BY ERIK NORLAND, SENIOR ECONOMIST AND EXECUTIVE DIRECTOR, CME GROUP JUNE 1 India: The Next China? All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience. India s economy, which grew at a sizzling -1% annual rate from to 11 except for a break during the - 9 global financial crisis has settled into a significantly slower pace of expansion. While the -% growth rate achieved since 1 is still impressive compared to most of the world s economies, the pace is disappointing for a country that aspires to become an economic superpower on the scale of neighboring China (Figure 1). In late 1 and early 1 India s economy showed signs of renewed growth that might point to stronger performance ahead. However, the composition of India s resurgence has shown a deterioration in quality. Improving that quality won t be easy without significant reforms that Prime Minister Narendra Modi s government hasn t yet been able to enact. Figure 1 Year on Year Real GDP Growth 1 1 While the composition of growth and the external sector look worrisome, it s not all bad with India s economy: inflation has come down and India has thus far avoided the downturn hitting Russia, Brazil and other commodityproducing countries. Moreover, India s relatively lower level of private sector debt and comparatively faster growing population may lead it to outperform China, which has dominated growth among emerging economies. Composition of Growth: Worrisome Trends Since 1, the only area of India s economy that has shown any real strength is the financial sector (Figure ). Other areas of the economy grew excruciatingly slowly, including construction (Figure 3), manufacturing (Figure ), transportation/communication/tourism (Figure ), as well as India s long suffering agricultural (Figure ) and mining sectors (Figure 7). Moreover, both exports and imports have stopped growing. A fast-growing financial sector isn t necessarily a negative development, but if it is the only area that s growing it could be indicative of a credit bubble forming. That said, while debt-fueled economic expansion often ends in tears, it can go on for many years, sometimes even decades, before the party ends and India appears to be in the early stages of the game. 7 9 1 11 1 13 1 Source: Bloomberg Professional (INQGGDPY) 1
JUNE 1 Outside of finance, only two other areas of India s economy have shown significant strength in recent years: government spending and utilities (Figures and 9). The utilities sector slowed a great deal in 1 along with other parts of the economy, but was pumped up with a significant increase in public investment ahead of India s 1 elections that brought Modi s Bharatiya Janata Party (BJP) to power. The previous government, led by Prime Minister Manmohan Singh, also boosted spending on government and community services ahead of the 1 elections but unlike utilities, government spending never really suffered slow growth in 11 or 1. And it didn t win the election for his party. Figure. A Banker s Boom: Finance is outstripping the rest of the economy YoY Growth: & Banking Figure 3. Construction stagnated in 1 and 13 but perked up late in 1 YoY Growth in & Construction 1 1-7 9 1 11 1 13 1 Source: Bloomberg Professional (INQGGDPY and INQGCONY) Construction Figure. Manufacturing led from to 11 but has stagnated since 1 1 Banking, Real Estate and Financial Services YoY Growth in & Manufacturing 1 1 1 1 7 9 1 11 1 13 1 Source: Bloomberg Professional (INQGGDPY and INQGBNKY) 9 3-3 Manufacturing - 7 9 1 11 1 13 1 Source: Bloomberg Professional (INQGGDPY and INQGMFGY)
JUNE 1 Figure. Transport, hotels and communication have also under-performed since 11 YoY Growth: & Transport/Comm Figure 7. Mining has also been a constant laggard YoY Growth: & Mining 1 1 1 1 1 Mining - - Transport, Hotels & Communication 7 9 1 11 1 13 1-7 9 1 11 1 13 1 Source: Bloomberg Professional (INQGGDPY and INQGMNGY) Source: Bloomberg Professional (INQGGDPY and INQGTRDY) Figure. Agriculture has lagged for years YoY Growth: & Agriculture 1 Figure. The previous government boosted public spending ahead of the elections but lost anyway YoY Growth: & Govt. Services 1 1 Agriculture 1 1 Government Community and Social Services - - - 7 9 1 11 1 13 1 7 9 1 11 1 13 1 Source: Bloomberg Professional (INQGGDPY and INQGTRDY) Source: Bloomberg Professional (INQGGDPY and INQGSERY) 3
JUNE 1 Figure 9. They also boosted spending on utilities which had suffered in 1 Figure 1. Imports and Exports YoY Growth: & Utilities 1 1 Electric, Gas and Water Total $ Value in Millions Rolling Twelve Month Periods 3 1 1 3 7 9 1 11 1 13 1 1 Imports Exports - 7 9 1 11 1 13 1 Source: Bloomberg Professional (INMTIMU$ and INMTEXU$) Source: Bloomberg Professional (INQGGDPY and INQGELEY) To a large extent, the weakness in India s manufacturing sector simply reflects the softness in external demand. India s exports grew strongly from to 11, with a brief dip in and 9 amid the global financial crisis. Since 11, however, exports have stagnated (Figure 1). The weakening of the Indian Rupee, which lost about one third of its value versus the US Dollar between July 11 and September 13, did very little to boost exports. The weakness in the currency did, however, reduce India s imports, which narrowed the current account deficit (Figure 11). This reduction in the current account deficit mechanically increases GDP, and is partially responsible for growth appearing to perk up in 1. But falling imports aren t really a sign of healthy growth; rather they confirm that domestic demand is weak. Figure 11. Current Account Deficit as a % of GDP 3 1-1 - -3 - - - 1999 1 3 7 9 1 11 1 13 1 Source: Bloomberg, ICA%IND That said, a smaller current account deficit should support growth going forward by reducing India s reliance on external financing. Moreover, the trade deficit should continue to decline in 1 as a result of the collapse in oil prices. India produces essentially none of its own oil and the slump in oil prices should add approximately.% to GDP as a first order effect, which will be felt mostly in terms of reduced fuel subsidies and a smaller budget deficit. Reduced fiscal deficits will, in turn, allow for more flexible spending in other areas and may help to pave the way for reforms that will boost the non-financial sector of India s economy.
JUNE 1 A large part of the reason why the weakening of India s currency did so little to boost exports is that the Rupee only weakened versus the US Dollar and the Chinese Renminbi. With respect to other key currencies, such as the Brazilian Real, Euro and Japanese Yen, the Rupee fell in 11 and 1 but then the other currencies caught up on the downside, leaving their relative exchange rates close to 11 levels. Meanwhile, the Rupee actually strengthened versus the Russian Ruble (Figures 1). As such, the Rupee hasn t done as much to help India s competitiveness vis-à-vis the rest of the world as one might imagine if one looked at the currency only from a US Dollar perspective (Figure 13). Moreover, it might indicate that if India s manufacturing sector is to be boosted, it might require, among other things, a weaker Rupee versus a broader basket of currencies than just the Dollar and Renminbi. One potential objection to further currency weakness would be inflation. Happily, India s inflation rate has declined markedly (Figure 1), opening the possibility that the Reserve Bank of India (RBI) might continue to ease policy. Indeed the RBI has cut its repurchase and reverse repo rates by 7 basis points since the beginning of 1. It hasn t cut its cash reserve ratio, which has been at a historic low since 13 (Figure 1). Much like in Europe, Japan and the United States, easier monetary policy hasn t translated as yet into higher consumer price inflation. In India, however, it might be responsible for the rapid growth of private sector credit and the boom in the financial services sector. Figure 13. Indian Rupee vs. Developed Currencies 13 Figure 1. 1 Indian Rupee vs. other BRIC currencies 11 January 1, = 1 1 1 1 1 1 Russian Ruble Brazilian Real Chinese Renminbi January 1, = 1 1 9 7 7 9 1 11 1 13 1 1 Source: Bloomberg Professional (INR, BRL, CNY and RUB) Euro Japanese Yen U.S. Dollar 7 9 1 11 1 13 1 1 Source: Bloomberg Professional (INR, BRL, CNY and RUB) Figure 1. India Inflation Statistics 1 1 1 1 Industrial Workers CPI 1 Combined CPI 1 3 7 9 1 11 1 13 1 1 Source: Bloomberg Professional (RSPOYLDP, INCPIINY and INFUTOTY)
JUNE 1 Figure 1. Reserve Bank of India Policy Tools 1 9 7 3 1 Repurchase Rate Reverse Repo Policy Rate Cash Reserve Ratio Finally, further interest rate cuts (as well as the lag impact of previous rate cuts) might also boost India s lagging construction and manufacturing sectors. The manufacturing sector would also benefit from another round of currency weakness which might come about if the RBI continues to ease policy. Figure 1. Private and Public Sector Debt Government Private 3 9 1 1 Source: Bloomberg Professional (RBICRRP, INRPYLDP and RSPOYLDP) All of this begs the question, how much further can India s financial services sector grow before it ends in a massive financial bubble? Information collected by the International Center for Monetary and Banking Studies suggests that India s private sector debt amounts to only % of GDP. This is actually lower than in most other emerging market countries included in its study. Only Indonesia, Mexico and Russia had lower private sector debt levels. India s level of private sector indebtedness pales in comparison to China (1% of GDP), Hungary (1% of GDP) or Thailand (1% of GDP). On the flip side, India s public sector debt amounts to 7% of GDP, rather high by the standards of its peer group. Even so, the overall level of public and private sector indebtedness is in the middle-to-low end of the range (Figure 1). This should allow the RBI the latitude to ease policy further so long as inflation remains contained and the bank is not worrying excessively about any immediate financial bubble. That said the RBI would be wise to continue to monitor the leverage ratios of India s banking system, and household and corporate sectors going forward. Doing so might put them in a position to avoid the sort of credit bubbles that wrecked growth in Japan during the 199s, emerging Asia in 1997, the United States and Europe post-7 and the one currently threatening to undermine growth in China. Debt as a % of GDP 1 1 China Hungary Thailand Czech Republic Argentina South Africa Poland Source: "Deleveraging, What Deleveraging?" Buttiglione et al, International Center for Monetary and Banking Studies Easier monetary policy and further potential weakening in the Rupee won t solve all of India s growth problems. The implementation of Modi s reforms, including the fate of the Land Acquisition Bill which seeks to ease land purchase rules to jump-start stalled projects worth hundreds of billions of dollars -- will also play a key role in determining whether or not India s economy will move forward with a healthier mix of sectoral growth. India has crumbling infrastructure and is riddled with transportation bottlenecks that limit its potential. The passage of the bill would create opportunities to repair and develop infrastructure, create industrial corridors, rail lines, expressways etc. The bill has run into intense opposition, however, and the BJP lacks the votes to push it through. Turkey Brazil India Indonesia Mexico Russia
JUNE 1 Despite these obstacles, India remains a country of enormous promise. India s demographics are setting the stage for strong economic growth and we expect that India will outperform China in terms of economic growth rates over the next few decades. India has a young and fastgrowing population relative to China (Figures 17A and 17B). Over the next quarter century, India s population will likely grow by %, while China s will barely change (Figure 1). Moreover, India s rural-urban transition is at an early stage compared to China and has the potential to drive growth for years to come. India s potential for growth has enormous consequences for a variety of markets, including agriculture, which is the subject of an upcoming paper on the future of food. Figure 1. Population Growth India 1 World Brazil 1 USA 199 = 1 1 1 China 1 Germany Japan 199 199 1 1 3 3 Source: US Census Bureau Figure 17 A. China: Age and Sex Structure 1 Male Population Female Population 1+ 9-99 9-9 -9-7-79 7-7 -9 - -9 - -9-3-39 3-3 -9-1-19 1-1 -9 - % % 3% % 1% % % 1% % 3% % % Source: US Census Bureau, International Database Figure 17 B. India: Age and Sex Structure 1 Male Population Female Population 1+ 9-99 9-9 -9-7-79 7-7 -9 - -9 - -9-3-39 3-3 -9-1-19 1-1 -9 - % % 3% % 1% % % 1% % 3% % % Source: US Census Bureau, International Database Copyright 1 CME Group. All rights reserved. 7
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