Near-term risks rising in India and China but the fundamentals remain excellent

by Dave

Business Intelligence Middle East (Standard Chartered Bank report)
Despite these huge differences, in recent months [India and China] have faced a common set of big problems, which they share with the Middle East: a global slowdown, rising inflation, big FX inflows, excess liquidity, and pressure on their currencies to appreciate. And the way New Delhi and Beijing have managed these pressures are remarkably similar in many ways. Look past the short term and we cannot but notice that the kinds of policies that New Delhi is now pursuing are, slowly but surely, making India a little more like China every day. Higher savings, more investment and a better fiscal position (well, kind of), are some of the examples. Both though are finding the balancing act between growth and inflation tricky to manage; risks in both economies have risen considerably in the last six months and look set to remain elevated. For both the golden years of fast, untroubled growth, are over, at least for the moment.

Both India and China are slowing, predominantly because of US weakness, cost pressures and domestic tightening measures (both raised interest rates in 2007, India two times, China five).

Inflation in India hit a 13-year high of 11.63% in June, more than 600bps above the RBI’s comfort zone. In India, the big driver of the wholesale price index is fuel and raw materials, which are filtering down to the household level more quickly than in China. Fuel prices were hiked in India in February (by a nominal 3% to 5% for gasoline and HSD) and more recently in June (by 9% to17%), while Beijing recently hiked retail gas prices by almost 17% in June, after a 20% move in November 2007. Both governments have tried to delay these hikes but with global oil likely to remain above US$120 for the next few months, more hikes will have to come. If India passes on the full impact of global oil prices to the local consumer, inflation could easily approach 25%.

India’s credit growth was fast in 2007, 30% year-on-year, while China’s was slow in comparison, 16%, though this is the fifth year of strong credit growth in an already liquid economy. Both are now focused on bringing that down in order to control inflation, but neither has done enough. Indian loan growth is still rising at 26% year-on-year, and money supply (M3) is growing at 21%, well outside the RBI’s comfort zone of 16.5% to 17.0%. As a result we can expect more hikes in the banks’ cash reserve requirement (CRR), which has already been hiked by 125bps (to 8.75%) since January 2008.

One of the most encouraging stories of the past few months has been the rise of Indian exports of processed goods. They have boomed, a significant change from the previous dominance of agricultural exports. This has been useful in preventing a massive ballooning of the trade deficit on the back of high oil prices and other imports. Trade has grown as a proportion of GDP, with imports now equivalent to 20% of GDP, exports 14%. (Of course, India is only a few steps along the road that China took in the 1980s, to a place where total trade is now equivalent to 64% of GDP in China.) But like China, India’s exposure to a slowing US economy is more limited. Last year, only 14% of exports were to the US, compared with 23% for China.

In 2007-2008 India’s savings rate was 34.8% of GDP, thanks to higher corporate and government saving, as well as stable household savings. Investment has risen as a result, from around 20% of GDP five years ago to 34% today. India still needs to be a bit more of a dragon here, as 30% of agricultural output is still wasted before reaching market because of the lack of infrastructure, and the country also has a power deficit of some 15% at times of peak demand.

Higher saving, more investments, plus more manufactured exports. In these respects, India is looking a bit more like China these days, and that will support more growth over the next decade.