Another Tale of China and India: International Reserves

In recent years, it is common that China and India are mentioned and compared in the media and academic articles. Both China and India are among the world’s oldest civilizations, and have a rather short history of economic reforms and integration with the modern global economy. The emergence of these two populous countries has presented both challenges and opportunities for the world economy. The discussion of the recent economic performance of China and, may be to a lesser extent, India is full of the usual hyperbole. It is quite obvious, however, that China and India follow two different paths to push their economies into their high growth trajectories.    

Here we consider China’s and India’s holdings of international reserves to illustrate a difference between their economies. XingWang Qian, a graduate student in UCSC compiled the data for the following discussion.  

In recent years, both China and India have experienced a substantial increase in their holdings of international reserves.

Figure 1 shows that China’s holding is much higher than the India’s one. Nonetheless, the growth rates of their international reserves are quite comparable – from 1990-2007, the average annual growth rate of China’s holding of international reserves is 32% and that of India’s is 37% and, from 2000 to 2007, the Chinese growth rate is 37% and the Indian one is 33%.[i]

 Figure 1: International Reserves: China and India

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While the two countries’ holdings of international reserves have experienced comparable growth, the sources of growth are quite different. In case of China, the popular belief, at least the one articulated in the mass media, is that China accumulates international reserves via running trade surpluses. Figure 2, in fact, shows that trade surpluses are a main, but not the only, source of the growth of China’s international reserves.

Figure 2: China: International Reserves and Trade Balances

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The case of India is quite different. The trade balance does not increase but reduce India’s holding of international reserves. For most of the time, India has a trade deficit. In fact, India’s trade deficit appears ballooning in the 2000s. Obviously, India accumulates its international reserves through other channels.

Figure 3: India: International Reserves and Trade Balances  

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Figures 4 and 5 depict the sources of China’s and India’s international reserves. Loosely speaking, China accumulates international reserves mainly via FDI and trade surpluses – with the latter source gains importance in recent years. For India, its growth in international reserves is mainly financed by non-FDI flow (some people call it hot money) and income and transfer. India is one of the largest remittance recipients. The income and transfer item in the figure is mainly dominated by remittance; India ran a current account surplus despite the large trade deficit between 2001 and 2004.

Figure 4: The Sources of China’s  International Reserves 

 

image005_01.gif  Figure 5: The Sources of India’s  International Reserves

 

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Even China and India have experienced comparable growths in their holdings of international reserves, their growths are financed through very different channels.[ii] Right now,  XingWang Qian is exploring the implications of the differences in the compositions of holdings of international reserves. A few observations are in order.  

First, India roughly finances its trade deficit with remittance. It accumulates international reserves mainly though non-FDI flow. If one believes non-FDI flows are an unstable source, then the Indian economy may be susceptible to the adverse economic effects of capital flights and sudden-stops, which can be triggered by, say policy inconsistence. Relatively speaking, China is less likely to be affected by the capital flight story; assuming that trade surpluses and FDI flows are less likely to be reversed in a short-time period.  

Second, there are costs of holding these huge sums of international reserves. One cost incurred by China and India is the interest cost of sterilizing capital inflows. Until recently, the local Chinese interest rate is lower than the US interest rate. Thus, China’s interest cost of sterilization is quite favourable. India’s version is difference – the Indian interest rate is about 3% higher than the US interest rate.  

Another cost is the foreign exchange loss. The Chinese yuan, for instance, has appreciated for more than 15% against the US since 2005. The appreciation represents a huge foreign exchange loss of holding international reserves in US dollar. For instance, 15% of the 2007 holding of 1.530 trillion is 229.5 billion, which is about 7% of China’s 2007 GDP.  During the same period, the Indian rupee has appreciated less than 10% against the US dollar. Of course, there are other costs associated with sterilization including pressures on the banking sector and domestic inflation that we do not consider here.  

Third, the differences in compositions may have implications for how to invest these international reserves. Again, if we assume the sources of China’s holding of international reserves are more stable than those of India’s. Then China should afford to invest (parts of) its international reserves in less liquid and more risky foreign assets to secure a higher (average) return.  

We do not have information about the ways China and India invest their international reserves. From the US treasury website, however, we note that, at the end of 2007, the amounts of US treasuries held by China is about 31% of its international reserves (477.6 against 1,530) and by India is about 6% (14.9 against 267). For this specific investment category, it seems China is more conservative than India.  

We appreciate if readers have any insight on these and other issues related to the differences in China’s and India’s international reserves.


  

[i]         Here are the China’s and India’s annul holdings of international reserves        

International Reserves (US$, Billions)
  India China
1990 2 30
1991 4 44
1992 6 21
1993 10 22
1994 20 53
1995 18 75
1996 20 107
1997 25 143
1998 27 149
1999 33 158
2000 38 168
2001 46 216
2002 68 291
2003 99 408
2004 127 615
2005 132 822
2006 171 1,068
2007 267 1,530

     

 

[ii]        International reserves are usually compared in the form of ratios – one of the commonly used one is the ratio of international reserves to imports. The implications of using these ratios to assess the adequacy of international reserves are examined in the article: Are All Measures of International Reserves Created Equal? An Empirical Comparison of International Reserve Ratios.

13 Responses to "Another Tale of China and India: International Reserves"

  1. satish   June 21, 2008 at 12:24 pm

    very excellent analysis. India reserve growth in last 2 years is basically because of external commercial borrowing and non-resident indian deposits.this reserve growth will lead to outflow when paid with interst over next 5 years. so RBI has to think this matter seriously when defending rupee when outflow starts because of outflow payments of external borrowings and nri deposits. Next 5 years will be troublesome if oil prices does not falll.

  2. Anonymous   June 21, 2008 at 12:50 pm

    Interesting post. As you note, China’s reserves are dominated by trade surplus and FDI, while India’s are dominated by non-FDI and remittances. This shows the kind of development path followed by these countries. China has used its comparative advantage in manufacturing, undertaken complementary structural and policy reforms to attract FDI in this sector as a result of which it has become a major source of employment. While in India reforms have been slow enough to deter FDI so that foreign capital eying short-term opportunity via strong country fundamentals, interest rate differential, appreciation arbitrage enters the country (and leaves at the same pace when domestic and global risks rise).

  3. Guest   June 21, 2008 at 12:59 pm

    Good analysis. Shows why China has a SWF while India been reluctant to set up one. More so because India’s trade deficit is mainly due to oil imports. But I think India invests more than 6% in US treasuries, may be close to 30-40% of its reserves, RBI is very conservative regarding risk and investment allocation.

  4. Anonymous   June 21, 2008 at 1:04 pm

    In the next few months, oil prices will worsen India’s trade deficit, service exports to US, EU will slow, FII is flowing out on risk aversion, global credit crisis may reduce inflow of external commercial borrowings…seems like a perfect storm for RBI in terms of monetary management and forex reserves.

  5. Guest   June 21, 2008 at 1:09 pm

    some other costs of reserves can be added to the above: costs of private sector borrowing from abroad (used by Rodrik), and cost of holding reserves vs. investing them in infrastructure and other public goods (i think in case of India the returns in these sectors will be very high). This in turn may help attract FDI flows in the future.

  6. Guest   June 21, 2008 at 1:18 pm

    Good one. As mentioned above remittances are an important source of forex reserves for India. But guess recently people have been investing in India via other sources to take opportunity of high returns rather than remitting money. For instance, investing in FII, hedge funds, private equity (real estate??) that invest money in India. So even remittances may slowly be shifting to more volatile sources. Another source of reserves are service exports but recently there have been questions about for how long India can sustain comparative advantage in the back-office model.

  7. Guest   June 22, 2008 at 7:40 pm

    So India essentially collects international reserves from hot money inflows. This may impose serious implication to the economics stability in India. Currently, India has a double digits inflation rate. How well that India adjusts its policies to deal with the high inflation will be very crucial, since any inconsistent policy can possibly trigger a self-fulfill crisis.

  8. bsetser   June 23, 2008 at 2:16 pm

    most of india’s reserves seem to be with the BIS rather than in US treasuries. India’s recorded holdings of treasuries are very low, and its latest reports on reserve management indicate that it has shifted deposits out of the commercial banking system toward the BIS

  9. Guest   June 23, 2008 at 9:10 pm

    May discuss the reserve issue with external debt management

  10. J. Bhandari   June 28, 2008 at 12:26 am

    Good Article . but we can add some more dimensions to this analysis . The article looks unidimensional . When we are comparing these two Economies we must not forget that the Chinese data includes Hongkong also.Till recently Chinese living abroad also contributed handsomely.The author is arguing is that Indian Economy is more susceptible to the external factors. I think this is more true for Chinese economy as they are more open and dependent on their exports. Thier growth is export led growth.Recent recession is going to affect Chinese more than India.We must remeber East -Asian crisis ,India came clean in that crisis and last but not the least the issue of relaibility of data. We all know the Chinese data is not fully relaible whereas Indian data is more relable.We also have to understand that there are few thing the Chinese can do as Communist country which India can’t do as democracy.

  11. satish   July 2, 2008 at 4:34 am

    China will also suffer if US goes into a severe recession. Its industries are heavily leveraged and will face capital investment led slowdown as happened in US 2001 recession. Consumers will be spared because there will be no currency crisis. But India will face a currency crisis. Consumers and investment will crack under these circumstances.

  12. Panuwatana   July 4, 2008 at 5:17 am

    In response to J. Bhandari’s comment above, I believe certain facts need to be examined. First, the major reason why the Indian economy was unaffected by the Asian financial crisis was owing more to its underdeveloped economy than anything else (think the Philippines). Second, the Chinese economy was negligibly impacted by the crisis as its market was heavily regulated (forget about capital flight) as well as its strong macros. Third, China and Hong Kong still collect their statistics separately and most analysts still treat them as separate economies (in any case Hong Kong’s reserves are only a fraction of China’s).The issue at hand is how China and India are going to come out of the emerging global crisis. Obviously China’s exports sector will suffer–the extent of which will depend on the ability of its manufacturers to cut costs, improve efficiency and secure new markets. The same is also true for India. However, the major difference is: China already has the reserves money; India does not. Now, what’s not mentioned in the article is, alas, debt.India’s external debt is about half of China’s. But its reserves, even if the Chinese data are less reliable–but keep in mind that China has been assiduously trying to underestimate its reserves figures, are meager by comparison. Combine the vulnerability of its foreign currency sources, debt issue, reliance on imports, and chronic budget deficits, unless India rethinks its development strategy it’s not going to escape a financial crisis this time around.

  13. Nirvikar Singh
    Nirvikar Singh   July 25, 2008 at 1:29 am

    Yin-Wong:In your post you seem to combine remittances and portfolio flows. These are two very different animals, with totally separate implications for vulnerability. We’ve already seen a reversal of portfolio flows to India in the last months. They are, in many ways, "hot money." But remittances often come from emigrants and temporary workers abroad, and are invested in real estate, or used for consumption within India. Thus, remittances end up looking more like income transfers or FDI. Reading the comments, I think several readers have been misled by your post as to India’s situation vis-a-vis capital flows and international reserves