Could India’s biggest threat to growth be…Itself?

Raghuram Rajan could be the ‘go-to-guy’ to get India out of it’s slower than expected growth-woes

Hey folks! Let’s take a dive into some metrics that have come out of India recently; figures which have many investors scratching their head wondering, ‘what happened to the rapid-growth (and returns) seen only a few years back?’

Let’s get down to the point and expose the elephant in the room: GDP growth. The once jewel of the British Empire’s economy expanded at a rate of only 5.5% in the April-June period. Granted this was higher than the 5.3% GDP growth of the previous three months BUT it cannot even come close to the 9% expansion of early 2011!

"Whilst an upside surprise at 5.5%, the pace of growth is undeniably below potential and validates the need for the government to address sluggishness in investment and external sector activity," said Radhika Rao an economist at Forecast Pte.

So let’s break down what’s holding our mighty elephant back:

        Slowing global demand and uncertainty: What a surprise! (well, not really)… with key economies in trouble (such as Europe and even China) the global macro climate is hurting India in a big way.

•      India's factory output fell 1.8% in June from a year earlier, the third fall in four months

•      Foreign direct investment in India fell by 78% in June, from a year earlier

          A growing trade deficit:

•     Recent figures show that imports outgrew exports by 15.5 Billion dollars

•       India's trade deficit with China jumped 42% to $40 billion in the last financial year

             An indecisive government in a political deadlock and numerous allegations of corruption has harmed India’s outlook toward foreign investors.

•          There is becoming a growing concern amongst economists and opposition parties that India’s government  will only pursue reforms which are favorable to its political partners

•       Analysts are recommending that the government needs to take action to improve the investment climate in order to maintain a high growth rate in the future

            The S&P's has stated it would be more comfortable if the government raised retail petroleum prices and reduced energy subsidies as it has promised, and introduced a goods and services tax (GST)

Let’s talk about the Trade Deficit for a moment…

A 15.5 Billion dollar deficit is no laughing matter, especially given the perceived notion of India being an exporting power house. What’s happening… is this a cause for concern? Or should we be tingling from the excitement of new growth possibilities? Well, if India plays its cards right, the latter may be the correct course of action.

India has significant investment needs; it has issues in its infrastructure – or lack thereof – and needs to import capital goods as a part of where it is in its growth cycle. The result is (no matter how you spin it), India simply needs to import at this phase in the game.

And with a specific note on China; as China advances its production to a more value-added model, India will become more of a manufacturing center than what it is today – so it might sound like a good idea now to recapitalize and invest in infrastructure for the future.

So who will guide India through these uncertain times?

Enter: ‘reformed minded’ and newly appointed Chief Economic Adviser to the Indian Government: Raghuram Rajan (he called the 2008 Financial Crisis in 2005!!)

Could he be the man to save the day in India? As a strong believer in liberalization and privatization, he says “We need to become paranoid again [about growth], as we were in the early 1990s,” And while it might take some work, here’s what he suggests in terms of policy reform as quoted from a recent speech:

1)   Raise fuel prices to international levels in a set of quick steps, and then completely deregulate them. Announce this as soon as politically possible, and do not roll back.

2)   Be kinder to foreign investors – they are not the enemy but a necessity -- we need their money to fund our spending to the tune of 4% of GDP. No doubt, however badly we treat them today, they may eventually want to be in India, but crisis are always about timing. We need them now, when India looks increasingly tattered compared to alternative investment opportunities, not five years from now when growth recovers.

3)   We should bring certainty about taxation to foreign investors, and resist the temptation to levy new retrospective claims.

What in effect Mr. Rajan is trying to do hand India over to the free market again. Reduce government subsidies and appease foreign investors by making India a reliable market to do business in. Can it work? I think so, but there needs to be strong support from the government and a crackdown on corruption for it to happen.

The bottom line:

While recent scares in growth and trade metrics might make you skeptical of India’s future – hold on a moment and think: the trade deficit is there because India needs to invest in capital for production and infrastructure, all which will pay off in the future. Moreover, now with a more free-market inclined chief economic advisor, India will (hopefully) take the correct policy actions to promote a healthy market and ensure foreign investors are kept happy and wanting to come back to India for their business needs.

Matthew MacMull

Will the “Once beloved Dragon” continue to soar?

It has been a joyful and exciting ride for China, exceeding analysts’ expectations on economic growth for the past two decades. In retrospect, China was once considered as one of the least attractive investing regions around the globe mainly because of its rigorously centralized control over all industries and the lack of openness to the global market. However, that has been changed due to China’s tremendous endeavor to undertake constant reforms of economic development plans and absorb so called “Westernization”. 

 

Upon the successful achievement in somewhat decentralized government in the late 1970s, initiating its first economic reform, China was able to shift its concentrated industry from agriculture to manufacturing, taking the advantage of cheap labour to be competitive in the global market. Nonetheless, China’s incomparable competitiveness in the cheap labour has diminished due to the fact that the vast majority of offspring of unskilled parent, working in a factory, have high education and pursue the highly rewarding careers, which causes the increase in wages. Therefore, China has recently faced the challenges by industrialization that increases the cost of economic growth.

 

Furthermore, the cost of industrialization has widened the income gap and weakened the driving force from the reform and opening-up. This indicates that China needs to come up with a better strategy to attack the issues involved in accomplishing the practical fiscal/monetary and foreign policy.

In the case of employing the effective expansionary fiscal policy, focusing on the increase in government expenditures, the central government has to restore its credibility of infrastructure development. “The bridge – which cost $300 million and was in use for less than a year – was at least the sixth bridge to collapse in little more than a year in China.”

                               
According to The Economist, infrastructure projects are being used as a way of boosting the construction industry. As a result, the government has plans to build 70 new airports and expand another 100 airports by 2015, despite the fact that many existing airports are loss-making.
 

In addition to the challenges with fiscal policy, China has encountered the negative impact from the uncertainty in Europe and therefore decreased interest rates twice already in the first half of the year in response. This initiative has been successful in terms of maintaining low yuan to be competitive in the global market. However, there is a misleading outcome that the exports rose 1 percent year-on-year to $176.9 B in July, but plummeting from the 11.3 percent growth seen in June this year. WSJ has recently come out with some negative reports that the IMF lowered its estimates for China’s economic growth for Q3 due to the deepening Euro crisis and that they expect hard landing taking place in China, which may drive up the price in realty market at a faster rate than the wage increase.

Despite some negative outlook on China’s economic growth, there are a few positive signs. According to Financial Times, China is prepared to attract more foreign direct investments by allowing higher foreign stakes in financial markets and loosening the strict restrictions for foreign speculators to invest in property market. As well, Chinese Premier, Wen Jiabao, assured that the central government and policymakers have collectively put a lot of efforts to meet the targeted economic growth of 7.8 % for Q3 this year by cutting the required reverse ratio and easing inflation that allows more room to adjust monetary policy.

Bottom line:  

We have come to the conclusion that the challenges China is undergoing now are inevitable yet surmountable. The success for China to sustain the economic growth heavily depends on how the central government and policymakers collaborate to develop the new economic stimulus programme that focuses on fiscal policy “if” the economy continues to underperform. At a time when a Rmb4trn (US $586B) spending package to pull the economy out of a slump was introduced in 2009, China successfully managed to 1) establish and strengthen its infrastructure by approving investments undertaken by local governments and state-owned companies, 2) restrain yuan to be competitive by lowering the interest rates with precaution. Now, China is facing new challenges of 1) properly analyzing the potential local investments, 2) effectively and timely responding to the euro crisis, 3) stimulating FDIs in financial securities market.

Young G.