These days Indian Institute of Foreign Trade(IIFT) , the business school from which I have recently graduated, is all abuzz about a new assignment from the Prime Ministers Office. IIFT has been tasked with setting up a new school of foreign trade in Africa to train professionals in international business management. As India and Africa inaugurate the second Indo-African summit , this initiative is a very good example of the way in which India and Africa can partner to achieve mutual prosperity and security in the 21st century.

It is now almost universally agreed that Africa would be a very important economic region in the 21st century.  It will not only be a supplier of crucial raw materials , but would also be a big and flourishing market in itself. Its combined GDP is now more than that of India and is expected to grow fast . The worlds leading economic powers are vying with each other to secure crucial supplies as well as to corner a slice of the consumer market. Mirroring the changing world geopolitical scenario, the strategic and economic influence of India and China is increasing in Africa at the expense of Western nations. At the same time the competition between India and China is increasing. Although , not a neo-colonial scramble for Africa , this rivalry is real and is  bound to intensify in the coming decades. India needs to stand up and fight for its interests in Africa , albeit with different tools.

Most of the Chinese engagement in Africa usually consists of  heavy investment  in physical infrastructure with a view of securing access to natural resources. A majority of these deals are financed by the Chinese Export Import Bank and are usually executed by Chinese contractors. The projects are executed by Chinese managers using Chinese instruments and Chinese labor. Some labor gangs are even reported to bring their own prostitutes from China. Although ensuring efficiency, this model increasingly alienates the Chinese businesses from the local population and have little trickle down effect . To a population which is very sensitive about colonial exploitation, this high handedness is slowly adding to public resentment which might one day explode.

India cannot and should  not emulate this. India must carefully position itself as a partner to Africa in growth. Our focus should not be on investing in physical infrastructure as much as on the social infrastructure.Rather than being state sponsored, Indian engagement with Africa should be led by private sector. Robust people to people ties should be built and encouraged.  Indian businesses should be encouraged to invest into those sectors which are most crucial to African growth, such as water, agriculture productivity, medicine , education. Indian businesses should also provide as much employment as possible to the local people, even if that means investing heavily into training employees.

And all this should be done not because it is nice to say and do , but because it makes ample business sense. This is the 21st century , and todays Africa will never accept any colonial master. As its people become more educated , and more aware , they are more likely to share their wealth with a friend than an oppressor. We need to extend them a firm hand of friendship with a clear heart and conscience.


Reading Chinese tea leaves

October 22, 2010

China’s GDP and Inflation figures for the quarter ending September are out . And they look promising indeed . GDP at 9.6% although a tad lower is still pretty impressive. Inflation at 3.6% per cent is a little more than August’s 3.5% .

Default template

The figures mean that  China is growing robustly and the economy is not yet on the threshold of overheating . And this provides an interesting perspective to Tuesday’s interest rate hike by the Peoples Bank of China .

The 25 basis point interest rate hike, the first in three years ,  was in itself not a ground shaking event. But it had a huge psychological impact . Markets all over the world were spooked amidst fears that the world’s fastest growing economy is overheated and planning to curb growth .

Although the markets are right to worry about the overheating of Chinese economy, Tuesday’s move by the Central Bank ,like all things Chinese , was based on  much more complex, and political, reasons.

This rate hike is to be seen as a signal to US before the coming G-20 summit . One of the major argument proposed by US favouring a devaluation of the Yuan was based on the premise that a weak Yuan causes inflation in China , and in todays era of sluggish economic growth it is in China’s interest to let the Yuan appreciate rather than going for the more risky option of interest rate hike. China has hit back by doing the exact opposite.

China has let it be known that it has enough confidence in its growth to accept the risk of interest rate hikes. Tuesday’s cuts are a signal to the world that the China is not going to do much about its currency and would prefer to handle any inflationary pressures through domestic policies.

Impressive indeed . But behind all this nationalistic grandstanding , lurks a very real and potent danger to the Chinese miracle : a rapidly building asset price bubble. And  the Chinese leaders, who are busy proclaiming the resurgence of their nation and letting it be known to the whole wide world that China would not cave in to any external pressure ever again,  are doing precious little to tackle it.

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China is awash in money. As the great Chinese middle class becomes richer and richer, a boom mentality is setting in . Interest rates in the Chinese informal market are running at 20%, rates that were last seen during the dot com bubble in US. There is a mad rush towards the real estate sector. Couples are faking divorces to get past the “one house per  family” policy. High-end property prices in dozens of Chinese cities have doubled during the global financial crisis.   An asset price bubble, particularly in the real estate sector , appears to be rapidly building up.

Sooner or later this asset price bubble would spill over as inflation in the customer price index . Although, the September figures show only a marginal increase, there is a clear and persistent danger of inflationary trends in the Chinese economy.

Precious little is being done by the Chinese political mandarins to rectify the situation . Much of Chinese competitiveness , as this article points out , is based on low interest rates. The Chinese government is worried about the potential adverse effects any monetary tightening could have on this competitiveness. More worryingly, powerful political interests in China have vested interests in not letting the rates rise . Tuesdays interest rate hikes, by their relative ineffectuality, serve to demonstrate, at least for the time being,  the unwillingness of the government to tackle the situation head on .

But again , we must not rush to draw conclusions . One of the best strategy when dealing with the Dragon is patience. Let us wait and watch , because this could well turn out to be more complex than it seems .



There is war brewing. The guns are primed, the sights set, and the enemy marked.  The soldiers are jittery, and the atmosphere explosive. A rash action by either party could trigger a ferocious war causing untold mayhem .

No , I am not talking about Israel standoff with Iran. I am talking about the currency wars which government officials of both China and US are preparing to fight.

The innocuous sounding “H. R. 2378 — Currency Reform for Fair Trade Act” was passed by the US House of Representatives  by a vote of  348 to 79 on 28th of September .  The bill calls for the US Department of Commerce to start imposing – even without approval by US President Barack Obama — punitive tariffs on certain countries. The initiative specifically targets countries that have “a fundamentally undervalued currency,” “persistent global current account surpluses” and very large currency reserves – in other words, China.

Ahead of the impending elections and faced with massive unemployment and sluggish economy, the US politicians are baying for Chinese blood. They want to put and end to the deplorable Chinese practice of currency manipulation, which makes Chinese exports cheaper and causes US industries to shut shop.


Unequal Competition


But the Chinese are in no mood to oblige. They are determined not to suffer the same fate as Japan of the 1980’s. Under US pressure the Japanese were forced to let yen appreciate. Within one year, the value of the yen had increased by some 60 percent. In order to balance out the negative consequences of the revaluation for the country’s export industry, the Bank of Japan lowered interest rates to nearly zero, thereby triggering a huge speculative bubble on the stock exchange and the real estate market. Even today, Japan has still not recovered from the prolonged crisis that ensued.

And then there are political considerations.  The Chinese government, which has long positioned itself as crusaders to restore Chinese glory, cannot afford to lose face in front of their domestic constituency by bowing to Chinese demands.

So I guess, the Chinese won’t do anything except a slow and gradual revaluation of their currency, which gives time to their export industries to adjust.

Uncle Sam can now either it its own words or proceed with sanctions. Under Republican pressure and increasingly being branded as a weak president, Obama cannot afford to do nothing.  He would  go for sanctions. And then we can kiss free trade and the recovery of the world economy goodbye.

It would be like the 1920’s and 1930’s. European powers bent upon reviving their sluggish economies indulged in protectionist policies that ultimately led to a deflationary cycle and ultimately the Great Depression.

There is a lot at stake, and I am keeping my fingers advised. In the meantime I am buying gold , I will advise you do the same.


Gold prices


The New Silk Route

October 3, 2010

A cursory look at a map of Eurasia will shortly reveal a very interesting fact. All the major centres of civilization ( and power) are on its periphery. Whether it is India in the South, China in the East, Russia in the North or Western Europe in the West .  And for millennia these civilizations have traded and communicated with each other through that vast thoroughfare of humanity : the Central Asian Steppes.

Ever since the dawn of humanity , Central Asia has been crisscrossed by caravans laden with exotic items bound for distant lands.  These trade routes, sometimes collectively called the Silk Route have served as arteries of trade and also , and perhaps more importantly, conduits for exchange of ideas .

Silk Route in the first century AD( Courtesy : Wikipedia)

As networks connecting nodes of civilizations and wealth, they hade immense geopolitical significance.  Nations had vied for their control and much blood has been spilled on the steppes to decide who can tax the rich caravan trader . Some of the world’s most ferocious conquerors, Ghenghis Khan, Tamerlane started their careers with a desire to become the master of this lucrative trade route.

For India, participation in and control of these trade networks was always vital.  Through the millennia, access to and control of the southern part of this route was essential for the vibrancy of our economy and the safety of our country .In fact , the patterns in decline of Indian power and trade closely corresponds to loss of our ability to project power on the southern branch of the silk route.

This trade route eventually lost its importance with the Portuguese and Spanish discovery of sea routes to Asia. Soon, the Silk Road was forgotten and relegated to the history books as an exotic relic of a bygone era.

Now in the twenty first century, these trade routes are once again been revived.  And not just for trade.

From Kashgar to Constantinople, from Lhasa to Tehran, the Chinese are quietly reactivating these old trade routes that once served  not only as channels for the export of Chinese goods but also Chinese power projection.

And this time , it is not  silk that is the principal commodity and it is not the caravans of  two humped Bactrian camel , it is a motley collection of Chinese manufactured goods travelling on shiny new  railway lines that the  are being laid down to connect most of Central Asia and beyond with China.

The proposed extension of Qinghai- Tibet railway line and the proposed Kashgar- Gwadar railway line, would help integrate the Chinese rail network with that of Pakistan.  The Pakistanis on their part are in talks with the Turks and the Persians to create an Ankara- Islamabad link.  This network could eventually be extended all the way to Europe.  There are already talks of a Berlin to Beijing network .

For the Chinese, such a project would be immensely beneficial. Their goods would be able to find markets in not only Europe but also in the rapidly growing and populous economies of Pakistan, Iran, Turkey, Uzbekistan etc.  This will also help them in securing direct access to the oil rich Persian Gulf and Arabian Sea, thus reducing their vulnerability to disruption of their sea-borne oil imports.

The Middle kingdom could leverage this to integrate Central Asia more tightly into its sphere of influence. And combined with the dual nature of these projects, they will give China an unmatched ability to project power anywhere in Asia.

The ramifications of this project would be far-reaching and would change the whole structure of world trade and politics.  And if succesfully executed could indeed make China as the dominant world power of the 21st century.

There is no denying that this reactivation of the old Silk Route will be a seminal event in world trade and geopolitics. Sadly, India once again doesn’t have any means to participate or project power on this new avatar of Silk Route.

Despite everything, the Chinese economy has shown incredible resilience recently. Although its biggest customers — the United States and Europe — are struggling (to say the least) and its exports are down more than 20 percent, China is still spitting out economic growth numbers as if there weren’t a worry in the world. The most recent estimate put annual growth at nearly 8 percent.

Is the Chinese economy operating in a different economic reality?  Will it continue to grow, no matter what the global economy is doing?

The answer to both questions is no. China’s fortunes over the past decade are reminiscent of Lucent Technologies in the 1990s. Lucent sold computer equipment to dot-coms. At first, its growth was natural, the result of selling goods to traditional, cash-generating companies. After opportunities with cash-generating customers dried out, it moved to start-ups — and its growth became slightly artificial. These dot-coms were able to buy Lucent’s equipment only by raising money through private equity and equity markets, since their business models didn’t factor in the necessity of cash-flow generation.
Funds to buy Lucent’s equipment quickly dried up, and its growth should have decelerated or declined. Instead, Lucent offered its own financing to dot-coms by borrowing and lending money on the cheap to finance the purchase of its own equipment. This worked well enough, until it came time to pay back the loans.
The United States, of course, isn’t a dot-com. But a great portion of its growth came from borrowing Chinese money to buy Chinese goods, which means that Chinese growth was dependent on that very same borrowing.
Now the United States and the rest of the world is retrenching, corporations are slashing their spending, and consumers are closing their pocket books. This means that the consumption of Chinese goods is on the decline. And this is where the dot-com analogy breaks down. Unlike Lucent, China has nuclear weapons. It can print money at will and can simply order its banks to lend. It is a communist command economy, after all. Lucent is now a $2 stock. China won’t go down that easily.
The Chinese central bank has a significant advantage over the U.S. Federal Reserve. Chairman Ben Bernanke and his cohort may print a lot of money (and they did), but there’s almost nothing they can do to speed the velocity of money. They simply cannot force banks to lend without nationalizing them (and only the government-sponsored enterprises have been nationalized). They also cannot force corporations and consumers to spend. Since China isn’t a democracy, it doesn’t suffer these problems.
China’s communist government owns a large part of the money-creation and money-spending apparatus. Money supply therefore shot up 28.5 percent in June. Since it controls the banks, it can force them to lend, which it has also done.
Finally, China can force government-owned corporate entities to borrow and spend, and spend quickly itself. This isn’t some slow-moving, touchy-feely democracy. If the Chinese government decides to build a highway, it simply draws a straight line on the map. Any obstacle — like a hospital, a school, or a Politburo member’s house — can become a casualty of the greater good.
Although China can’t control consumer spending, the consumer is a comparatively small part of its economy. Plus, currency control diminishes the consumer’s buying power. All of this makes the United States’ TARP plans look like child’s play. If China wants to stimulate the economy, it does so — and fast. That’s why the country is producing such robust economic numbers.
Why is China doing this? It doesn’t have the kind of social safety net one sees in the developed world, so it needs to keep its economy going at any cost. Millions of people have migrated to its cities, and now they’re hungry and unemployed. People without food or work tend to riot. To keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system stabilizes. It’s literally forcing banks to lend — which will create a huge pile of horrible loans on top of the ones they’ve originated over the last decade.
But don’t confuse fast growth with sustainable growth. Much of China’s growth over the past decade has come from lending to the United States. The country suffers from real overcapacity. And now growth comes from borrowing — and hundreds of billion-dollar decisions made on the fly don’t inspire a lot of confidence. For example, a nearly completed, 13-story building in Shanghai collapsed in June due to the poor quality of its construction.
This growth will result in a huge pile of bad debt — as forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple: There is no miracle in the Chinese miracle growth, and China will pay a price. The only question is when and how much.
Another casualty of what’s taking place in China is the U.S. interest rate. China sold goods to the United States and received dollars in exchange. If China were to follow the natural order of things, it would have converted those dollars to renminbi (that is, sell dollars and buy renminbi). The dollar would have declined and renminbi would have risen. But this would have made Chinese goods more expensive in dollars — making Chinese products less price-competitive. China would have exported less, and its economy would have grown at a much slower rate.
But China chose a different route. Instead of exchanging dollars back into renminbi and thus driving the dollar down and the renminbi up — the natural order of things — China parked its money in the dollar by buying Treasurys. It artificially propped up the dollar. And now, China is sitting on 2.2 trillion of them.
Now, China needs to stimulate its economy. It’s facing a very delicate situation indeed: It needs the money internally to finance its continued growth. However, if it were to sell dollar-denominated treasuries, several bad things would happen. Its currency would skyrocket — meaning the loss of its competitive low-cost-producer edge. Or, U.S. interest rates would go up dramatically — not good for its biggest customer, and therefore not good for China.
This is why China is desperately trying to figure out how to withdraw its funds from the dollar without driving it down — not an easy feat.
And the U.S. government isn’t helping: It’s printing money and issuing Treasurys at a fast clip, and needs somebody to keep buying them. If China reduces or halts its buying, the United States may be looking at high interest rates, with or without inflation. (The latter scenario is most worrying.)
All in all, this spells trouble — a big, big Chinese bubble. Identifying such bubbles is a lot easier than timing their collapse. But as we’ve recently learned, you can defy the laws of financial gravity for only so long. Put simply, mean reversion is a bitch. And the longer excesses persist, the harder the financial gravity will bring China’s economy back to Earth.