A Comparative Study of the Role of the Service
Sector in the Economic Development of China and
                     India
...
Introduction

         As tariffs have fallen to very low levels in many economies, trade in services
has become the focus...
to be much more gradual due to political sensitivities of certain service sub-sectors.
What are the implications of this p...
in these sectors can overcome the law of diminishing return faced by the agricultural
sector that relies on fixed factor, ...
declining to 45 per cent in 2004 can be seen in figure 1.3. India’s manufacturing
sector’s GDP contribution seemed to have...
the first 5 months of the year 2005, manufacturing GDP growth reached a record of
10.5%    against   8.1%     during   the...
Figure 1.2 Percentage of GDP by Sector, China

            (%)

    100

     90
            33     33       34.4   36.5
 ...
Source:       Center         for      Monitoring        Indian         Economy       (CMIE)


           Coming back to In...
as trade, community services, public administration, real estates
                     and transport. Hence, despite all t...
etc. This is often the case for countries that are in a transitional period in economic
restructuring.

         Once agai...
60                                                                                                                       8...
manufacturing and services barely changed in a decade. The absence of a fall in
employment in the agricultural sector is c...
Million Person

     20




     15




     10




      5




      0
                                                  ...
Table 2 India’s Service Sector Output and Employment Growth at a
                                   Disaggregate Level

  ...
initial demand for services was largely derived demand from rapidly expanding
manufacturing sector whose average annual gr...
manufacturing in the 1990s. Specifically, service input contribution to output growth
in manufacturing increased from a me...
2.          Service          Sector           Trade            and           Investment

       In the previous chapter, t...
China’s figure changed marginally during this period from 6.33 to 6.81 as can be seen
in figure 2.1 below. These figures s...
1,400,000                                                                             -

                      1,200,000  ...
sectors, that of India is highly concentrated in software and IT services 15. Figures 2.4
(a) and (b) demonstrate that Chi...
Figure 2.4 (b) Import Service: China


                  18,000

                  16,000

                  14,000

     ...
14,000


              12,000


              10,000
 US million




               8,000


               6,000


       ...
It should be noted that India’s service sector export does not defy basic
economic theory of comparative advantage. After ...
vertically integrated industries with different processes taking place in different
countries according to the cost advant...
research brief by McKinsey (2006)20, India’s national savings rate at roughly 20 % is
only half of that of China’s whoppin...
billion in 1997 to US$ 37 billion in 2003, while that for the service sector remained
flat            at             US$  ...
100%
      90%
      80%
      70%
      60%

      50%
      40%
      30%
      20%
      10%
        0%                ...
US$ Million
     7,000

     6,000

     5,000

     4,000

     3,000

     2,000

     1,000

        0                 ...
100%

     90%

     80%

     70%
                                                                                       ...
US$ Million
     1,000
       900
       800
       700
       600
       500
       400
       300
       200
       100
...
perpetual unpredictability with respect to the opening of its service markets.
Although the UPA government attempt to mobi...
involve extensive liberalization of the service sector until the year 2007.                     India
potential gains from...
schedule of commitment would be that which India submitted during the last round of
negotiation in 1994.            Since ...
According to a recent review of China's financial sector development by
Ding Lu (2006)26, the opening up of China's financ...
banks in India has increased to 25%; (b) foreigners are allowed to own up to 49% of
equity shares in private banks, which ...
The insurance market contributes to 10-15% of India’s financial asset. The
market is relatively closed with 27% foreign eq...
India’s distribution sector is highly fragmented.                 Approximately 97% of
India’s retail market is made up of...
2007, with the exception of legal and medical services. Foreign firms are prohibited
   from being engaged in local legal ...
Source:           IMD          World       Competitiveness                Yearbook   Source:        IMD          World    ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
A Comparative Study of the Role of the Service Sector in the ...
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  1. 1. A Comparative Study of the Role of the Service Sector in the Economic Development of China and India (Revised report) June 19, 2006 By Deunden Nikomborirak Thailand Development Research Institute
  2. 2. Introduction As tariffs have fallen to very low levels in many economies, trade in services has become the focus of interests for the studies of both trade and development in lieu of trade in goods. Experiences show that an economy – regardless of the level of development -- cannot maintain its competitiveness in the long run without an efficient service sector. China and India, the two largest emerging economies undergoing rapid economic transformation and growth, too, have been witnessing an increasing role of their service sector. The sector contributes to bout two fifths of China’s GDP and roughly a half of that of India as can be seen in figure 1.1. Figure 1.1 Service Sector GDP share (1995 – 2004) (%) 60 50 49 49 46 46 48 48 45 45 42 42 40.7 41.7 41.5 40.7 40 38 39.3 36.5 33 33 34.4 30 20 10 0 year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 China Services 1/ India Services 2/ Source: 1/ India' data from World Development Report 2005. China's revised GDP data from Quarterly Update, February 2006, World Bank Office, Beijing 2/ IMD World Competitiveness Yearbook The drivers of the service sector growth in the two countries differ, however. . China has a solid domestic manufacturing base from which services grow, while India’s economy appears to leap directly from agriculture to services, driven by external demands for IT related services. Looking into the future, China’s broad and deep WTO accession commitments will have significant implications to the country’s service sector development. India’s unilateral liberalization, on the contrary, is likely 2
  3. 3. to be much more gradual due to political sensitivities of certain service sub-sectors. What are the implications of this policy divergence to the future role of the service sector to the economies of India and China? This study shall review and compare the role of the service sector in China and India in the context of the development of the domestic economy and integration with the global economy. At the same time, it also seeks to make rough predictions with regard to likely future trends given the current policy environment. The organization of the paper is as follows. The first chapter provides an overview of service sector’s contribution to national income and employment in both countries. The second chapter looks at services in the context of international trade and investment in order to gauge the extent to which foreign markets and capital played a role in the development of both countries’ service industry. The third chapter examines and compares the two countries’ policies with regard to service sector liberalization in order to be able to speculate future trends and patterns of their respective service sector growth. The final chapter concludes on the findings of a comparative study of China’s and India’s service sector development. 1. Service Sector’s Contribution to Economic Development Empirical studies in development economics reveal that most developing countries undergo a similar economic structural shift through the course of economic development with shrinking agricultural sector and expanding manufacturing and service sector. For example, Chenery and Taylor (1968) found that a country’s industrial GDP and employment shares tend to rise as it becomes richer at the expense of agricultural sector’s share, except for economies that rely heavily on exports of primary products. At higher income level, income and employment shift to services. These findings are based on empirical tests that employed large cross-country data sets1. The reason for such a structural shift can be explained from both the supply and the demand side. From the supply side, growth in manufacturing and services may outpace that in agriculture because of the employment of technology and capital 1 Chenery, Hollis, B. and Lance Taylor (1968). "Development Patterns: Among Countries and Over Time," Review of Economics and Statistics, November 1968, 391-416
  4. 4. in these sectors can overcome the law of diminishing return faced by the agricultural sector that relies on fixed factor, namely land. As the industrial sector grows, demand for particular services, such as transportation, housing and construction naturally increases, giving further stimulus to the service sector. On the demand side, the expanding share of manufacturing and service sectors is believed to be contributed by higher income demand elasticity for manufacturing products, and even higher for services products. That is, as income rises, the population demands proportionately more of manufacturing and service products and proportionately less of agricultural products. Available secondary macroeconomic data collected in this study reveals that the development of the service sector in China seems to closely follow the historical pattern experienced by both developed and developing countries, while India’s shift out of agriculture directly into services appears to diverge from the common path. 1.1 Contribution of the Service Sector to GDP As can be seen in figure 1.2, during the past 10 years, China’s service sector’s GDP contribution increased significantly. In the year 1995, service sector contributed to just 3 per cent of China’s GDP. The figure changed to 40.2 per cent in 2004, an increase of 7.2 percentage points. Manufacturing sector’s share, however, decreased marginally by 2 per cent from 48 to 46 per cent during that time. The expanding service sector GDP share came mainly at the expense of the agricultural sector share, which declined from 0 per cent to 13 per cent as shown in figure 1.2. It is therefore clear that, during the last decade, the manufacturing sector boom in China has led to an even higher growth in the tertiary sector and that service sector growth has been facilitated by the release of resources from the least dynamic sector, the agricultural sector. In contrast, India's service sector growth has clearly been the engine of growth of India’s economy during the last decade. Service sector contribution to the national GDP increased from 42 per cent in 1995 to 49 per cent in 2003, before 4
  5. 5. declining to 45 per cent in 2004 can be seen in figure 1.3. India’s manufacturing sector’s GDP contribution seemed to have fallen over time from 28 per cent in 1995 to 27 per cent in 2004. Unlike China, however, India's manufacturing has never experienced double digit growth. Mitra, Devashish (2006)2, found that rigid labor market due to state labour rules and regulations3 and lack of infrastructure development are the two key factors hindering labor productivity improvements, employment and capital accumulation that would spur progress in India's manufacturing sector. It is interesting to note that, while India’s sectoral GDP share appears to indicate a declining agricultural share, the annual figures appear rather unstable as can be seen in figure 1.4 below. This is due mainly to the inherent volatility of India’s agricultural output due to its heavy dependence on the monsoon. Consequently, service sector’s GDP share also appears to vacillate. For example, the marked decline l in the service sector GDP share in the year 2004 resulted from a particularly good agricultural year. According to the Centre for Monitoring Indian Economy (CMIE)4, agriculture sector grew by 9.3% in 2003-2004, against 8.9 % for services. However, the sector’s growth, as unpredictable as it has been, is likely to be less than 1 per cent in 2005-2006. Another interesting point about India’s sectoral development is the rising prominence of the manufacturing sector. Figure 1.4 illustrates how industrial sector’s growth is catching up with that of the service sector. According to the CMIE, during 2 Mitra, Devashish (2006), INDIAN Manufacturing: A Slow Sector In a Rapidly Growing Economy, Department of Economics, The Maxwell School of Citizenship and Public Affairs, Syracuse University, New York 3 The Industrial Disputes Act (IDA) requires firms employing more than 100 workers to obtain a permission from state governments in case of layoffs. Obtaining such a permission may be difficult due to political reasons. Also, the Industrial Employment Act stipulates that employers with 100 or more workers (50 in some states) must specify the terms and conditions of employment for each employee. This can pose a major hurdle in the event where a firm needs to respond to changing market conditions and intra-company transfer is required since modification of the terms and conditions cannot be amended without the consent of the employee. 4 South Asia,” India Mills Get Busy”, July 15, 2005. http://www.atimes.com/atimes/South_Asia/GG15Df01.html
  6. 6. the first 5 months of the year 2005, manufacturing GDP growth reached a record of 10.5% against 8.1% during the same period a year earlier. The rising prominence of the manufacturing sector is also underscored by the sudden surge of FDI into the industrial sector in 2004 as will be discussed in chapter 2. Industries that are major recipients of FDI include automobile and components, pharmaceutical, electronic devices and industrial equipments. While it may be somewhat too soon to conclude, these figures signal that India’s manufacturing may finally be emerging out of its long dormancy, following a series of economic reforms that have gradually taken place in India over the last decade. 6
  7. 7. Figure 1.2 Percentage of GDP by Sector, China (%) 100 90 33 33 34.4 36.5 80 38 39.3 40.7 41.7 41.5 40.7 70 Services 60 Industry Agriculture 50 47.2 47.5 47.5 40 46.2 45.8 45.9 45.2 44.8 46.2 46 30 20 10 19.8 19.5 18.1 17.3 16.2 14.8 14.1 13.5 12.5 13.1 year 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Source: World Bank Office, Beijing (2006), Quarterly Update: February 2006 Figure 1.3 Percentage of GDP by Sector, India (%) 100 90 80 42 42 46 45 46 48 48 49 49 45 70 Services Industry 60 Agriculture 50 28 30 40 26 30 26 25 27 27 26 26 30 20 30 28 27 28 28 28 25 25 25 25 10 year 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Note: Data year 1999 from WDI, Data other years from IMD Source: 1. IMD World Competitiveness Yearbook 2. World Development Indicators (WDI) database Figure 1.4: India’s Annual GDP Growth by Sector
  8. 8. Source: Center for Monitoring Indian Economy (CMIE) Coming back to India’s service sector, looking at growth figures of various service sub-sectors reveals the following: (1) the sector’s growth has been concentrated in a few service sub- sectors, namely, business services, communications, banking and hotel and restaurant services. (2) service sectors experienced highest growth rates are those most open to FDI, perhaps with the exception of banking that still maintains certain restrictions concerning foreign ownership of local banks. The high correlation between market openness to foreign investment and growth in India’s service sector was evidential in a report published by the World Bank5. This may be the case because of India’s particularly heavy reliance on foreign investment given the limited pool of domestic savings6. (3) legal services, real estate and transport services that are very much closed to foreign investment experienced lower growth. (4) With the exception of banking, these fast-growing service sub- sectors are relatively small in size compared to other services such 5 The World Bank (2004), Sustaining India’s Services Revolution: Access to Foreign Markets, Domestic Reforms and International Negotiations. Available at http://web.worldbank.org 6 According to McKinsey Quarterly, January 22, 2006, India’s financial stock in 2003 totaled only 0.9 billion (137% of GDP) compared with China’s 5.1 billion (323% of GDP). 8
  9. 9. as trade, community services, public administration, real estates and transport. Hence, despite all the hypes about India’s service- sector led growth, growth potentials of the country’s service sector are barely realized. Should these major service sectors become more open to domestic or foreign competition, service sector growth could be much higher than witnessed in the past. Table 1 Average Annual Growth Rate and GDP shares of Service Sub-sectors 1980s 1990s Service Sub-sectors Growth (%) GDP Growth GDP share (%) (%) share (%) Business Services 13.5 0.3 19.8 1.1 Communications 6.1 1.0 13.6 2.0 Banking 11.9 3.4 12.7 6.3 Hotels and Restaurant 6.5 0.7 9.3 1.0 Community services 6.5 4.3 8.4 5.5 Trade (Wholesale and retail 5.9 11.9 7.3 13.7 trade) services Other 5.3 1.0 7.1 1.7 Transport 6.3 3.8 6.9 4.3 Insurance 10.9 0.8 6.7 0.7 Public Administration, defense 7 6.0 6 6.1 Legal services 8.6 0.0 5.8 0.0 Dwelling, Real estates 7.7 4.8 5 4.5 Personal services 2.4 1.1 5 1.1 Railways 4.5 1.4 3.6 1.1 Storage 2.7 0.1 2 0.1 Source: Reproduced from Gordon and Gupta (2004). 1.2 Employment in the Service Sector Stylized facts reveal that GDP and employment shares are usually closely related. Mobility of labour ensures that productivity levels across different sectors of the economy are equalized. However, in practice, labour is not perfectly mobile across sectors due to many obstacles such as skill requirements, relocation of labour,
  10. 10. etc. This is often the case for countries that are in a transitional period in economic restructuring. Once again, on the employment front, China seems to follow the common pattern experienced by most other developed and developing countries, while India stands out as a unique case. As can be seen in figure 1.6, since 1995 China’s service sector’s employment share has been on the rise continuously, roughly in keeping with the sector’s GDP contribution. In the year 1995, service sector contributed to 33 per cent of the country’s GDP and 28.2 per cent of employment. Seven years later in the year 2002, the figures were 41.7 and 33.5 respectively. That is, an increase in service sector value added share by 8.7 percentage points was accompanied by an increase in labour share by 5.3 percentage points. China's service sector employment elasticity during this period is calculated to be 1.6. Such has not been the case in India. In 1995, service sector contributed to 42 per cent of the country’s GDP and 67 per cent of its total employment. This would indicate a relatively low labour productivity in the service sector. The figures in 2002 were 49 and 69 respectively. That is, while service sector’s GDP contribution rose by 7 per cent, its contribution to employment merely increased by only 2 per cent. This implies that the employment elasticity of India’s service sector is roughly 0.3, which is extremely low compared with China’s figure of 1.64. Looking into each country’s sectoral employment data shown in figure 1.7, it became obvious that the increase in China’s service sector employment was made possible by the inter-sectoral shift of labour supply mainly from the manufacturing sector, and, to a lesser extent, the agricultural sector. The decline in employment against rapid output growth in China’s manufacturing sector indicates a marked productivity gains. Figure 1.6 Service sector contribution to Employment 10
  11. 11. 60 80 68 68 69 70 50 67 67 67 67 68 46 48 49 46 45 48 42 42 42 60 41 Employment share (%) 38 39 40 37 GDP share (%) 34 50 33 33 30 40 32.2 33.5 30.5 30.6 31.6 28.2 28.9 29.8 30 20 20 10 10 0 0 1995 1996 1997 1998 1999 2000 2001 2002 GDP (China) GDP (India) Employment (China) Employment (India) Source: Service sector employment share calculated from data appeared in tables 1.7 and 1.8 below Figure 1.7 Employed Persons in China Million Person 400 300 200 100 0 year 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Agriculture Manufacturing Services Government Agencies etc Source: China Statistical Yearbook 2004 Turning to India, a striking feature of the employment data during 1993-2003 shown in figure 1.8 is that the number of persons employed in agriculture,
  12. 12. manufacturing and services barely changed in a decade. The absence of a fall in employment in the agricultural sector is contradictory to most countries’ experience. India’s jobless service sector growth stems from the fact that the sector’s growth has been driven largely by only a few service sub-sectors – i.e., banking, telecommunications and IT-enabled services. Additional employment generated by these sectors was not able to offset the rapidly falling labour demand elasticity faced by other service sub-sectors as productivity level rises from extremely low levels as discussed earlier. The study by Banga (20057) reveals that in the nineties India experienced a sharp fall in the employment elasticity in certain large, fast growing service sub- sectors, namely government and banking services. For example, the employment elasticity of government services fell from 0.5 during 1983-84 – 1993-94 to 0.07 during 1993-93 – 1999-2000, while that for financial services fell from 0.92 to 0.73. This is because of major improvements in technology employed by new entrants to the market as well incumbents helped cut down labour input and boost productivity. A report by McKinsey and Co (2001) 8 confirmed large productivity gains contributed to the unspectacular employment record of India service-sector led growth. The report estimated labour productivity in 6 service sectors, namely, energy distribution, housing construction, retail distribution, retail banking, software and telecommunications. It found that India’s software services that experienced the most rapid growth have the highest productivity levels, followed by telecommunications, banking and construction. On the contrary, retail distribution, energy distribution and hosing construction that are closed to foreign investment experienced significantly lower productivity level. Figure 1.8 Employed Persons in India 7 Banga, Rashmi (2005), Critical Issues in India’s Service-led growth. Working paper No. 171, Indian Council for research on International Economic Relations. Paper available on line at www.icrier.org 8 McKinsey & Co. (2001), India: The Growth Imperative: Understanding the Barriers to Rapid Growth and Employment Creation. 12
  13. 13. Million Person 20 15 10 5 0 year 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Agriculture Manufacturing Services Source: Economic Survey 2005-2006. Ministry of Finance, India. Http://indiabudget.nic.in/es2005-06/esmain.htm Looking closer at the sub-sector level in table 2, one finds that the only two service sub-sectors that experienced high employment growth in the nineties are telecommunications and computer-related business. Again, these three services represent “islands” in the large sea of the service sector that remain highly protected. It is also noteworthy that the banking sector, which has experienced relatively healthy growth, did not contribute much to employment. This is due to the displacement of workers from inefficient public sector banks as the country gradually liberalized its banking sector after a spade of nationalization of banks in 1969 and 1980. In light of the banking sector experience, the opening of the India’s other service sub-sectors occupied by state-owned enterprises saddled with excessive employment is likely to have a small impact on employment prospects.
  14. 14. Table 2 India’s Service Sector Output and Employment Growth at a Disaggregate Level Service Sub-sectors Value-added Growth in Employment Growth 1990s (%)* between 1993/1994 & 1999/2000** 1 Computer related Business Services 19.8 services – 20.6 % s Other business services – 11.6% 1 Telecommunications - 33 Communications 13.6 % % Postal – 6% P Courier – 6.2% Banking 12.7 4.3 Hotels and Restaurant 9.3 7.3 Community services 8.4 NA 7 Wholesale – 6.4% Trade (Wholesale and retail 7.3 W Retail – 7.1% trade) Other services 7.1 NA 6 Air transport – 6.2% Transport 6.9 A Water transport – 2.6% W Road transport – 6.5% Insurance 6.7 3.8 Public Administration, defense 6 NA Legal services 5.8 6.2 Dwelling, Real estates 5 6.2 Personal services 5 NA Railways 3.6 3.2 Storage 2 NA Source: * from table 1; ** from The World Bank (2004), Sustaining India’s Services Revolution: Access to Foreign Markets, Domestic Reforms and International Negotiations. Available at http://web.worldbank.org 1.4 Summary The role of the service sector in the economic development in China and India during the last decade has been markedly different as follows. First, the role of the service sector in China has been mainly to facilitate domestic production and trade in goods, while growth in service sector in India was triggered by external demand for software and IT-related services. It should be noted, however, that while China's 14
  15. 15. initial demand for services was largely derived demand from rapidly expanding manufacturing sector whose average annual growth during 1978-2005 was a spectacular 17%9, higher income levels among its population eventually spurred growth in other consumers-oriented services such as tourism. Second, China’s service sector growth is highly employment elastic, while that in India, employment contributions fell far behind that of income. This has been the case because the sector's growth engine, which concentrates narrowly on a few export-oriented sub-sectors, was not able to generate sufficient employment to offset the sharp fall in employment elasticity experienced in other service sub-sectors resulting from productivity improvements. It is probable that the rising prominence of India's service sector preceding that of the industrial sector is nothing more than a temporary blip in the country's development path. The long overdue industrial reform that has been holding back the manufacturing sector growth is finally producing some visible results with recent statistics showing impressive industrial sector growth coupled with strong FDI figures. In other words, the dynamism of India's service sector led growth is only relative, rather than absolute. That is, if manufacturing industries were free from stifling state rules and regulations and were more open to foreign investment, the service sector would certainly not have attracted all the limelight. The local manufacturing sector would have been able to fully exploit the wealth of skilled and semi-skilled labour that India had to offer foreign multinationals. And India would have gained a strong comparative advantage in many of its manufacturing products, in particular those that employ IT and business services more intensively. Nevertheless, the role of the service sector during the last decade should not be overlooked. According to an empirical work by Banga and Goldar (200410), growing use of services had a significant favorable effect on growth of output of Indian 9 India' data from World Development Report 2005. China's revised GDP data from Quarterly Update, February 2006, World Bank Office, Beijing 10 Banga, Rashmi and B.N. Goldar (2004), Contribution of Services to Output Growth Productivity in Indian Manufacturing: Pre and Post Reform, ICRIER Working paper No. 139.
  16. 16. manufacturing in the 1990s. Specifically, service input contribution to output growth in manufacturing increased from a mere 1 per cent in 1980s to 25 per cent in 1990s. The end of India’s service-sector led growth will be welcomed by many critics of India’s IT-service led export growth. The limitation of such a growth pattern is well recognized in many studies, in particular that by Papola (2005)11. He noted that since service exports represent only 6 per cent of the service sector output12, very high growth is required to sustain the imbalance between the goods and the services account13. Moreover, sustaining such high export growth can prove elusive, given the emergence of many alternative outsourcing centers among low-wage countries. India is in dire need to diversify its export base. 11 Papola, T.S. (2005), “Emerging Structure of India Economy: Implications of growing Inter-Sectoral Imbalances”, Presidential Address, at the 88th Conference of Indian Economic Association, Andhara University, Vishakhapatram, Sec 27-29, 2005. 12 Papola ibid. 13 Already, India is experiencing sharp deterioration in its trade account. Trade deficit rose from US$ 15.4 billion in the year 2002-2003 to US$ 38.1 billion in 204-2005. The figure for the first quarter of 2005-2006 has already reached US$ 16 billion according to the article “India as a Global Power”, Aspects of India Economy, No.41, December 2005. The paper is available at www.rupe- india.org/41/reality.html 16
  17. 17. 2. Service Sector Trade and Investment In the previous chapter, the role of the service sector in the context of China’s and India’s economic development is assessed. In this chapter, the focus will shift instead to the extent to which these countries’ service sector growth and development rely on foreign markets or capital and technology. Perhaps it is important to begin by pointing out the fundamental difference in the formation of India’s and China’s trade and investment policies during the last decade. As a centrally planned economy, China has been able to steer its economy along a more liberal path with little political hurdles. Since 1978, the country took steps to gradually opening up its domestic market to foreign trade and investment, culminating into its accession to the WTO in 2001. In a democratic political system, liberalization policy is bound to attract opposition from many interest groups. On the contrary, India’s economic reform since the eighties has been piecemeal and intermittent. This is likely due to the country’s political environment since, unlike the centrally-planned China, India is a multiparty democracy. Hence, external policy must tune itself to the delicate political balances. Coalition governments are often made up of parties with dissimilar economic philosophies and beliefs. Frequent changes in government also disrupt the continuity of economic reforms. Nevertheless, it should be noted that India’s commitment to economic reform since the early nineties has remained in tact until now, despite a few changes in the government along the way. It is against the backdrop of this general political and economic environment that the services trade and investment performances of the two countries will be assessed in the following sections. 2.1 Trade There is not doubt that China’s astounding manufacturing export growth economy has done much to integrate the country with the global economy. In terms of services trade, however, India has a higher share of services trade to GDP figure. During the year 1995 – 2002, both experienced rising share of services trade to GDP. India’s figure almost doubled from 4.65 per cent in 1995 to 8.57 cent in 2002.
  18. 18. China’s figure changed marginally during this period from 6.33 to 6.81 as can be seen in figure 2.1 below. These figures seem to indicate that services trade still plays a very limited role in the overall development of India’s and China’s economy, even for India where services export contributed to 34 per cent of total export in 200414. A striking difference between China’s and India’s service trade is that while India recorded continuous improvement in the service trade balance from over US$ 4 billion in deficits in 1995 to US$ 6 billion surplus in 2002, China’s figure deteriorated. It began with a deficit of approximately US$ 6.5 billion in 1995 and ended up with almost US$ 7 billion in 2002 as can be seen in figure 2.2. These figures are consistent with the analysis in section 1, which describes the service sector as India’s economic growth engine, while that in China is secondary to the manufacturing trade. Figure 2.1 Services Trade as a Percentage of GDP (1995 – 2002) 10.00 8.00 8.57 7.06 7.65 7.63 6.33 6.81 6.00 5.85 6.22 5.83 6.15 6.26 5.29 5.14 5.34 4.65 4.77 4.00 2.00 - 1995 1996 1997 1998 1999 2000 2001 2002 China India Source: Calculated from services trade data from Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003 Figure 2.2 China’s Net services trade and GDP (1995 – 2002) 14 Karmakar, Supana (2005), Indian-ASEAN Cooperation in Services – An Overview, ICREAR Working paper No 176, pp 16. The paper is available on line at www.icrier.org/WP176.pdf 18
  19. 19. 1,400,000 - 1,200,000 -1,000 -2,000 1,000,000 Services (US million) GDP (US million) -3,000 800,000 -4,000 600,000 -5,000 400,000 -6,000 200,000 -7,000 - -8,000 1995 1996 1997 1998 1999 2000 2001 2002 ye ar GDP Net services Source: 1. Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003 2. International Financial Statistics Yearbook 2004. IMF. Figure 2.3 India’s Net services trade and GDP (1995 – 2002) 600,000 8,000 500,000 6,000 4,000 Services (US million) 400,000 GDP (US million) 2,000 300,000 - 200,000 -2,000 100,000 -4,000 - -6,000 1995 1996 1997 1998 1999 2000 2001 2002 ye ar GDP Net services Source: 1. Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003 2. International Financial Statistics Yearbook 2004. IMF. A closer look at the composition of the services trade in the two countries reveals that while China’s trade in services covers a broad range of service sub-
  20. 20. sectors, that of India is highly concentrated in software and IT services 15. Figures 2.4 (a) and (b) demonstrate that China experienced an increase in the export of tourism, business services and transport services. At the same time, it imported a wide variety of services supporting its manufacturing production activities, such as transportation, other business services, insurance and royalties and license fees. It also recorded a surge in tourism import as overseas travel increases with rising income levels. The trend and composition of China’s services trade confirm the role of services as facilitating trade and production of manufactured goods. Figure 2.4 (a) Export Service: China 25,000 20,000 15,000 US million 10,000 5,000 - 1995 1996 1997 1998 1999 2000 2001 2002 year Transportation Service Travel Communications Construction Insurance Financial Computer and information Royalties and licence fees Other business services Personal, cultural, and recreational Government, n.i.e Source: Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003 15 India’s data does not isolate IT related services from “other services” category. However, India exports of IT-enabled services include call centers, medical transcription, data entry, credit card administration, etc. 20
  21. 21. Figure 2.4 (b) Import Service: China 18,000 16,000 14,000 12,000 US million 10,000 8,000 6,000 4,000 2,000 - 1995 1996 1997 1998 1999 2000 2001 2002 year Transportation Service Travel Communications Construction Insurance Financial Computer and information Royalties and licence fees Other business services Personal, cultural, and recreational Government, n.i.e Source: Balance of Payments Statistics. Part 1: Country Tables. IMF Yearbook 2003 Turning to India’s figures, the picture is markedly different. The only service that showed a remarkable growth in export is software services. Travel, transportation, communication and management experienced less dramatic increase in export growth as can be seen in figure 2.5 (a). A similar pattern can be found on the import side where the “other services” stood out as the single service category that saw a surge in import as can be seen in figure 2.5 (b). This service category includes a very broad range of business services such as professional services, computer related services, research and development services, real estate services, rental services and other business services such as advertising services, market research and polling, etc16. Although a more disaggregate data on the import of the “other services” category is not available, the import of computer-related services would expectedly dominate this category due to the prevalence of transnational companies operating in this business in India. Figure 2.5 (a) Export Service: India 16 See list of service sectors and sub-sectors for India’s export and import classification inhttp://dgftcom.nic.in/exim/2000/appendicies/appendixword/app-36.doc.
  22. 22. 14,000 12,000 10,000 US million 8,000 6,000 4,000 2,000 - year 1997 1998 1999 2000 2001 2002 2003 Travel Transportation Insurance Government Not Included Elsewhere Communication services Construction services Financial services Software services News agency services Royalties, copyright and license fees Management services Other services Source: 1. Data year 2001-2003 from RBI Bulletin. India’ Invisibles. March 2005. http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=5978 2. Data year 1997-1999 from Aaditya Mattoo, Deepak Mishra and Anirudh Shingal. Sustaining India's Service Revolution, Access to Foreign Markets, Domestic Reform and International Negotiations, World Bank, 2004. http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/TRADE/0,,contentMDK:202114 28~pagePK:64020865~piPK:149114~theSitePK:239071,00.html Figure 2.5 (b) Import Service: India 9,000 8,000 7,000 6,000 US million 5,000 4,000 3,000 2,000 1,000 - year 1997 1998 1999 2000 2001 2002 2003 Travel Transport Insurance Government n.i.e. Communication services Construction services Financial services Software services News agency services Royalties, copyright and license fees Management services Other services Source: same as figure 2.5 (a) 22
  23. 23. It should be noted that India’s service sector export does not defy basic economic theory of comparative advantage. After all, much of India’s service exports rely on “cheap labour”, be they call-centre services, data entry services, credit card administration, etc. Even higher-value work being outsourced to India such as animation, web design, medical transcription, India is still competing on “wage costs” rather than technical innovation, at least for now. To conclude, China’s and India’s trade in services differ as follows. First, China’s continues to experienced a deficit in services trade as the economy grows, while India came out of deficit and has been in surplus ever since the year 2000. This can be taken to imply that China generally displays a comparative disadvantage in services, while India a comparative advantage. But things are not so simple in case of India. The services trade surplus has been driven mainly by strong growth in just two isolated service sub-sectors, mainly software and IT-enabled services. Services import, on the other hand, has been contained by strict FDI controls and a sluggish industrial activity. Indeed, India’s service account surplus may dissipate if and when its manufacturing sector begins to grow at a faster pace. Second, the composition of services traded in China and India is markedly different, reflecting the fundamental difference in the underlying economic structure. China’s services trade cover a broad range of “manufacturing related services” such as transportation, insurance, royalty fees, business services, etc. At the same time, with rising income level, consumption-related services such as tourism also experiences healthy growth. Services trade in India, on the hand, concentrated solely on the export-oriented service sector – i.e., outsourcing businesses. In the absence of a vibrant manufacturing base and an increase in the level of income of the general population17, India is deprived of trade in services related to production and domestic consumption. 2.2 Investment In the era of globalization, trade and FDI would likely be highly correlated for both goods and services. The “splitting up” of the production process within 17 Indeed, there is much criticism that wealth generated from service-sector is highly concentrated not only in terms of the industry and its employment, but also in terms of geography as there are only a few IT and software centers in India.
  24. 24. vertically integrated industries with different processes taking place in different countries according to the cost advantage of the specific location is a boon to both investment and trade. While globalization of the production of goods is now commonplace, that in services has only recently been made feasible by advancement in communications technology. The globalization of service is known as the “business process outsourcing (BPOs)” in services, which is gaining importance in many service sectors such as travel services, software, banking and health. As businesses decide to outsource certain activities, they would often invest in the host country to set up facilities and purchase the services from the local suppliers contributing to both FDI and trade. Mann (2004)18 pointed out that the bulk of growth in cross-border services trade involves affiliate sales. In this chapter, the extent to which FDI contributes to the growth in services trade and development in China and India will be examined. There is no doubt that China has been and still remains the magnet of foreign investment. According to the World Investment Report 200519, China received US$ 60 billion from a total of US $ 648 billion worth of global FDI, while India only US$ 5 billion. That is, China received roughly a tenth of global FDI, and India receives less than a tenth of China’s FDI. These figures illustrate clearly that FDI’s role in India’s economy has been limited. As can be seen in figure 2.6, inward FDI flow was equivalent to 5.36 per cent of the China’s GDP in 1995. The figure declined to 3.8 in 2003 as China was able to better tap the large pool of rapidly expanding domestic savings to finance economic growth with rapidly rising income and more efficient financial intermediaries. The FDI to GDP figure for India was a mere 0.59 per cent in 1995 and 0.75 per cent in 2003. It is ironic that China has been receiving more FDI than India, when the latter is clearly in dire need of FDI much more so than the former. According to a 18 Mann, Catherine (2004), Summary: Brookings Data Workshop: Service Offshoring: What do the data tell us? Paper available at www.brookings.edu.pge/20040622/summaryfinal.pdf. 19 World Investment Report (2005) published by UNCTAD. Available at www.unctad.org/en/docs/wir2005_en.pdf 24
  25. 25. research brief by McKinsey (2006)20, India’s national savings rate at roughly 20 % is only half of that of China’s whopping 40%. FDI could have compensated for India’s savings shortfall. But these figures reveal that FDI widens rather than closes the savings-investment gap between China and India. India’s restrictive foreign investment policy has denied the country much needed financing to overhaul dilapidated infrastructure that has -- for a long time – posed a major obstacle to economic growth. Figure 2.6 FDI Inflows as percentage of GDP (%) 10 8 6 5.36 5.11 5.04 4.80 4 4.07 4.04 4.17 3.80 3.77 2 0.59 0.65 0.86 0.62 0.70 0.68 0.72 0.48 0.50 0 year 1995 1996 1997 1998 1999 2000 2001 2002 2003 China India Source: UNCTAD Statistical Databases On-line. http://www.unctad.org/Templates/Page.asp? intItemID=1888&lang=1 Turning to the composition of FDI inflows, one finds that, in keeping with its economic structure, FDI inflows into China have been channeled mainly to the manufacturing sector. In 1997, 63 per cent of FDI went to the manufacturing sector, 35 to the service sector and the remaining 2 per cent to agriculture as can be seen in figure 2.7(a). In 2003, the service sector’s share was further reduced to 29%, while that of manufacturing reached 70 % due to the continuous boom in the industrial sector. In terms of volume of FDI, China experienced an influx of FDI into its manufacturing sector, while inflows into the service sector remained flat. As can be seen in figure 2.7(c), FDI figure for the manufacturing sector increased from US $ 28 20 McKinsey Quarterly, 22 January 2006, “India’s Lagging Financial System”. Available on-line at www.mckinseyquarterly.com
  26. 26. billion in 1997 to US$ 37 billion in 2003, while that for the service sector remained flat at US$ 15 billion. A closer look at the FDI inflows into the Chinese service sector in figure 2.7(d) confirmed that no service sector stood out as the key attraction to FDI during 1997 - 2003. This seems to indicate that, in comparison to its manufacturing sector, China’s service sector has been less engaged with the global economy. But this may all change because of the country’s broad and comprehensive accession commitments in liberalizing its service sector that will be discussed in greater details in Chapter 3. Since 2002, China has taken measures to open up several service sectors, such as relaxing foreign ownership restrictions and geographical limitations of foreign operation in the financial, education, media and distribution sectors. Figure 2.7 (a) China’s FDI Share By Sector (1997 – 2003) 100% 90% 80% 70% Services 60% Manufacturing 50% 40% Agriculture 30% 20% 10% 0% year 1997 1998 1999 2000 2001 2002 2003 Source: China Statistical Yearbook 1998-2004 Figure 2.7 (b) China’s FDI Share By Industry (1997 – 2003) 26
  27. 27. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% year 1997 1998 1999 2000 2001 2002 2003 Farming, Forestry, Animal Husbandry and Fishery M ining and Quarrying M anufacturing Electric Power, Gas and Water Production and Supply Construction Transportation,Storage, Postal and Telecommunications Services Wholesale & Retail Trade and Catering Services Banking and Insurance Real Estate M anagement Social Services Health Care, Sports and Social Welfare Education, Culture and Arts, Radio, Film and Television Scientific Research and Polytechnic Services Other Sectors Source: China Statistical Yearbook 1998-2004 Figure 2.7 (c) China’s FDI Inflows By Industry (1997 – 2003) US$ Million Actually Utilized FDI by sector, China 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 year 1997 1998 1999 2000 2001 2002 2003 Manufacturing Construction Transportation,Storage, Postal and Telecommunications Services Wholesale & Retail Trade and Catering Services Banking and Insurance Real Estate Management Social Services Other Sectors Source: China Statistical Yearbook 1998-2004 Figure 2.7 (d) China’s FDI Inflows By Service Activities (1997 – 2003)
  28. 28. US$ Million 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 year 1997 1998 1999 2000 2001 2002 2003 Electric Power, Gas and Water Production and Supply Construction Transportation,Storage, Postal and Telecommunications Services Wholesale & Retail Trade and Catering Services Banking and Insurance Real Estate M anagement Social Services Health Care, Sports and Social Welfare Education, Culture and Arts, Radio, Film and Television Scientific Research and Polytechnic Services Other Sectors Source: China Statistical Yearbook 1998-2004 Turning to India, service sector FDI share stands at roughly half of total FDI inflows, a figure comparable with the GDP share. But service FDI share has been experiencing a gradual decline as evident in figure 2.8 (a), however. In the year 2004, 48 per cent of FDI inflow into India went into its service sector, a marked fall from 55 per cent only 2 years earlier. The simple reason for the slack in FDI in India’s service sector is that the software and IT-related businesses that are the main drivers of the sector’s growth are labour or skill-intensive, rather than capital intensive. Much of India’s capital-intensive service sector, such as transport and real estate remain very much closed to foreign investors. Examining the FDI inflows in greater level of industry disaggregation reveals that construction, financing, insurance, real estate and business services and computer services have been receiving the lion’s share of the FDI. In monetary terms, besides manufacturing, computer services and finance, insurance , real estate & business services were recent FDI attractions as can be seen in figure 2.8 (c-d). Figure 2.8 (a) India’s FDI Inflows By Sector (2002-2004)* 28
  29. 29. 100% 90% 80% 70% Services 60% Manufacturing 50% Agriculture 40% 30% 20% 10% year 0% 2002 2003 2004 Note: * Data in this table exclude FDI inflows by way of acquisition of shares by non-residents under section 6 of FEMA, 1999 Source: Reserve Bank of India Annual Report 2004-05. http://www.indiaonestop.com/economy- fdi.htm#FD Figure 2.8 (b) India’s FDI Inflows By Major Activities (2002-2004) Share of FDI: Industry-wise inflows*, India 100% Others Others Others 90% Computer Services 80% Computer Services Computer Services Financing, Insurance, Real Estate 70% Financing, Insurance, Real Estate & Business Services Financing, Insurance, Real Estate & Business Services 60% & Business Services Construction 50% Construction Construction 40% 30% 20% Manufacturing Manufacturing Manufacturing 10% 0% year 2002 2003 2004 Fisheries Mining Manufacturing Food & Dairy Products Electricity Construction Trade, Hotels & Restaurants Transport Financing, Insurance, Real Estate & Business Services Computer Services Educational Services Research & Scientific Services Health & Medical Services Other Services Others Note and Source: Same as figure 2.8 (a) Figure 2.8 (c) India’s FDI Inflows By Major Activities (2002-2004)
  30. 30. US$ Million 1,000 900 800 700 600 500 400 300 200 100 0 year 2002 2003 2004 Manufacturing Construction Trade, Hotels & Restaurants Transport Financing, Insurance, Real Estate & Business Services Computer Services Health & Medical Services Other Services Note and Source: Same as figure 2.8 (a) Figure 2.8 (d) India’s FDI Inflows By Major Service Activities (2002-2004) US$ Million 400 300 200 100 0 year 2002 2003 2004 Electricity Construction Trade, Hotels & Restaurants Transport Financing, Insurance, Real Estate & Business Services Computer Services Educational Services Research & Scientific Services Health & Medical Services Other Services Note and Source: Same as figure 2.8 (a) The declining service sector’s FDI share will likely to continue given the emergence of India’s manufacturing industry from its long dormancy against the 30
  31. 31. perpetual unpredictability with respect to the opening of its service markets. Although the UPA government attempt to mobilize private foreign investment into the construction of electricity, energy, roads, airports and seaports21, by lifting foreign ownership restrictions in many service sectors, the policy has faced with public opposition in the cases of retail business and airport modernization project and in the case of an investment in the steel industry, from the National Advisory Council22. To conclude, comparing China’s and India’s trade and investment policies, the following conclusions can be drawn. First, FDI plays a much more important role in the development of China’s economy, including its service sector, than in the case of India. Second, both China and India has been experiencing rather sluggish FDI growth in the service sector, perhaps because of the relatively closed service sector in both countries. Third, India is beginning to see large volume of FDI flowing into its manufacturing sector for the first time in 2004, while China will likely see healthier FDI inflows into its newly open service markets, in particular financial services. Thus, both India’s and China’s FDI trend may reverse their past trends respectively. 2.3 Conclusion China’s economy, including its service sector, is generally more integrated into the global economy than that of India. This is mainly because of China’s economy has been, and will likely be, more open to foreign investment than India. Bar software and IT-related services, and to a certain extent, the financial business, India’s service sector remains very much detached from the global markets with little FDI and cross-border trade. China’s cross border services trade and investment growth thus far have been driven mainly by the country’s booming industrial activities. India’s cross border services trade, on the other hand, has been concentrated in a few export-oriented services, while foreign investment has been severely constrained by the domestic investment regime that restricts foreign ownership in many services. The FDI gap is likely to widen as China continues to implement its WTO accession commitments that 21 Invest in India. http://www.indiainbusiness.nic.in/invest-india/introduction.htm 22 The Hindu Business on Line, October 11, 2005. “World Investment Report 2005 India: Not quite yet the investors' darling”. Available on-line at http://www.thehindubusinessline.com/ 2005/10/11/stories/2005101100701000.htm.
  32. 32. involve extensive liberalization of the service sector until the year 2007. India potential gains from broader service sector liberalization will likely be held back by domestic political constraints. This is the subject of discussion in the next chapter. 3. Service Sector Liberalization To what extent can past assessment of China’s and India’s service sector tell us about future trends? The answer is not a lot. This is because much of service sector’s development and performance will be shaped by the country’s policy concerning privatization, regulation and liberalization. China has made broad and deep commitments in opening up its service markets as part of its WTO accession process beginning in 2002 until the year 2007. India, on the other hand, has also made unilateral moves to open up many of its closed service sub-sectors. The pace of India’s market opening is likely to be gradual given the political constraints to which the coalition government is subject23. This chapter will examine policy commitments in case of China and policy directions in case of India with regard to the liberalization of the service sector in order to make rough conjectures on the future role of the service sector in both countries. 3.1 China’s WTO commitments in services and India’s Current Status From 2002 to 2007, many of China’ service markets will be fully liberalized. Some key service-sub sectors included in its WTO accession liberalization package includes financial services, insurance, telecommunications, media, distribution, professional services and construction. A summary of China’s commitment in major service sectors is shown in table 3 in the appendix. The same table also shows India’s current rules and regulations governing access to each service sub-sectors collected from several different sources. The reason for choosing actual rather than committed liberalization in case of India is because liberalization commitments in the GATS tend to be much more conservative than actual practices, except for new members. Moreover, the only official specific 23 The current Congress party-led government includes the Communist party that takes a more conservative view of market liberalization. 32
  33. 33. schedule of commitment would be that which India submitted during the last round of negotiation in 1994. Since 12 years have lapsed, one cannot expect those commitments to reflect the current regime. More recent offers submitted to the GATS during the on-going negotiation are not a good proxy of the future regime, since the outcome is unpredictable given the request-offer modality in negotiating. 3.2 Sectoral Comparison The following section will examine sector-specific commitment/regime in major service sectors and its likely impact on the domestic economy and foreign trade and investment. a Financial services China will be the economic power house with most open banking sector in the World by the year 2006. This is because China has committed to full access for foreign banks in 5 years. Since 2001, financial sector liberalization has been phased in by gradually relaxing foreign equity restrictions, business scope24, and geographic restrictions. China’s commitments in financial services shown in table 3 indicate that geographical restrictions will be phased out by 2006 and foreign banks will be able to make local currency loans to not only Chinese, but also foreign enterprises in the same year. To fulfill such commitments will require most radical change in the banking system that is currently dominated by 4 major state-owned banks all of which are saddled with large non-performing loans extended to state-owned enterprises. The figure for NPL of China’s banking system ranges from anywhere between the official figure of 25% and the calculated rate of 60%25. Liberalization of the banking sector will indeed threaten the survival of these banks, and in turn, state owned enterprises that rely on their unfailing credit extensions. Government subsidies to prop up these banks are also prohibited under the accession process and national treatment will have to be observed. 24 For example, a foreign bank may not be allowed to extend local currency loans to non-resident clients. 25 According to Matthias, Bekier, Ricjard Huang and Gregory Wilson. “How to Fix China’s Banking System”, The McKinsey Quarterly, 2005, No. 1 pp. 110-11
  34. 34. According to a recent review of China's financial sector development by Ding Lu (2006)26, the opening up of China's financial sector according to its WTO commitment has been on schedule so far. By the end of October 2005, 138 foreign banks have been approved for conducting Yuan-related businesses, although their combined assets totaled to only a mere 2% of China's domestic banking sector. In case of foreign currency loans where foreign banks' participation has not been restricted, however, their market share is as high as 54.5% in certain pioneering cities such as Shanghai. The Chinese government has taken major steps in dealing with large NPLs at the four state banks since the late nineties. This included a series of debt-equity swaps arrangements and capital injections. Most recently in 2004, the government has corporatized 3 of the 4 state banks and injected approximately US$ 60 billion to prepare them for IPO. This is because it believes that only a fundamental change in the ownership of these banks can solve the problem of bad loans. In October 2005, the China Construction Bank (CCB) successfully launched its IPO on the Hong Kong stock exchange, followed by the Bank of China (BoC) on the first of June 2006. While China’s banking will eventually be fully liberalized, securities business, however, will continue to bar foreign majority ownership. Foreign equity limit of 49% still applies for businesses conducting domestic securities investment, fund management business. A lower limit of 33% applies to the business of underwriting domestic equity issues. Turning to India, according to McKinsey 200627, the country’s financial system is more efficient in allocating resources than that in China. This analysis is echoed by that of the World Bank (2004)28, which found that Indian businesses have better access to loans than do their Chinese counterparts. Fifty-four per cent of Indian SMEs have access to overdraft facilities in 2002, compared with 26 for Chinese ones. India’s superior banking sector can be attributed to the fact that (a) India has allowed entries of foreign and private banks such that the market share of non-public 26 Ding Lu (2006), China's Banking Sector Meeting the WTO Agenda, China Policy Institute Discussion Paper 5, April 2006, The University of Nottingham, U.K. 27 McKinsey quarterly, 22 January 2006. “Reforming India’s Financial System”. 28 World Bank, India: Investment Climate Assessment 2004. 34
  35. 35. banks in India has increased to 25%; (b) foreigners are allowed to own up to 49% of equity shares in private banks, which helped the injection of new technology and management into private banking and (c) the government has been successful at cutting down non-performing loans such that the current NPL rate hovers around 9% of total outstanding loans. This figure is markedly lower than that China’s figure of 25-60%. Nevertheless, India’s financial system still has plenty of room for improvement. Like China, India’s banking is sprawled with state-owned banks whose efficiency drives are undermined by state-directed lending and strict labour laws. And, like China, liberalization of the banking sector has been retarded mainly due to concerns about the survival of these state banks that clearly cannot compete with foreign banks. Presently, foreign banks are not allowed to own more than 5% of equity share in an Indian bank, except when the central bank identifies weak domestic banks that require foreign takeover. Limitations on the opening of new branches also apply to foreign banks so that the scale of their businesses is circumscribed. The current plan is to open up foreign banking until the year 2009 in order to give state-owned banks some time to adjust to prepare for competition. There are no details with regard to how broad and deep the opening up of the sector will be. Given China’s commitments in opening up its banking system, it is probable that China’s financial system will soon overtake that of India, given that it is able to clear state banks NPLs problems. s Insurance China’s Insurance market is much more open and competitive than that of India. Until 2003, foreign insurance companies have been able to enter China’s market mainly through branch operations or joint ventures with 51% ownership in case of non-life and 50% ownership in case of life insurance. Their licenses have been granted on a city basis, however. The establishment restrictions have been lifted in 2003 for non-life and geographical restrictions were lifted in the following year, along with any restrictions on business scope. Foreign ownership restriction is also abolished in 2004, with the exception of 50% limit in case of life insurance that remains.
  36. 36. The insurance market contributes to 10-15% of India’s financial asset. The market is relatively closed with 27% foreign equity ceiling. However, an increase in the foreign equity share to 49% was announced by the Ministry of Finance in June 2004 and is expected to come into effect in early 2006 29. . Telecommunications sector China clearly lags behind India when it comes to the telecommunications sector. This is mainly because China’s telecommunications industry remains relatively closed compared with that of India. As can be seen in table 3, according to its accession commitments, China will continue to impose a 49% foreign equity limit for basic telecommunications services and 50% for value added services. India, on the other hand, allows 100% FDI into non-infrastructure value added services such as ISP services without gateway, electronic mail and voice mail services. For basic telecom services such as fixed line and mobile voice services, the foreign equity share is subjected to a lower ceiling of 74%. India’ relatively open regime has yielded visible results. Figures 3.1 (c) and (d) show that international telephone and mobile phone costs in India are visibly cheaper than those in China, despite the fact that the rate of telephone and computer penetration in India are far behind those in China as illustrated in figures 3.1 (a) and (b). ( Distribution Distribution services consist of 3 main service sub-sectors, namely, wholesale, retail and franchise. China’s distribution is fully liberalized except for chain stores with more than 30 outlets selling a range of products. That is, majority ownership is prohibited in retail chain stores, which sells multiple products and different brands of products such as newspaper, books and pharmaceuticals that have more than 30 outlets. It should be noted that in addition to these commitments, China has also opened up the whole logistical chains, including delivery services, storage and warehousing services, inventory management, refrigeration, etc. 29 The new rule has not come into effect as of March 31, 2006 36
  37. 37. India’s distribution sector is highly fragmented. Approximately 97% of India’s retail market is made up of small scale mom and pops store that purchase goods from similarly fragmented suppliers30. FDI in retail, regardless of size, and in franchise, has been strictly prohibited, while that in wholesale is subject to approval by the Foreign Investment Promotion Board (FIPB). However, a series of measures have been taken since the beginning of the year 2006 to help overhaul India’s distribution service. First, the long standing prohibition of foreign FDI in real estate and property has finally been lifted, paving way for a boom in the construction of new shopping malls. Second, in February 2006, the government has partially opened up the franchise business by allowing foreign investors to own 51 % equity share of retails stores selling single-brand products. Third, the opening up of the much coveted large- scale retail business is highly anticipated. After several years, Wal-Mart has been allowed to open up a market research office in Bangalore in February 2006 31. With these recent changes, India’s retail is on the verge of a boom. Like China, India’s logistic businesses have been open to FDI. Despite the legal restriction of foreign equity share at 51%, several global logistics company, such as DHL and Courier, have been granted permission to hold almost 100% equity share in local logistics businesses by the Foreign Investment Promotion Board. But in stark contrast with China, India’s notorious lack of infrastructural facilities, such as roads, rail and port, however, pose a serious constraint to the logistics business and raise overall distribution costs32. . Professional services Professional services consist of legal services, accounting, auditing and book keeping services, architecture and engineering services, urban planning and medical and dental services. China’s professional services will be very much open by the year 30 RetailME, April 4, 2006, “Passage to India”. Article available at www.retailme.com/mewspreview.asp 31 PSFK, March 14, 2006, “India’s Retail Sector Opening Up May Create a Job Boom”. Article available at www.psfk.com/2006/03/india_retail_s.html 32 The Hindu Business Line: Internet version, October 13, 2003. “Leveraging Logistics for Competitiveness.
  38. 38. 2007, with the exception of legal and medical services. Foreign firms are prohibited from being engaged in local legal affairs and are confined to undertake legal affairs in their country of origin. Foreigners are also prohibited from owning hospitals in China and the issuance of license for operating a hospital will be decided on a need-based basis. India’s professional services are relatively open for architecture, urban planning and medical services. Not so for legal and accounting services, however. International law firms are not allowed to open offices in India and partnerships with foreign professionals is prohibited. FDI is also prohibited in accounting, auditing and book keeping services and foreign professionals are not allowed to undertake statutory audits. Figure 3.1 India’s and China’s Telecommunication Sector’s Performance: A Comparison Figure 3.1 (a) Figure 3.1 (b) Number of f ixed telephone lines per 1000 inhabitants Number of computers per 1000 people number number 240 45.0 40.0 41.0 209.0 200 35.0 32.5 160 30.0 138.0 138.0 27.0 120 25.0 22.0 102.0 20.0 80 73.6 15.0 14.3 55.5 12.0 40 43.8 46.0 10.0 9.7 9.0 10.0 31.0 37.0 37.0 8.0 22.3 20.3 7.0 6.5 10.8 13.6 17.9 5.0 5.0 5.0 3.0 3.0 4.0 0 2.0 0.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 year 1996 1997 1998 1999 2000 2001 2002 2003 2004 year China India China India Note: no data available year 1999 Note: no data available year 1999 38
  39. 39. Source: IMD World Competitiveness Yearbook Source: IMD World Competitiveness Yearbook Figure 3.1 (c) Figure 3.1 (d) International fixed telephone charges Mobile telephone charges US$/ 3 min. US$ / 3 min. 12.00 0.50 10.60 10.00 0.40 8.00 0.30 6.60 6.65 6.65 6.65 6.28 6.00 5.69 5.69 5.44 0.22 0.22 0.20 4.00 0.15 0.15 3.09 2.90 2.90 2.90 0.12 0.13 2.00 0.10 1.51 0.00 0.48 0.00 1996 1997 1998 1999 2000 2001 2002 2003 2004 year 2001 2002 2003 year China India China India Note: 1. no data available year 2000 Note: Mobile telephone costs is US$ per 3 minutes in peak 2. International fixed telephone costs is US$ per 3 minutes in hours(local) peak hours to USA, for USA to Europe Source: IMD World Competitiveness Yearbook Source: IMD World Competitiveness Yearbook 3.3 Conclusion It is clear that China’s liberalization commitments upon its accession to the WTO are by far broader and deeper than India’s policy in the foreseeable future. This imply that China’s service sector will likely undergo drastic transformation in the next few years with an influx of foreign investments into service sub-sectors that were once closed to foreign investment, in particular financial, distribution and logistics services. India’s service sector’s future liberalization prospects are difficult to gauge. There are mixed signals with regard to future directions of India’s service sector. Real estate and retail trade services have been made much more open to foreign investment. At the same time, however, the government’s proposed “Postal Amendment Bill” that would prevent private operators from carrying documents weighing less than 500 grams, thereby expanding the scope of India Post’s exclusive rights, seems to be going in an opposite direction. However, given the current

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