China is currently undergoing a major shift from its investment-led, export-driven economic model to one led by domestic consumption and this transition has implications for global capital, commodities as well as the broader world economy, believes noted economist Sanjeev Sanyal.

In an interview with CNBC-TV18's Latha Venkatesh and Sonia Shenoy, Deutsche Bank Global Strategist and Managing Director Sanyal said the latest crisis in the world's second largest economy is resulting from the above-mentioned shift and it is going to alter global dynamics in a major way. "China will continue to slow down [during the transition], capital will flood out and will have to go elsewhere. It remains to be seen if countries such as the US or India can absorb this excess capital [that will flow out of China]," he said, adding that moves such as interest rate cuts by the Chinese central bank will only help smoothen the transition. The development is significant from India's standpoint as it could use cheap global capital to build capacities and overhaul its infrastructure, as well as benefit from what may be a broken commodity market for years. "But it will require leadership reform. Cost of capital has to come down structurally. Bank reforms have to take place," Sanyal said. Below is transcript of the interview on CNBC-TV18.

Latha: What have you made of the rate cut, is that even a first step for the healing of the Chinese economy and in first place is the world over estimating the Chinese slowdown? 

A: What you are seeing right now is precisely what I have been speaking about for several years now which is that China is now shifting out of its investment driven growth model and as it shifts out of that there is a huge amount of capital that it is releasing and flooding the rest of the world. So, as it cuts rates, this may smoothen the transition a little bit maybe but it will not resolve the problem which is that China will continue to slowdown, its investment rate will continue to decline and capital will keep flooding out and flooding the world which will keep the global cost of capital low irrespective of what the Fed does.

Latha: Do you think the global economy or investors are right in estimating that demand from China whether it is for consumption goods or for commodities, is going to continuously decline because that seems to be driving the mayhem in other stock markets? 

A: The fact that China’s investment rate will keep declining and will keep declining over the next decade or more is something that I have been talking about for a long time. So, I am not at all surprised by that and by the fact that China’s demand for commodities is consequently also slowing down. So, all of that is not surprising. The question now is, who in the world is going to take this huge amount of excess capital and begin to invest that and that will bring back the demand. In the end, a country like India may benefit but ultimately it has got to be the US which should be willing to take at least a significant part of this excess capital and put it into investment activity. If that happens the world will again return to massive global imbalances but at least we will get growth. However, on the other hand, if it doesn’t happen then we will slosh around in this environment of low demand, cheap capital and continuous bubbles appearing.

Sonia: How does India get impacted in all of this because what we have been left with after the devaluation of the yuan is a very big competitive disadvantage? From hereon how do you see things shape up for India? 

A: Short-term any global uncertainty, slowdown is not good for India but if you are taking a somewhat longer term perspective, a prolonged period of cheap capital and cheap commodities, both of which India needs from the rest of the world is good for India. So, if you look past this period of turbulence, potentially India could benefit from this by using this period to go out there and build up its economy. It requires however a lot of economic policy leadership in the sense that you now need to begin to reform the economy in a way that allows a big construction boom, investment activity to pick up again and so on and that in turn requires the banking sector to be reformed and the cost of capital to be structurally brought down. The rest of the world will fund us to do a lot of this but we have to take the onus on us to take on the job of reforming the economy.

Latha: Let us look at some numbers, what do you think the yuan could do, some people say that it can even go to 7 before the year us out, what is your reading? 

A: First of all, let us be very careful about how we interpret this so called crisis in China. This is not an emerging market crisis in the sense of Argentina. You are talking about China which is a huge creditor country, it has enormous reserves and internally also it has a lot of resources. So, this is a structural shift, this is not an emerging market crisis. China can defend its currency for a long time given the amount of reserves it has. 

Latha: In nobody’s mind is that China is weak in terms of defense. The question that is occurring is that will China use the currency to prop up more demand for its factories; will active yuan depreciation be the policy? 

A: There may be some pressure that they are releasing but it is not the case that they structurally keep devaluing because they are entirely aware that given how large a exporter they are, they can’t grab market share by making themselves competitive in that particular way. A small country can devalue against the world and get away with it, China is the world’s largest exporter and it can’t get away with doing that. So, I don’t think that is what they are attempting to do. They have the resources of defending their currency or at least stopping it from going anywhere in that collapse kind of way so that is not what is about to happen.

Latha: Your dollar-yuan guess would be what? At the most they go to 6.5 in 2015?

A: I think there will be at the most a small move. The real issue is completely different. It is a continuous decline in domestic demand and investment activity and the problem that there is enormous amount of historical misallocation that they are carrying with them that they need to clean up. However when they clean up, the lending process will also slowdown even further. So, this is about resolving the domestic demand, domestic investment trajectory in a circumstance where they are saving and investing half their economy and you have a situation where there is enormous over capacity in every sector, the labour force is already shrinking, population will soon beginning shrinking so this is about managing that transition to the next phase. 

Sonia: Do you think China’s monetary easing would put pressure on the Reserve Bank of India (RBI) to cut rates earlier than the September policy? 

A: It helps, the rest of the world has even cheaper capital than before but ultimately the RBI has had – the domestic circumstances should dictate this, my view has been for some time that the RBI has plenty of scope for reducing interest rates. The wholesale price index (WPI) as you know is in negative territory, the consumer price index (CPI) is not very high, other than onion prices and a few other food commodities there is no domestic demand led pressure on inflation. There is scope for very large declines in interest rates; not small ones but large ones.

Latha: Given your assessment of Chinese economy and its ability to consume commodities how long, how many years do you think this commodity down cycle could last? Steel is USD 320 HRC, for how long now – two years or three years?

A: You are misinterpreting, this is a structural shift; you are talking decades from China. The question is who in world will take this on? What you are seeing here is not dissimilar to what happened in Japan in the 1990s, it has shifted from being a high investment economy to a lower investment economy. This is a structural shift. What happened to commodity prices then depends on what happens to the rest of the world. Does the US take on the onus of investment, does India do it?