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
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
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
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
Figure 5: The Sources of India’s International Reserves
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.
|International Reserves (US$, Billions)|