizeable government deficit, the overall savings rate of the country is stagnant.

This relatively low savings rate is a constraint on fixed investment.

Contribution to growth in the 1990s

% pa

0

1

2

3

4

Labour Capital TFP* China India

Gross investment rate

% GDP

20

30

40

50

1990 1993 1996 1999 2002 2005

China India

Gross savings rate

% GDP

10

20

30

40

50

1990 1993 1996 1999 2002 2005

China India


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May 200613

Chapter 3: Infrastructure

This chapter looks at infrastructure and analyses whether the countrys

infrastructure is supporting or impeding economic growth.

Physical infrastructureSince China started its reform process, the country has put enormous effort into

upgrading its infrastructure, intensifying its efforts especially in the 1990s. Looking

at India, in comparison, one can only conclude that Indias investments in

infrastructure are lagging behind Chinas. As noted before, the poor state of

Indias physical infrastructure is actually being perceived as an impediment.

In 2002, China spent more than USD 250 billion on infrastructure, while India

spent, USD 31 billion. As a result, China has 30.000 km of highway, approximately

ten times more than in India.

So far, lack of funds, stemming from high budget deficits, has been a major

constraint in India. However, the Indian government is keen on improvements to

the infrastructure, and has taken several encouraging steps in the past few years.All diesel and petrol taxes were raised to fund infrastructure investments. Since the

required funding can not be raised by the government alone, due to budget

constraints, the government is seeking the participation of the private sector. While

public-private partnerships could be a solution in India, they did not work in, China.

In China only about 9% of the total highway spending in the 1990s was funded by

the private sector. About 70% of the investments were funded from road

maintenance fees, vehicle purchase fees and other government revenue sources.

In short, India needs to get its public finance in order to find (public) funding for

infrastructural projects.

An important facet of a physical infrastructure are harbours. The efficiency of

Indian harbours has increased considerably in the past years because of

privatization. However, India still has a long way to go, compared to China. China

has invested enormous amounts in upgrading its harbours, because they play an

essential role in its export driven growth. In fact, three of the top 10 ports in Asia

are in China. The efficiency of Chinese ports in comparison to those in India is

evidenced by the average lead time for consignments to the US: it takes 6-12

weeks from India, whereas it takes only 2-3 weeks from China. The overall

inefficiency at Indian ports has been a key reason in the preference of global

shipping lines to establish hub in Singapore and Dubai.

Despite the low quality of roads and harbours, both countries but especially India

suffer the most from lack of consistent and high infrastructure services. The

electricity sector is a case in point. Companies in China and India regularly suffer

power blackouts. The summer of 2005 saw serious power shortages in parts ofChina. However, the situation looks even more serious in India. In 2003, the power

shortages is estimated at 9.1%, up from a 5.9% shortage in 1999. As a result, 61%

of manufacturers in India have their own generators, compared to 27% in China.

Apart from the poor availability of electricity, tariffs charged in India are among the

highest in the world. An inefficient distribution setup and cross subsidization to

residential customers and farmers results in a large part of the burden being borne

by industrial customers. Currently, about 20% of the electricity generated in the

country is distributed to farmers at an almost negligible charge. Another 40% is

Lead time of exports to US

Number of weeks

0

1

2

3

4

5

Transittime

Loading/unloading

timeatports

Timeatcustoms

forexports

Processingtimeat

customsfor

imports

China India

Average costs of freight for imports

Freight payments as % of total import value

0

2

4

6

8

10

12

Ind ia Emerging

markets

World Developed

economies

Electricity costs industrial clients in 2002

USD / KWH

0.00

0.02

0.04

0.06

0.08

0.10

China

Sweden

France

Germany

US

UK

Korea

Taiwan

Singapore

India

Italy


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May 200614

lost in transmission and distribution. Hence, about 60% of the total electricity

produced yields virtually no revenues.

The financial system

A strong banking sector is one of the key ingredients for rapid and stable economic

growth in transition economies. An efficient financial sector can promote savingsand enable the flow of a larger share of savings into productive investments. The

efficiency of the banking sector will be important for the systemic stability of the

financial system.

Comparing the banking systems of the two countries, India shows a far better and

healthier financial system, based on factors regarded as essential to a healthy

financial system. First, India has a central bank with clear cut rules for

safeguarding the stability of the financial system. The supervision of the Reserve

Bank of India (RBI) is at some points even stricter than international safeguards

such as the Basle requirements. For example the Capital Adequacy Ratio (CAR)

set by the RBI is at 9%, whereas the Basle requirement is 8%. This stricter

requirement has resulted in a CAR of above 10% in recent years. This has

resulted in higher earnings and hence in an improved capital base. Furthermore,

the RBI changed the Non-Performing-Loans recognition norm (NPL) from 180

days to 90 days in 2004, in order to ensure that the asset quality of the banks

remain sound.

In China, the four large state-owned banks, which account for about 55% of the

total assets of the banking system, have traditionally been operating under the

strong influence of government bureaucracy and mandates. This has resulted in

multiple and mixed business goals for banks. Their ownership structure and

corporate governance have adversely influenced their ability to evolve a self-

managing risk-assessment system. Because of this strong state interference with

the banking system, the capital adequacy ratio in 2003 was a mere 4.6%. Although

the government improved the CAR of two large banks (Bank of China and China

Construction Bank) by injecting USD 45 billion in January 2004, the CAR of the

rest of the state-owned banks remains weak. Even for the joint-stock banks, the

capital adequacy was just 6.8% compared to the Basle requirements of 8%.

Secondly, the risk appraisal system in India is much more robust than that of

Chinese banks. This is especially so in private and foreign banks which have

implemented IT-solutions. Public sector banks, by comparison, have inferior risk

assessment systems, as evidenced by higher NPLs. Even so, they are still

superior to those at Chinese banks, which lack adequate data collection on

borrowers and facilities for a quantitative approach to measuring and managing

credit risk. However, Chinese banks are now gradually trying to improve their

credit appraisal process, bringing in international best practices.

Thirdly, as a result of strict supervision by the RBI and better risk appraisal

systems, the asset quality of Indian banks has improved considerably in the past

years. The NPL ratio dropped to 8.8% in 2003 from 15.7% in 1997. In China, the

lack of an adequate risk assessment system has resulted in large balances in non-

performing assets (NPA) in the banking system.

Last but surely not least, the competition in the Indian banking sector is greater

than in China. Halfway the 1990s the RBI allowed the private sector to open new

banks, which has increased the level of competition. As a result, the share of (less


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May 200615

efficient) public banks in the total assets declined from 85% in 1996 to 74% in

2003. Furthermore, the increasing importance of foreign banks, which used to

operate as branches in India, but are now allowed to set up subsidiaries, will likely

further boost competition in India.

Until the early 1990s the Peoples Bank of China (PBOC) was the key bank InChina. With the start of the reform process in 1978, the government created four

new banks and gave regulatory responsibility to the PBOC. Up to the late 1990s

there were no other commercial banks in China. Since then several banks with

joint ownership have been formed, and foreign banks are allowed a limited

presence in the banking system. However, the lions share of the banking system

is still in the hands of the four big state banks. The limited competition in the

banking system in China can be interpreted as a weakness.

In sum, and according to the IMD World Competitiveness Yearbook, India scores

far higher than does China in banking and financial services and the transparency

of financial institutions.


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May 200616

Chapter 4: International relations

This chapter highlights developments in the internal and external political

landscapes of China and India. It looks at the status, direction and impact of their

political relationships, and the factors driving the developments.

Political relations

Despite their similarities as Asian giants and as two of the worlds most robust

emerging markets, China and India are markedly different in their respective

political affairs. These differences are reflected in their domestic and international

politics; their approach to the management of these relations; and their impact on

regional and global politics.

Chinas internal and external politics are driven by its controlled transition to a

market economy and its emergence as a strategic power in the new geopolitics.

Internally, Chinas political environment is stable with the government and the

Communist Party exerting control over most aspects of the society. Externally,China is involved, active and influential. As a permanent member of the UN

Security Council, it wields enormous influence in how major crises, such the Iran

nuclear stand-off, are resolved. In general, China shows a preference for

pragmatic policies, and an interest in avoiding conflict and confrontation. However,

its bilateral relations, its military build-up, its profile as an arms merchant, and its

lack of transparency and accountability defy expectations of Chinas positive

impact on world stability and change.

India, by comparison, remains a tumultuous democracy, ensnared in the

challenges of being the worlds largest democracy in economic transition. Its

domestic political environment is riven with instability. Its engagement in foreign

affairs appears limited in scope and influence, and is no longer suggestive of theimpact India once bore as the leader of non-aligned nations in the cold war.

Internal politics: China

Chinas domestic political stability rests on a number of features. Power remains

centralized in Beijing and in the Chinese Communist Party. There is no organized

challenge to the current power structure. Unlike India, China has no separatist

groups, nor militant ethnic factions to compound the problems of economic change

with issues of political security. The government maintains tight control over mass

media and the Internet. The country has experienced strong economic growth that

has favoured the rise of a strong, urban middle class. To strengthen its economic

program and release social pressures, the government has introduced a populist

reform agenda. It aims at creating a harmonious society with more balanced

regional and socio-economic growth and more accountability for public authorities.

Against this backdrop of overall political stability are growing strains of public

discontent. Like India, Chinas economic growth has favoured urban areas, leaving

the rural economy behind with 2/3 of Chinas 1.3bn population. It has created

regional disparities in economic growth and income; raised volatile issues of

peasant land-use and land-rights; and made public corruption an open issue.

Additionally, Chinas economic progress has extracted costly and disastrous

environmental damage: massive chemical spills, such as the 80-kilometer sludge


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May 200617

of benzene and toxic chemicals that covered the Songhua River last November;

and severe pollution that have ruined the land and health of residents in several

villages. These are major sources of discontent that have erupted in violent

protests and mass demonstrations by farmers and peasants. In 2005, the

government recorded 87,000 protests and mass incidents (Global Insight, May

2006). They have also given rise to activists who have begun to openly challengelocal officials for corruption, and Chinas legal system over land use and peasant

rights.

Mindful of the potential for public unrest to foment greater instability, the

government has responded with a promise for more accountability by government

authorities, and with a rural reform agenda. The New Socialist Countryside will

attempt to redress the socio-economic and environmental ills of rapid and unequal

growth. Among other things, it will provide massive infrastructure spending, and

more money for education and medical care.

While the government has loosened its reins on the economy, it continues to hold

firm on political liberalization, trying to avoid pitfalls that could destabilize the

political order. Limited forays, such as direct elections at selected village levels,

are offset by strict controls. They include media censorship and party control over

law enforcement and judicial decisions.

Internal politics: India

India provides a contrast to China. Indias internal political environment is generally

unstable. It is a populous democracy with well established multi-party politics and

robust institutions (including a strong and active civil society, estimated at 30,000

groups). It is also hostage to causes and conflict generated by left wing extremists

and armed revolutionary groups who are prevalent in vast areas of the country

(156 districts and 13 states). Indias ruling parties come and go, undermined by a

fractious legislature and corruption, and lasting rarely long enough to make

needed changes. However, expectations are strong and widely-held that the

current coalition government under Manmohan Singh will prove an exception.

The ruling government is an alliance led by the Congress Party and consisting of

three smaller entities. It has the support of four communist parties, known as the

Left Bloc which is vital to the effectiveness of the ruling coalition. As with China,

the massive proportion of Indias population resides in the rural countryside. This

population forms the backbone of popular support that helped elect the Congress

Party in the last elections. They are a major source of domestic pressure for higher

living standards and integration into the mainstream economy.

Also like China, Indias economic growth has primarily benefited urban areas. Thepressures of rising expectations among rural and farm populations are complicated

by left wing extremism (Maoists) and separatist insurgencies which have existed

for decades in India, and are again on the rise. Their demands range from

autonomy to claims for a greater share of the countrys natural resources. Nearly

600 people have been killed in skirmishes since January 2005; and the

government reported in March this year that the number of insurgency-related

killings had risen dramatically. Recently, the Maoist rebel groups merged into one

revolutionary organization, which is expected to increase its threat and fire power.


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May 200618

India is also vulnerable to communal and religious protests that often erupt into

violence. Hindu Muslim riots in 2002 resulted in 1,000 deaths according to

government estimates. This May, 6 people were killed and 60 were injured in a

religious riot sparked by local authorities who had razed a 200 year old Sufi shrine

for a road-widening project

Among other measures to relieve social unrest, the Indian government has passed

a Common Minimum Employment program and a new quota system to increase

the numbers of poor and backward groups in higher education. The latter has

generated strong middle class opposition, especially among college students. This

will undoubtedly play into the claims of left wing groups, including extremists.

International affairs: China

Among the key drivers to Chinas foreign relations are its quest to secure energy

assets and other raw materials; nationalism and Chinas bid for regional

leadership; and containing the US Underpinning these efforts are Chinas

engagement in international institutions, such as the WTO, and the United

Nations, where it is a permanent member of the UN Security Council; its bilateral

and multilateral treaties; and the growth of its defence program and its arms

industry.

Chinas relationships with African countries reveal a singular focus on securing

new markets and assets to support Chinas economic growth. It has pursued

bilateral treaties, with countries like Zimbabwe, Sudan and Angola for oil and

mineral rights and for the sale or supply of Chinese arms. It provides aid and

economic support with few conditions, such as the safeguards imposed by the

World Bank to promote good governance and combat corruption. These

relationships bring added benefits to China in the form of allies who support

Chinas positions in international forums; such as the United Nations and the UN

Human Rights Council.

Chinas regional relationships are framed by its nationalist sensitivities and its goal

of being the strategic leader in the region. Both Japan and Taiwan provoke Chinas

strong sense of nationalism. Cross-strait relations have been subject to tensions

produced by Chinas continuing claim on Taiwan as its province. In 2005, China

passed legislation that codified the possibility of using force if Taiwan claimed

independence. However, in a move designed to isolate the Taiwanese leadership,

China is successfully courting Taiwans business community and the opposition

KMT party, and is dissuading governments like the US from receiving state visits.

These moves signal a change toward non-military stratagems and reduced

tensions in cross-strait relations.

Chinas political relations with Japan are troubled by wartime history and Japans

past atrocities, their competition for the leadership of Asia, Japans close ties with

the US, and its increasing rivalry for energy supplies. An outstanding issue in the

oil and gas rivalry between the two countries is the ultimate destination of the new

Russian pipeline from Siberia to the east: whether the terminus will be in Japan or

in China. Despite strong commercial ties, competition and mistrust will continue to

prevent Sino-Japanese relations from consolidating into a regional alliance.

In 2003, China surprised much of the world with decisive action and leadership in

the North Korean nuclear crisis. It suspended oil shipments to North Korea, sent


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May 200619

envoys, and shifted troops along the China-Korean border. Since then, China has

been the lynchpin in the on-going 6-party talks. Not only because of its leverage on

North Korea as the major donor and ally, but also because of the implications for

the regional balance of power, China can be expected to play a pivotal role in the

talks and influence their ultimate outcome. Elsewhere in the region, China is

strengthening its ties with the ASEAN countries through bilateral and multilateralpacts, even as their economies become increasingly tied with Chinas.

In the Indian sub-continent, China seems more focused on maintaining the current

regional political alignment, devoid of changes that would contain China. It is a

traditional ally of Pakistan and a major arms supplier for the country. It maintains

close ties with the Myanmar government. Although it is currently not a challenger

to Chinas bid for Asias leadership, India is an important power in the region, and

the relationship of the two countries is important to regional stability.

International affairs: India

While the ties between India and China are currently stable and reinforced by

developing commercial ties, the risks to the relationship are noteworthy: with its

affiliations with the West, India could be seen a proxy for western interests to curb

Chinas influence in the region. China and India fought a border war in 1962 that

left an unresolved border dispute that could emerge as a major irritant in the

relationship. Most significantly, India signed a ground-breaking civil nuclear

cooperation agreement with the US this year. If seen by China as an attempt at

political realignment in the region, it could decide to rebalance the situation by

assisting Pakistan with its nuclear weapons program. As has been expressed in

various quarters, this could start a destabilizing nuclear arms race on the sub-

continent.

While the economies of east and south east Asian countries are increasingly tied

to China, the same cannot be said with regard to India. This has a bearing on

Indias influence in the region. While it is a giant among emerging markets, its

political influence in the region is not commensurate with its stature. Indias

regional concerns may be best seen in the context of issues presented by

Pakistan and Nepal.

Border security and Kashmir figure prominently in its relationship with Pakistan.

Having fought a war and border skirmishes, India also worries about Chinas

interest in assisting Pakistans nuclear arms program and about its defence

agreement with China. However, the two countries have undertaken confidence

building measures (which Pakistan believes are not enough). In Nepal, the Indian

government seeks to impede interaction between its own Maoists and those of

Nepal in order to prevent the formation of a zone of political instability and guerrillaactivity, spanning Andra Pradesh to Bihar. Through contacts established by the

members of the Left Bloc, the government has attempted to shore up

parliamentary rule and to bring Nepali Maoists into mainstream politics.

Geopolitics

In global politics, China is emerging as a military power with closer ties to Russia.

Chinas military build-up has been formidable and suggests that it is second only to

the US in defence spending. By official reports of the Chinese government itself,

the defence budget has grown 10% annually for the last 15 years and by 300% in


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May 200620

real terms. However, these official figures are widely taken as false estimates of

the true level of Chinas military spending. A study released recently by the

International Institute for Strategic Studies, UK, estimates that China actually

spends 70% more, or USD 75.5bn (in purchasing power parity) for 2003. As China

is a nuclear power, we may assume that the spending includes the modernization

of its nuclear forces. In addition to its own defence build-up, China is a major armssupplier, providing conventional and advanced weaponry to countries worldwide,

including those that are major conflict zones, such as Sudan.

China is also developing closer ties with Russia based on common energy

interests and a shared interest in counterbalancing American power. The two

countries recently signed major energy accords for large scale shipments of

Russian gas to China through the construction of new gas pipelines. Another, a

resolution on a crude oil pipeline from Siberia is still pending. Both countries dislike

American interference in internal affairs and would like to see American power in

check. In 2005, China and Russia held their first joint military exercise in a show of

strategic partnership. In the Iran nuclear crisis, they have been coordinated in

their response against American calls for sanctions.

Chinas political relations with the US itself are often troubled. It sees America as a

de-stabilizing force in global politics, and undoubtedly wants to curb US power,

particularly its influence in Asia. The U.S has urged China to be a responsible

stakeholder in the global community and China has answered with a doctrine

expressed as the peaceful rise of China. Notwithstanding these considerations,

both countries are ultimately pragmatic, and their strong commercial and trade ties

may prove resistant to politics.

India is a less prominent player than China in global politics, and less also by its

previous role in the cold war when it served as the leader of the non-aligned

nations. It currently exercises its regional and international weight as a rising

economic power through trade and economic channels. It shares the leadership

with Brazil for the G20 nations. It has made a bid for membership in the UN

Security Council. Its nuclear cooperation agreement with the US has given India

new status, and it is proceeding with a defence build-up, commensurate with its

rising status as an emerging economic power. However, for the moment at least,

India remains largely unheard in the geopolitical manoeuvrings related to issues,

such Irans nuclear programme.

Summing up

In summary, Chinas emergence as a pivotal player in international affairs can be

seen as a transformative development for geopolitics. As a start with Russia, but

later on its own, China will be a centre of power in the global balance of power. Itsinfluence, as suggested by some of its current bilateral relations, may not always

be benign nor socially and politically progressive. In fact, it could bring a shift in the

global trend towards improved governance, civic rights and environmental and

social accountability.

The dynamics of a transition economy of Chinas immense size, scale, and

complexity, also carry inherent vulnerabilities that could complicate Chinas

expressed intentions to be a global power with peaceful aspirations.


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May 200622

Chapter 5: Trade and FDI opportunities for the Netherlands

This chapter examines the development of FDI and foreign trade of the two

countries and make projections for the period up to 2020. Additionally, it looks at

the economic relations of the two countries with the Netherlands.

The projected growth path for the two economiesSince FDI and foreign trade projections are closely related to the expected growth

path of the economy, our assumptions are based on the growth trajectory of the

two countries for the period ahead up to 2020. We take the Economist Intelligence

Unit (EIU) long term growth projections for the two economies as our starting point.

In accordance with the EIU, we expect the two economies to slow down in the

coming period and we share its opinion that, from 2013 onwards, Indias growth

rate will outpace that of China. This projection is based on a number of factors.

Compared to China, India has a more balanced growth: a strong and growing

internal demand combined with external demand which is gaining importance.

China, on the other hand, remains too dependent on its export-led growth model.

However, regarding the expected slowdown of the two economies, our projections

diverge considerably from the EIU. As shown in the graph, the EIU expects the two

countries, especially China, to slowdown substantially, dipping to growth rates of

4.5%, which is less than half the current growth rate. For Chinas economy, this

could more or less be considered to be a landing: the growth rate is insufficient to

create enough jobs in order to absorb its growing work force, which will only start

to decline after 2020.

We also expect Chinas growth rate to come down more quickly than that of India.

However, we expect the growth rate to stabilise around 6% in the period up to

2020.

Foreign investment: opportunities for the Netherlands

The past

The influx of FDI in China has attracted a great deal of attention in the past

decades. In the period 1990-2005, China attracted an average FDI influx of USD

33 billion per annum. By comparison, India has attracted an average FDI inflow of

less than USD 3 billion per annum for the same period, indicating an average of

3.5% and 0.6% of GDP for China and India, respectively.

It should be noted that the foreign investment boom in China was started by

overseas Chinese. From 1985 to 1996, two-thirds of FDI in China came from Hong

Kong, Macau and Taiwan, where about 30 million ethnic Chinese live, many ofthem with close ties to the mainland. Moreover, these places specialised in labour

intensive manufacturing industries for export. Because of fast rising labour costs,

manufacturing operations were moved to coastal China. Overseas Indians, in

contrast, are scattered around the world and across professions.

The future

As stated previously, average FDI inflow in China was 3.5% of GDP for 1990-

2005. However, as shown by the next graph, this very high number mainly

reflected high inflows in the second half of the nineties. Since then, the amount of

GDP

% y-o-y

4

5

6

7

8

9

2006 2010 2014 2018

India (AAB forecast) China (AAB forecast) India (EIU forecast) China (EIU forecast)


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May 200623

FDI as a percentage of GDP is on a declining path. We think that this trend will

continue in the period ahead, for two reasons. First, the importance of FDI in total

investment is declining in China. Given its enormous savings rate the country has

ample resources to finance its own investment. The share of FDI in total

investment declined from 16% in 1994 to 6% in 2004. We are of the opinion that

this trend will continue in the period ahead to 2020. Secondly, the country isexperiencing over-investment, which will have to be corrected in the period ahead.

This will slow down the investment growth in the country, and, therefore, the FDI

inflow.

Taking the above as a starting point, we project an average influx of FDI in China

to be 1.5% of the GDP in the period up to 2020. As seen in the next table, the

enormous size and growth of Chinas GDP means that the absolute amount of FDI

will continue to grow, reaching USD 82.0 billion in 2020. During 1990-2005, the

Dutch share averaged 0.4% of total FDI in China. We assume that this percentage

will stay the same in the period up to 2020. Therefore, Dutch FDI to China will

average around USD 222 million during the period 2006-2020. Compared to an

average of USD 128 million in the period 1990-2005, this represents a jump of

USD 94 million on an average yearly basis.

Projected inflow of foreign investment in China

GDP (USD bn) Total FDI (1.5% of GDP) Dutch FDI (0.4% of total)

2006 2239.3 33.6 0.134

2007 2423.0 36.3 0.145

2008 2614.4 39.2 0.156

2009 2810.4 42.2 0.168

2010 3010.0 45.1 0.180

2011 3205.6 48.1 0.192

2012 3410.8 51.1 0.204

2013 3625.7 54.4 0.217

2014 3850.5 57.8 0.231

2015 4085.4 61.3 0.245

2016 4330.5 65.0 0.259

2017 4590.3 68.9 0.275

2018 4865.7 73.0 0.291

2019 5157.7 77.4 0.309

2020 5467.1 82.0 0.328

Total 835.3 Total 3.3

Average 55.3 Average 0.222

As stated above, India attracted far less FDI during the same period, 1990-2005.

However, the liberalisation of the economy at the start of this millennium hasboosted not only the growth rate of the country but also its foreign trade and the

influx of FDI. As seen in the next graph, FDI is on the increase as a percentage of

the GDP. We think this trend will continue in the period ahead, especially since

India will open up its banking system to foreign banks in 2009. This will have an

additional positive effect on the influx of FDI into the country. Our projection is that

the FDI, as a percentage of GDP, will average 1% in the period 2006-2020.

Based on this projection, FDI inflows into India will almost reach USD 21 billion by

2020. We do not foresee any change in the percentage of Dutch FDI for the period

ahead, however. On average, Dutch investment represented 5.4% of total FDI in

Dutch FDI in China, 1990-2005

USD million

-200

-100

0

100

200

300

400

1990 1994 1998 2002

Average yearly inflow: USD 128 million

FDI in India

% GDP

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1990 1994 1998 2002

FDI in China

% GDP

0

1

2

3

4

5

6

7

1990 1994 1998 2002


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May 200624

India for 1990-2005. Our assumption is that this percentage will stay the same for

the period up to 2020. Therefore, Dutch FDI to India will average around USD 727

million during the 2006-2020 period. Compared to an average of USD 84 million

during 1990-2005, this represents a jump of USD 643 million on an average yearly

basis (see following table).

Projected inflow of foreign investment in India

GDP (USD bn) Total FDI (1.0% of GDP) Dutch FDI (5.4% of total)

2006 860.8 8.6 0.464

2007 916.8 9.2 0.495

2008 979.1 9.8 0.528

2009 1043.7 10.4 0.563

2010 1112.6 11.1 0.600

2011 1185.0 11.8 0.639

2012 1260.8 12.6 0.680

2013 1340.2 13.4 0.723

2014 1424.6 14.2 0.769

2015 1514.4 15.1 0.8182016 1609.8 16.1 0.869

2017 1711.2 17.1 0.924

2018 1819.0 18.2 0.982

2019 1933.6 19.3 1.044

2020 2055.4 20.6 1.109

Total 207.7 Total 11.6

Average 13.8 Average 0.727

Foreign trade: opportunities for the Netherlands

China

As stated in the opening chapter of this study, China has had an enormous andsingular impact on global trade flows. In the period 1990-2005, China increased its

foreign trade by an average of 20% per year, which reached 68% of its GDP last

year, up from 24% in 1990: In other words, an increase of 44 percentage points.

We believe that foreign trade will continue to expand in China. However, the

expansion will be less pronounced in comparison to the growth of the past fifteen

years. There are several reasons for this. First, we forecast a gradual slowdown of

the Chinese economy in the period ahead. This will have a dampening influence

on imports (into the country). In view of the fact that the Asian region is already

considered to be China-centric, a declining import demand from China will, in time,

have an dampening effect on the exports of the countries in the region, and

therefore, on the growth of the countries themselves. This will, in turn, influence

Chinese exports to these countries.

Secondly, there is the issue of the Chinese currency. The government has been

keeping the currency artificially low to stimulate exports, causing a good deal of

commotion in the rest of the world, especially in the US In response, the Chinese

authorities moved from a straight peg against the USD to a basket of currencies

last year. Thus far, the move has had very little impact on the value of the

currency. Therefore, pressure for an upward valuation will continue, especially

from the US. The issue has to be resolved in the future. Chinese exports cannot

continue to expand as they have in the recent past, without provoking protectionist

measures from other countries, particularly the US. This may not lead to an

Yuan against USD

8.00

8.10

8.20

8.30

3-1-2005 17-5-2005 28-9-2005 9-2-2006

Dutch FDI in India, 1990-2005

USD million

-50

0

50

100

150

200

250

300

1990 1994 1998 2002

Average yearly inflow: USD 84 million


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May 200625

immediate strong revaluation of the yuan, but a correction over a longer period

with visible revaluation cannot be ruled out. This process will have a dampening

effect on Chinas foreign trade, especially exports. Reduced export growth will of

course influence the growth rate of the country, which will then lead in turn to less

import demand.

Lastly, the political leaders of China have stated on several occasions that they

want to support internal consumption to reach a more balanced growth and

become less dependent on foreign trade. Given this desire and the accompanying

policies, we think that internal private consumption will, in time, play a bigger role

in Chinas GDP. However, it will be an uphill battle for Chinas political leaders to

accomplish this, because making policies is one thing, implementing them is

another, especially in a country of Chinas tremendous size and scale.

Taking these considerations into account, we project foreign trade, as percentage

of GDP, to increase to 90% in 2020. This is half the increase of the past fifteen

years and equals an increase of almost 250% of total trade up to 2020. In

accordance with the rise of total Chinese trade, Dutch trade with the country will

also increase considerably (see box).

India

Compared to China, foreign trade in India showed a less tempestuous

development in the past decade. The average increase in total trade was just 13%

per year, and the share of total trade reached only 28% of GDP last year, up from

13% in 1990. However, foreign trade recieved an enormous stimulus after trade

liberalisation at the beginning of this decade. The yearly increase averaged almost

25% during the last four years.

Looking at the future, we have made several considerations. First, comparing the

average GDP growth rates of the past fifteen years with our projections up to 2020

for the two countries, we anticipate Indias foreign trade development to be about

the same, on average, as the last fifteen years. The projected average growth for

India up to 2020 is 6.5%. The average growth in the period 1990-2005 was 6%. By

comparison, we saw that the average growth for China in the past fifteen years

was almost 10%, whereas we project an average growth of 7% in the period up to

2020. This is a significant deviation from the past.

Second, we see two opposing forces that could influence Indias foreign trade. On

the one hand, as noted before, Indias foreign trade recieved an enormous

stimulus in the last four years because of trade liberalisation. We think that this

trend will continue in the period ahead. This will have a positive impact on foreign

trade. The increase of foreign trade as a percentage of GDP could therefore be

higher than the 15%-points increase in the period 1990-2005.

On the other hand, as we explained in an earlier chapter, the infrastructure of the

economy is already perceived as an impediment to growth and especially to

foreign trade. Unless the government is able to deal with this situation and turn it

around, the problem will become even more acute, damaging foreign trade and

denying the same increases as in the past.

Given the growing economy and the governments expressed priority to upgrade

the countrys physical infrastructure, we believe that the situation will gradually

improve, becoming accommodative to trade instead of being an impediment. How-

Volume of Chinese foreign trade, 2006-2020

Total tradeAs argued in the text the total foreign trade volume of China

will increase to 90% of GDP in 2020. This equals USD 4920.4billion in 2020 (90% * 5467.1).

Dutch shareIn the period 1990-2005, the average Dutch share of trade inthe total Chinese trade was 1.6%. We take the assumption

that in the period 2006-2020 this market share will remain the

same. In 2020 the Dutch foreign trade with China couldincrease to USD 78.7 billion.

Dutch exportsIn the period 1990-2005, the share of Dutch exports of thetotal Dutch trade with China has structurally declined from

21% in 1990 to 9% in 2005. However, the past years thedecline somewhat levelled off. We take the assumption that in the period 2006-2020 the share of Dutch exports in the total

trade with China will stabilize around 8%.This implies that Dutch imports from China will increase toUSD 72.4 billion and exports to 6.3 billion in 2020. See graph

below.

0

1

2

3

4

5

6

7

2006 2010 2014 2018

Dutch imports form China

% total Dutch imports

0

2

4

6

8

1960 1970 1980 1990 2000


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May 200626

ever, because of the long lead times in infrastructural projects, this will take some

time. Thus, in the short to medium term the low quality of the infrastructure could

take a big bite out of foreign trade, but in the long run an upgraded infrastructure

will boost foreign trade. In sum, we project foreign trade to reach USD 883 billion

in 2020, and foreign trade as a percentage of GDP to increase at the same pace,

on average, as in the past. (see box).

Volume of Ind ian foreign trade, 2006-2020

Total tradeAs argued in the text the total foreign trade volume of Indiawill increase to 43% of GDP in 2020. This equals USD 883.8

billion in 2020 (43% * 2055.4).

Dutch shareIn the period 1990-2005, the average Dutch share of trade in

the total Indian trade was 1.5%. We take the assumption that

in the period 2006-2020 this market share will remain thesame. In 2020 the Dutch foreign trade with India would

increase to USD 13.3 billion.

Dutch exportsIn period 1990-2005 the share of Dutch exports as

percentage of total Dutch trade with India came down from

56% in 1990 to 41% in 1993. After 1993, this number hasvaried around 40%. For the period 2006-2020, we take the

assumption that the share of Dutch exports as percentage oftotal Dutch trade with India will on average remain 40%. Thisimplies that the Dutch imports from India will increase to USD

7.9 billion and exports to USD 5.3 billion in 2020. See graphbelow.

0

1

2

3

4

5

6

2006 2010 2014 2018


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Disclaimer

The information opinions, forecasts and scenarios contained in this publication have beencompiled or arrived at by ABN AMRO Bank N.V. from sources believed to be reliable and ingood faith, but no representation or warranty, express or implied, is made as to theiraccuracy, completeness or correctness. All opinions and estimates contained in thispublication constitute ABN AMRO Bank N.V.s judgement as of the date of this publicationare subject to change without notice. ABN AMRO Bank N.V. accepts no liability whatsoeverfor any direct or consequential loss arising from any use of this publication or its contents.The content of this report may be quoted without further permission, but dueacknowledgement is requested.

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