Why India Is a Bigger Risk Than China

Stephen Roach Project Syndicate December 29, 2011

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Why India is Riskier than China

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.

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Username Password New registration Forgotten password 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.

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!!!

AUTHOR INFO Stephen S. Roach 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. MOST READ MOST RECOMMENDED MOST COMMENTED Is Modern Capitalism Sustainable? Kenneth Rogoff What Can Save the Euro? Joseph E. Stiglitz A Summit to the Death Kevin O'Rourke Fragile and Unbalanced in 2012 Nouriel Roubini Occupy the Classroom? Dani Rodrik A New World Architecture George Soros Did the Poor Cause the Crisis? Simon Johnson America's Political Class Struggle Jeffrey D. Sachs To Cure the Economy Joseph E. Stiglitz No Time for a Trade War Joseph E. Stiglitz Occupy the Classroom? Dani Rodrik The Exchange-Rate Delusion Michael Spence Who Will Fix the US Economy? Henry Mintzberg A Summit to the Death Kevin O'Rourke The Worst and the Best of Austerity Jean Pisani-Ferry ADVERTISEMENT PROJECT SYNDICATE

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If you still don't believe me, you're bullish China thesis is in the midst of a multi year 60% drawdown.

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Why India Is a Bigger Risk Than China

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