In the aftermath of the financial crisis, emerging market economies, led by China and India, kept world growth from collapsing. As Europe again teeters on the brink of disaster and the tepid US recovery lurches along, the growth slowdowns in China and India augur rough times ahead for the world economy.
To keep these two engines of world growth on track, fiscal policy intervention must be a priority. What is needed in each country is a mirror image of the other. China needs more, well-targeted fiscal stimulus while India needs fiscal discipline. While these actions are diametrically opposed due to different circumstances in each country, they will have similar, positive effects. Fiscal policy, if executed well, could help stimulate private demand, boost business and consumer confidence and improve the effectiveness of monetary policy.
With both domestic and external demand slowing, the Chinese government faces a choice of policies to hit this year’s growth target. As in 2009-10, looser monetary policy and a rapid burst of credit expansion by state-owned banks could do the trick of boosting investment and output. But this would come at a heavy cost – a retreat from the goal of a consumption-driven economy, more wasteful investment spending and additional bad loans in the banking system.