The Asia Portfolio
Why India is Riskier than China
Stephen S. Roach
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NEW HAVEN – Today, fears are growing that China and India are about to be the next victims of the ongoing global economic carnage. This would have enormous consequences. Asia’s developing and newly industrialized economies grew at an 8.5% average annual rate over 2010-11 – nearly triple the 3% growth elsewhere in the world. If China and India are next to fall, Asia would be at risk, and it would be hard to avoid a global recession.
In one important sense, these concerns are understandable: both economies depend heavily on the broader global climate. China is sensitive to downside risks to external demand – more relevant than ever since crisis-torn Europe and the United States collectively accounted for 38% of total exports in 2010. But India, with its large current-account deficit and external funding needs, is more exposed to tough conditions in global financial markets.
Yet fears of hard landings for both economies are overblown, especially regarding China. Yes, China is paying a price for aggressive economic stimulus undertaken in the depths of the subprime crisis. The banking system funded the bulk of the additional spending, and thus is exposed to any deterioration in credit quality that may have arisen from such efforts. There are also concerns about frothy property markets and mounting inflation.
While none of these problems should be minimized, they are unlikely to trigger a hard landing. Long fixated on stability, Chinese policymakers have been quick to take preemptive action.
That is particularly evident in Chinese officials’ successful campaign against inflation. Administrative measures in the agricultural sector, aimed at alleviating supply bottlenecks for pork, cooking oil, fresh vegetables, and fertilizer, have pushed food-price inflation lower. This is the main reason why the headline consumer inflation rate receded from 6.5% in July 2011 to 4.2% in November.
Meanwhile, the People’s Bank of China, which hiked benchmark one-year lending rates five times in the 12 months ending this October, to 6.5%, now has plenty of scope for monetary easing should economic conditions deteriorate. The same is true with mandatory reserves in the banking sector, where the government has already pruned 50 basis points off the record 21.5% required-reserve ratio. Relatively small fiscal deficits – only around 2% of GDP in 2010 – leave China with an added dimension of policy flexibility should circumstances dictate.
Nor has China been passive with respect to mounting speculative excesses in residential property. In April 2010, it implemented tough new regulations, raising down-payments from 20% to 30% for a first home, to 50% for a second residence, and to 100% for purchases of three or more units. This strategy appears to be working. In November, house prices declined in 49 of the 70 cities that China monitors monthly.
Moreover, it is a serious exaggeration to claim, as many do today, that the Chinese economy is one massive real-estate bubble. Yes, total fixed investment is approaching an unprecedented 50% of GDP, but residential and nonresidential real estate, combined, accounts for only 15-20% of that – no more than 10% of the overall economy. In terms of floor space, residential construction accounts for half of China’s real-estate investment. Identifying the share of residential real estate that goes to private developers in the dozen or so first-tier cities (which account for most of the Chinese property market’s fizz) suggests that less than 1% of GDP would be at risk in the event of a housing-market collapse – not exactly a recipe for a hard landing.
As for Chinese banks, the main problem appears to be exposure to ballooning local-government debt, which, according to the government, totaled $1.7 trillion (roughly 30% of GDP) at the end of 2010. Approximately half of this debt was on their books prior to the crisis.
Some of the new debt that resulted from the stimulus could well end up being impaired, but ongoing urbanization – around 15-20 million people per year move to cities – provides enormous support on the demand side for investment in infrastructure development and residential and commercial construction. That tempers the risks to credit quality and, along with relatively low loan-to-deposit ratios of around 65%, should cushion the Chinese banking system.
India is more problematic. As the only economy in Asia with a current-account deficit, its external funding problems can hardly be taken lightly. Like China, India’s economic-growth momentum is ebbing. But unlike China, the downshift is more pronounced – GDP growth fell through the 7% threshold in the third calendar-year quarter of 2011, and annual industrial output actually fell by 5.1% in October.
But the real problem is that, in contrast to China, Indian authorities have far less policy leeway. For starters, the rupee is in near free-fall. That means that the Reserve Bank of India – which has hiked its benchmark policy rate 13 times since the start of 2010 to deal with a still-serious inflation problem – can ill afford to ease monetary policy. Moreover, an outsize consolidated government budget deficit of around 9% of GDP limits India’s fiscal-policy discretion.
While China is in better shape than India, neither economy is likely to implode on its own. It would take another shock to trigger a hard landing in Asia.
One obvious possibility today would be a disruptive breakup of the European Monetary Union. In that case, both China and India, like most of the world’s economies, could find themselves in serious difficulty – with an outright contraction of Chinese exports, as in late 2008 and early 2009, and heightened external funding pressures for India.
While I remain a euro-skeptic, I believe that the political will to advance European integration will prevail. Consequently, I attach a low probability to the currency union’s disintegration. Barring such a worst-case outcome for Europe, the odds of a hard landing in either India or China should remain low.
Seduced by the political economy of false prosperity, the West has squandered its might. Driven by strategy and stability, Asia has built on its newfound strength. But now it must reinvent itself. Japanese-like stagnation in the developed world is challenging externally dependent Asia to shift its focus to internal demand. Downside pressures currently squeezing China and India underscore that challenge. Asia’s defining moment could be hand.
Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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TruthSeeker 03:22 28 Dec 11
I am not sure where author got data about 5.1% fall in industrial output. In india real estate is still booming.. banks are very healthy, jobs are plentiful and country as a whole is improving. Inflation is the problem and if somehow govt control that, problem will be solved. Good thing is prime minister Manmohan singh is Finance guru and known how to solve the problem..falling rupee will improve India's exports so in long run its good sign for industry. Expect Rupee to stabalize around 55rupee to a dollar.
China is huge propegenda machine, can't trust anything they say, every data coming out of China is rigged. Ghost towns are plentiful and banks loaned money at super inflated prices. Hard landing in China is given!!!
anoop 06:44 30 Dec 11
http://www.foreignaffairs.com/articles/136963/patrick-chovanec/chinas-real-estate-bubble-may-have-just-popped?page=show
amarharolikar 05:24 07 Jan 12
It's true that the Indian economy faces a downward risk. However we need to keep in mind that during the peak of the 2008 crisis, when US GDP was ruling around negative 4% and the world seemed to be falling apart post Lehman, Indian GDP still grew by 5.8% in its worst quarter with the full year GDP growth being nearly 7% !.
The recessionary conditions today are overall fairly mild for the larger EU economies; US economy is chugging along at a nice pace; China is going through a very normal and mild cycle of growth moderation ; however Eurozone hangs like a damoceles sword over everything.
As far as the the most current state of Indian Economy, macro and technical indicators point to an increasing probability of the markets being at the bottom or near a bottom. If I have to assign a subjective probability, I would say that there’s a 60% chance that we have already touched the bottom. Of course that means that there is still a good 40% chance that a new bottom can be be made.
Key reasons why we could have probably bottomed out are:-
falling monthly inflation numberfalling commodity pricespossible bottoming out in US 10 year yieldsbullish divergences in MACD histograms in weekly and daily charts of Nifty.
However, to get a better confirmation on bottom we’ll need to see:-
the monthly WPI inflation come down to 7% levelscorporate profitability not getting any worsean uptrend starting in US Govt 10 Year yieldsbullish divergence in daily charts not being broken in next minor downtrend.
This part should will become clearer in another month’s time, by end of January 2012. If these bullish factors hold on for another month then very likely that a bottom has been made, and we then need to wait for the leading indicators for market breakout to turn green. However, If they break then the next stop is very likely to be Nifty levels of 4200.
The paragraphs below provide more details around the points summarized above
My analysis shows that quarterly profits and monthly WPI are the primary leading indicator for a market breakout for India. Variables like auto sales, US Govt 10 Year yields, commodity prices, gold prices, RBI rate cuts, advance tax estimates, IIP number and FII flows act as a secondary indicators to be used for confirmation.
- The very first indicator which reverses is the monthly WPI which shows a consistent drop to sub 5% YOY levels prior to a breakout. Monthly WPI has shown just a slight fall in Nov’11. However trends in weekly WPI inflation, world food indices and global commodity indices indicate a sharp fall in monthly WPI over next few months.
- Global commodity prices are on a decline – combined with lower WPI, will lead better corporate profitability in coming quarters. However commodity prices typically start to rise after touching a bottom, just prior to a breakout
- US 10 Year yields seem be forming a bottom, pointing to possible bottom in US equities too. Market breakout is typically preceded by a breakout in the yields, pointing to flow of funds to risky assets. Though, we would still need for the yields to rise before we can say that a breakout is near
- Rupee is not a major factor. A market bottom is typically preceded by a major fall in Rupee, however Rupee can continue to remain weak even as the market breaks out as long as quarterly profitability shows an improvement..
- From a technical perspective, the Weekly and Daily charts of Nifty are showing a bullish divergence in MACD histograms with prices making lower lows but the histograms making a higher low. This points to a possible bottom. However the key is that the bullish divergences should not get broken in the next minor downtrend. And if that is combined with markets making a higher low in the next minor downtrend, that will further increase the probability that a bottom has been formed.
By end of Jan 2012, we’ll come to know whether the abovementioned bullish indicators hold up or get broken. If the bullish indicators get negated, then the next bottom is likely to be around Nifty levels of 4200 based on long term support levels. That would mean a correction of just around 35% from the last highs. 30% kind of corrections are very normal corrections during bull markets and have happened many times over and have lasted anywhere from six months to nearly four years for the 2000-01 dotcom bust/ Ketan Parikh scam.
Amar Harolikar
http://taxationindia.blogspot.com/
regis_cabaret 05:13 11 Jan 12
I can't agree more on the outlook of Europe. I doubt the Euro can collapse and I believe Europe will manage to reinvent itself to regain economic momentum. At the same time, China is moving in the right direction and remains strong! Living there, I experience it every day!
HistorySquared 07:56 27 Dec 11
China is not a immune from effects of a credit bubble; contrary to popular opinion, the central government has not managed to trump thousands of years of history and figure out how to properly centrally plan an economy. Any bullish argument ultimately boils down to 9 men in a room to command and control an economy of over 1 billion. Central planning does not work anywhere, including China, although long periods of distorting the market can make it appear that it does.
Research shows the larger the credit growth, the worse the GDP drop, and China has implemented a doozy, worse than the US by many measures, since it's not just residential, but office space and infrastructure bubble as well. There is no soft landing.
NPLs are 1-2%, the most pessimistic forecasts are 8-12%, but previous bubbles in China ended with NPLs of 40%. Banks are insolvent, as are many SOEs. The best hope for China is they will sell off corrupt, inefficient, state assets, but it's going to take a complete Russia collapse first, and even then it may not happen.
Not only do India and China have credit bubbles, as does Brazil, Turkey, Indonesia, Thailand, they also have a corruption problem, and an oppresssin problem in the case of China; there are political ramifications, not just financial.
Stephen, you have what's akin to a "home country bias": it's ok, we're all human and have various behavioral bias. The first step in preventing these bias' from affecting investment decisions is acknowledging that we're human.
If you still don't believe me, you're bullish China thesis is in the midst of a multi year 60% drawdown.