Why India Will Soon Outpace China

Asia Confidential's picture

On the face of it, the title of this article will seem absurd to many. While China's economic growth has slowed, it's still running at a brisk 7.4% annual rate. Moreover, the Chinese government seems to be successfully slowing credit in order to rein in a burgeoning debt issue. And it's implementing a plethora of reforms which should propel the next phase of growth.

Meanwhile, India's a mess. This fiscal year's GDP will be below 5% and near decade lows, government and corporate debt is high, the current account deficit has been out of control until recently, inflation reached double-digits late last year, business confidence and investment are at extreme lows and corruption remains rampant.

Dig a little deeper though and the picture doesn't appear as favourable for China's economic prospects vis-a-vis India's. First, it's highly probable that China's GDP growth rate is slowing much more than the fraudulent figures put out by the government (I'm not picking on China here as many governments are guilty of this). Second, credit tightening in China will almost certainly take years rather than months given the boom which preceded it. Third, Chinese economic reform will be a drag on growth in the near-term, as can already be evidenced by the crackdown on corruption and its impact on retail consumption.

On the flip side, there are many signs that India's economy may have bottomed. The current account deficit has significantly eased, the currency has stabilised, inflation has substantially pulled back and corporate earnings are improving. With inflation down, interest rates will soon be cut, which may prove the catalyst for the next investment cycle. The election of a new, economically-friendly government should ensure an acceleration in investment and improved productivity.  

There are other positive developments which augur well for India too. For instance, there's an ongoing boom in the agricultural sector with rising investment and wages. This has resulted in India becoming a net food exporter - an important development given the country's dependence on agriculture.

For a long time, India's decentralised, often chaotic economic model has been seen as inferior to China's authoritarian, top-down model. A reappraisal of that view may soon be in order.

How India became a mess

Morgan Stanley's Ruchir Sharma has noted that India seems to go through cycles of economic crisis and reform every decade or so. In 1991, a balance of payments crisis preceded widespread economic deregulation which is credited for driving the rapid economic growth of the following two decades. In the early 2000s, another crisis resulted in further deregulation and privatisation of key industries.

Here we are about ten years later and there are economic troubles again. GDP growth has slipped below 5%. Inflation peaked in double digits before marginally declining of late. The fiscal and current account deficits have widened sharply.

The government is again largely to blame for the problems. The ruling Congress Party fell into the trap of thinking that economic growth in the high single digits during 2003-2007 was perfectly natural. But it was just the result of reforms from prior governments.

In response to the 2008 crisis, the ruling party initiated a large stimulus package. This worked for a time as the economy recovered faster than most other emerging markets. But combined with large-scale subsidies to bribe rural voters, to the tune of 2.3% of GDP, inflation soon lurched out of control. A lack of reform driven by infighting in the Congress Party and a judicial crackdown on political corruption didn't help. 

Foreign investors and bond rating agencies became increasingly nervous about India. In 2012, the ratings agencies threatened to downgrade the country's sovereign rating to junk status. Mid last-year, the rupee tanked as foreign investors grew concerned about the current account deficit following hints of QE tapering at that time.

These events were enough to spark the government into action. It's since liberalised foreign investment in retail and airlines. It's also started to cut back on energy and agricultural subsidies. More recently, the new central bank governor hiked interest rates to stabilise the currency and tame inflation.

Signs the economy has bottomed

There are a number of signs though that India's economy may have bottomed and better times lay ahead:

1) The current account deficit (CAD) has eased significantly. The last quarter saw the lowest CAD number in five years due to improved exports and lower gold imports. Bank of America Merrill Lynch forecast India's CAD will be 2% this fiscal year compared with 5% in 2013.

India CAD

2) Inflation has pulled back. Due to lower food prices, WPI inflation is at its lowest level in more than four years.

India inflation

3) The rupee has stabilised. Interest rate hikes and the declining CAD have helped.

4) Corporate earnings seem to be improving. The earnings revision ratio has been rising for the past eight months. Yes, it's still not great but at least it's heading in the right direction.

India earnings revision cycle

5) Nomura's composite leading index for India suggests growth is bottoming out.

India - nomura leading indicator

The key to an economic recovery though is business investment. There are tentative signs that this may be set to turn around:

  • Business confidence, while low, has improved of late in anticipation of a new government coming into power. 
  • Regulatory constraints for new projects should be eased post election. A Cabinet Committee on Investments has already started to reduce bottlenecks, but this should soon accelerate.
  • Higher interest rates are forcing Indian companies to reduce leverage by shedding assets. The process of decreasing debt, particularly among infrastructure companies, is necessary for businesses to be in a position to accelerate investment. 

Asia Confidential doesn't foresee a quick turnaround in capital expenditure given high corporate debt levels. But with the prospect of sharply declining interest rates and a new economically-friendly government soon in power, the conditions are in place for a gradual pick-up in business investment.

Modi: friend or foe?

The big question is whether the almost-certain-to-be new leader, Narendra Modi, can deliver on the inflated expectations of him. India's stock market is certainly answering in the affirmative as it hits new highs (though it's noteworthy that small caps have significantly lagged).

Modi's economic track record is undoubtedly impressive. He's been chief minister of Gujarat, a state with 60 million people, for 12 years. During that time, he's cut red tape, built substantial infrastructure and contained corruption. Business and investment have thrived. Gujarat GDP has grown 3x under Modi's leadership.  The state now produces 25% of Indian exports yet accounts for just 5% of the nation's population. Most social indicators in the state have also improved under his watch.

As leader, Modi has promised to replicate his Gujarat policies of improving infrastructure, reducing regulatory hurdles for businesses and ultimately achieve higher growth rates. Granted, he's been vague on how he's going to finance some of his promises. Given the fiscal situation, there's not much room for a substantial boost in spending.

The big blight on Modi's track record is his hardline Hindu nationalism. In 2002, Muslims in the Gujarati town of Godhra set fire to a train carrying Hindu pilgrims back from a town in Uttar Pradesh. 59 people died on the train. After the attack, Hindu groups called for a protest. This resulted in several days of violence directed at Muslims. 1,000 died and 200,000 were displaced.

Being chief minister at the time, Modi had the option to ban the protest or call in police, but he chose not too. This was condemned at subsequent investigations. And Modi's refusal to apologise for the incident continues to anger Muslims. The US actually revoked Modi's visa, suggesting "he was responsible for the performance of state institutions" in the riot.

The facts of this incident are damning but must be weighed against his economic track record and leadership qualities. They must also be weighed against the ineptitude and arrogance of the governing Congress Party over the past decade and for much of the past 50 years. 

What matters most though is the opinion of the Indian voter. There's a chance that Modi could win an outright majority of votes in the general election, which would allow him to rule without coalition partners. The most probable outcome is that he'll win a near-majority and will be able to build a coalition with a small number of partners.

By voting for Modi, Indians will be clearly saying that they're tired of the Congress Party's policies of protectionism, the bribes disguised as subsidies and corruption which goes along with these. They're demanding policies to promote economic growth, development and jobs. And they want decisive leadership rather than bumbling and infighting.

It may be a stretch to suggest that voters favour market-driven solutions over government-driven ones. But the tide has certainly swing in that direction. 

Ultimately, Modi is expected to be given a strong mandate for change and his business-friendly credentials bode well for the country's economic prospects.

Broader, ignored positives

Besides a bottoming economy and new, potentially improved leadership, there are also several other positive developments which point to a brighter future. India's much-maligned legal system and decentralised political system have proven strengths of late.

It's the judiciary which has led the way in fighting corruption. There's little doubt that corruption remains a huge issue in India. There are some estimates that it's cost the country US$80 billion over the past decade. According to Transparency International, India ranks 94 of 177 countries in its global corruption perception index, behind the likes of China and Brazil, both hardly paragons of clean administrations.

The courts have been central to curbing some of the rampant corruption. The cancellation of 122 mobile phone licences and jailing of the telecommunications minister in 2012-2013 being but one example. 

It'll be up to Modi to accelerate the crackdown on corruption. It's crucial that he does as corruption takes valuable money away from productive investments which can boost economic growth and keep inflation in check.

Undoubtedly, political decentralisation has helped the spread of corruption. But the upside from decentralisation is that India's growth has been shared by rural areas as much as the cities (unlike in China). 

In fact, rural areas in India are booming. Wages have risen by close to 15% per annum over the past ten years, compared to city wages which are down more than 2% over the same period.

Decentralisation provides part of the answer for the boom. Urbanisation - people moving from country to city - has also played a role as it's resulted in a tightening in the rural labor force and contributed to the rise in wages and investment.

A moment in the sun

All of the above isn't to suggest that India will displace China as Asia's next economic giant. Far from it. With GDP per capita of just US$1,250, India still has an enormous way to go to catch up with China (GDP capita of US$6,700) and the rest of the developing world (GDP per capita of close to US$10,000).

What Asia Confidential has sought to demonstrate instead is that India has more scope to surprise than China on the economic front. Part of that is because India's coming from such a low base. 

Moreover, this author can foresee a time in the not-too-distant future when India's economic growth matches, and likely surpasses that of China. The media may then be lauding the superiority of the Indian growth model over China's!

AC Speed Read

-  Despite slowing, China's economy is still growing at a much faster clip than India's.

- But that may be about to change with signs that India's economy has bottomed while China faces serious downside risks.

- With inflation falling in India, interest rates there are set to drop and this, combined with a new, business-friendly government, should provide the impetus for the next business investment cycle.

- For a long time, India's decentralised economic model has been viewed as inferior to China's authoritarian, top-down model. A reappraisal of that view may soon be in order.

This post was originally published at Asia Confidential:

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Davalicious's picture

Most of India is covered in shit. The reality is very far from the Bolywood fascade and a couple of small areas of cities where they managed to create order. India is going nowhere. If the British hadn't built infrastructure they would be closer to Africa than Europe. If they did't have our outsourced jobs we wouldn't be discussing this fantasy. When those jobs repatriate India will fall. India is nothing like China.

Wikidguy's picture

Mera Bharat Mahaan  lekin 100 mei 99 baimaan

kareninca's picture

Oh, come on.  There are things that I very much admire about traditional and also modern Indian culture, but the country is toast.  I traveled there back in the 80s when the population was far lower, and was amazed that humans could survive that degree of crowding; it's crazy now and getting worse.  And now they are aborting huge numbers of their baby girls; it is stunning these days, the sex ratios are so skewed, and it is worst in the better-off families (since they can afford ultrasounds),  This is part of the reason that brutal rape has became a common crime, and the constant groping of women in public a fact of life.  Chinese men seem to be dealing with the lack of women peacefully, but Indian men seem to be losing it; it will end in mass violence, probably initially directed at Muslims but going who knows where.

Wages rising in rural areas?  That is because of perverse government incentives  -  special government payments for rural labor  -  that induce people to return from the cities.  The author of the article does not even mention this.  Maybe it is good for people to return from the cities, it is true that there are not enough jobs in urban areas.  However, the money for these subsidies does not actually exist; they are not affordable and will not last. 

I Write Code's picture

All I know is, watching the work styles of Chinese and Indian immigrants here in the states, I'd place my money on China every time and twice on Tuesday.

That doesn't mean that India might not be due for a bump, maybe this Modi character is the Hindu version of President Reagan.  And maybe China is due for a slowdown.  But on a ten or twenty year basis: bet China.

I think one of India's main problems is they are almost all still more stuck in the socialist mode than China ever was.  In India, they really believe it.  In China, their classic culture was never really overwhelmed by communism, and wasn't really compatible with it either, in China if they were communists they were hypocrits.  In India if they are capitalists they are hypocrits.  Frankly I can't see why, it doesn't seem to me that socialism has made India any kind of paradise, it must fit into odd crevices in Hinduism that I don't know much about.

OptionsHedge's picture

A democratic change of power in India is around the corner. If Modi becomes the PM and implements policies similar to what made his Gujurat state a powerhouse of growth in the past decade it augers well for India. The knowledge based industries in India are ripe to dominate the banking infrastructure worldwide. And other such soft industries where knowledge rather than  brute force is dominant.

China has become the most polluted country in the world. The growth from being the supplier of shoddy and cheap goods for the world has come at a price that will take a heavy toll on the health of the population as the country chokes on itself. And its aging population will not have the vigor of India's younger demographics.

Talkinng of curruption, just look at US where for every congressman there are 500 lobbyists. Do not assume these lobbyists are working for the common good.

Short China, Long India is the trade of the decade if Modi comes to power.

sun tzu's picture

I doubt any country with an average IQ of 78-82 will become an economic powerhouse. Those "brilliant" Indians you see in the West are the cream of the crop who left that destitute country for a better life. There are 4 castes of people in India, and the ruling/intelligent classes are a small minority of the population

kchrisc's picture

India and the Indian people are wonderful, but when the DC US, Europe and the Petro$ go titsup, so does India.

The people are either very poor of have jobs connected to call-centers and manufacturing for the west.

sun tzu's picture

Most of them would be lucky to have call center jobs. The majority of the country is not much better off than Africa

laomei's picture

India? You mean the place where half the population has no access to toilets, the rivers are full of shit and corpses and there is literally nothing at all redeeming apart from some idiots who bought into the beatles so much as to believe that walking through a living hell on earth is "spiritual"?  That India?  Hahahhaahh.

Rising Sun's picture

India is too fragmented and its legal infrastructure doesn't scale - in other words, there's too much corruption and no way of slowing it or correcting it.


But good luck anyway.

Mountainview's picture

This articel was publish 10, 20 and 30 years ago with similar arguments...maybe Modi can make a temporary change as did Vajpee but the needed fundamental change for a longterm succes is so huge...

q99x2's picture

Do you have to work in India? If so I'm not going.

garypaul's picture

this article is full of 'maybe' and 'what-if'

If China has a crash, of course India will look better on paper for a little while.

Salah's picture

Go to India, live in India, work & travel in India....not only is it the world's largest pig-sty, it's a seriously corrupt pig-sty.  China was like this too, until Mao came along and took 30 yrs to "reform" it with a powerful, albeit brutal central govt.  that killed ~100 million along the way.  That will never be India's fate, because for the most part they don't have cold weather.  Go figure.

Joenobody12's picture

Another Indian wet dream.

RaceToTheBottom's picture

It would have been interesting to know more about how India's fortunes can be removed from what is going on in the rest of the world.  I thought most of India's revenue comes from supporting other countries, either selling to or providing resources to. 

Some discussion re that would have been appreciated.