Saturday, October 31, 2009

China's Economy and the Yuan

There has been so much talk about China's rising economy and its "yuan" policies. International pressures are building up on China to allow its currency, yuan, to appreciate. But to understand why China is fighting back and not allowing its currency to appreciate, we must look into the fundamentals of the Chinese economy. China is a low-wage country with abundant supply of cheap labor. Due to the opening up of China's economy and availability of cheap labor, there is a huge capital inflow into China. One of the main reasons for this buoyant flow of capital investment in China is because the yuan is pegged to US dollar. It was literally pegged to US dollar until a few years back (1US$ = 7.6yuan). After heavy pressures from international community, particularly the US, China allowed its currency to float although tightly managed against a basket of currencies. And "tightly managed" here means that China interferes heavily in the currency market to keep its currency's exchange rate with US dollar almost constant which stays around 1$ = 6.8 yuan.
It is important to note that during the enormous growth of the Chinese economy in the past decade, the Chinese domestic consumption has decreased from 45% to 35% of the GDP. During the last decade or so, the Chinese economy grew on two major factors - exports and government spending. The Chinese state heavily invests in fixed assets and capital infrastructure thereby providing a conducive atmosphere for export-oriented industries which in-turn combined with its currency pegging policy and cheap labor attract huge amounts of FDI, mostly in the form of capital investment.
The export-oriented manufacturing plants that blossom up due to this heavy capital investment and incentives by the Chinese state act as a major source of job creation. Due to the lack of proper social safety net in China, a major portion of the income earned through these jobs by the Chinese individuals get saved in the state-run banks. It is also important to note that many industries including the ones that require heavy investment and man-power are run by the government. The banks then lend, under the orders of the government, to these state-run industries and export-oriented industries which in-turn create more jobs which in-turn increases the savings rate of the country.
But the point here is - with so many state run enterprises, a major portion of the banks' loans go out to these state run industries thereby crowding out private industries and entrepreneurs. Due to this crowding out of private sector I strongly believe that innovation in and from China will be less than what is needed and what is possible. So, without innovation and competition, no quality jobs will be created. Without quality jobs it will be very difficult to sustain the Chinese economy on the long run. With consumer spending remaining so low, this only adds up to troubles of achieving a sustainable and inclusive growth.
For any innovation/research, a strong yuan will be needed. A strong yuan can help in acquiring high end technology from the international markets to the Chinese business industries and would help keep input costs cheap which will facilitate greater innovation to come out of China. But any increase of Chinese yuan relative to the US dollar or any other major currencies will severely affect the cycle of money flow in the Chinese economy. This is because domestic consumption in China contributes very little to its GDP and exports are the only major driver of growth for which the yuan has to be kept weak. But if yuan remains weak, then there is a question on sustainable high quality growth in the Chinese economy.
So the foremost point for China is to increase domestic consumption through proper social safety net programs and investment in vital areas such as rural health and education . And when the domestic consumption becomes a considerable number in the GDP calculation, China has to allow its currency to appreciate. A stronger yuan will have better purchasing power which will in-turn kick start the cycle of more domestic consumption, better innovation, entrepreneurship, quality jobs and sustainable economy. This can be better achieved if more competition is allowed within Chinese people for which the government has to liberalize its economy further which would mean that the Chinese state loosen its iron-grip on the business activity of the country and transform from a model of state-led capitalism to a more people oriented free market economy. Will this happen? We wish.

Friday, October 2, 2009

Cookie 1 : Telecom companies' tie-up talks collapse

Cookie 1 : As per the recent news, India's largest cell-phone service provider Bharti Telecom and South Africa's largest telecommunications company MTN failed to reach an agreement that would have resulted in a tie-up and eventually a full-blown merger which would have resulted in around 200 million subscribers coming under the administration and service of a single-entity.

This was a $26 billion cash & stock deal with Bharti taking 49% stake in MTN and MTN getting a 36% economic interest in Bharti. The deal collapsed not because of the companies, which are private and are owned by private shareholders but because of the related Governments. The Govt of South Africa wanted a dual listing - to have MTN listed in Johannesburg even after this deal. But Indian laws prohibit its companies to get dual listed. And to get dual listed, the Indian currency(Rupee) has to be fully convertible. As of now, there is no provision for a capital account convertibility of the Rupee. Potential discrepancies on various other factors like information disclosure rules etc.. were also pointed out by the Indian Govt for not allowing the company to dual list.

BTW, its said, that if this deal had gone through this would have been the biggest FDI in South Africa. But the shareholders of both companies were happy for the collapse of this deal. From Bharti's stand point, the shareholders say that this would have moved away a lot of cash from the company and from MTN point of view, the shareholders say that Bharti's per share offer was very low than the actual market value.