By Lior Alkalay
Research Analyst, eToro
It’s clear that markets have pinned their collective hopes on emergent economies to propel global growth. But the recent slowdown in China’s economy has generated quite a lot of concern, and it is only the Chinese government’s swift response to the slowdown that at least some of those worries were assuaged. But it’s not just China which is in economic danger; so too are Brazil, Russia and India – the B, R and I of the BRICs. India’s growth slowdown especially has got investors wondering if India is still a growth market.
I have long been a bull on India, but even I cannot ignore the numbers which are far from encouraging; in the first quarter of the year, India expanded at only 5.3% annualized, a far cry from 9.2% annualized growth in 2011’s first quarter. Records show that that is India’s slowest rate of expansionary growth in about a decade which, of course, encompasses the period following the 2008 financial crisis when economic growth fell to 5.8% annualized.
In large part, say some economists, India’s slowdown is due to a political paralysis and they believe that without the timely elimination of that paralysis, a far larger economic crisis could ensue. A key member of an economic advisory council to Manmohan Singh, the Indian Prime Minister, is appalled that the GDP data didn’t trigger alarms and red flags for the government’s leaders. An ex-IMF economist similarly questioned the government’s attitude, asking if the GDP numbers didn’t merit an immediate policy response, then what would?
Like the U.S. Federal Reserve, the Reserve Bank of India (RBI) plays a key role in promoting economic growth. But the RBI is dealing with a classic Catch-22 scenario; on the one hand, they have low growth rates to contend with, while on the other there’s surging inflation to consider. The RBI lowered its benchmark interest rate by 50 basis points a few months ago, and has since May it has been left unchanged at 8%. Accelerating inflation coupled with a greatly devalued Rupee make another rate cut a near impossibility, and despite extreme political and social pressure to do so, the RBI has been able to resist lowering it.
To give you an example of the severity of the inflation problem, you only have to examine the Wholesale Price Index, which eased back to 7.25% in June from May’s 7.55%, the slowdown attributed to a drop in fuel prices. At the same time, food prices surged to 10.71%, up from 10.66% in May. The RBI’s governor Duvvuri Subbarao said earlier this week that that was still “way above comfort levels,” and they feel a rate cut now would only increase inflationary pressures.
As I said, I’m a bull on India, but time and again I find myself defending India when debating the country’s future with colleagues. Yes, there are headwinds to growth, but I nonetheless see incredible potential in India and that is because, unlike Brazil or China, the outlook for sustainable growth in India is very bright.
Granted, Beijing has done wonders with developing Chinese infrastructure and establishing the country as a modern economy – indeed its economy is second only to the U.S. Giving credit where it’s due, both Brazil and Russia have also generated tremendous growth but is it sustainable? That is the question. As a long term investment opportunity, Brazil and Russia are far more risky, as they are reliant on certain pillars for their respective growth, pillars which could conceivably break in the future. For example, China leverages a low cost labor force and centralized (yet undemocratic) political decision-making process, while Brazil and Russia rely on their respective natural resources, generally to the detriment of everything else.
Looking at it from this perspective, India shines brightly; it has established and positioned itself among the globe’s largest hubs in the knowledge industry. That can be attributed primarily to India’s dominance in the so-called hi-tech industry; India produces a class of well-trained and skilled tech-oriented workers who are without parallel among their (BRIC) peers. Though they try, the other BRICs keep hitting a brick wall which India easily avoided.
We know that China’s leaders are making efforts to diversify into internal or domestic consumption; it’s a gradual process but analysts agree it is the only path to a growing and sustainable middle class. However, it is nearly impossible to do so with so heavily a reliance on cheap manufacturing because as average wages increase, the sector becomes less competitive, then growth slows. The government knows this, and because of this dynamic, has been trying to break into the technology-based industry. But establishing China as a hi-tech hub could take as much as a decade if not more because the industry demands a large buildup of not just knowledge but experience. In that respect, India has just about leveled the playing field and is now on a par with advanced knowledge economies like the United States, Australia, Israel and Sweden. India, despite its moderating growth, has already established a middle class with the qualifications nearly identical to its western peers; that is the challenge that many of other BRICs have failed to overcome.
Data and Stock Picking
It’s true that Indian growth has fallen off pretty sharply and has generally lagged China, but comparing it to China is not exactly appropriate. For all intents and purposes, India’s economy should be more appropriately compared with western economies, especially as it relates to economic growth and stock market performance.
Take for example, a comparison of India to the U.S.; it’s clear from the numbers that India is quickly catching up. While the U.S. economy grew at 1.9% in the first quarter (year-over-year), India over the same period grew at 5.3%. And investors expressed disappointment with India’s growth, but bear in mind it was more than twice the U.S.’ growth despite high inflation, poor infrastructure and economic policy paralysis!
Investors might argue that returns on Indian investments are diminished by the depreciating Rupee, but the performance of the Nifty, India’s major stock exchange, tells a different story. Over the past five years, the Nifty lost about 5% in real Dollar terms; in comparison, the S&P500 shed 11.78% and the German DAX dropped more than 25%.
I agree that India lags the west in some aspects, particularly development and infrastructure. Because of that a two-pronged economy emerged, one based on development and infrastructure and the other a growing middle class. The economy that is based on development and infrastructure is somewhat sluggish but the economy based on middle class growth seems to have in place all the conditions for sustainable growth. India’s middle class is made up of no fewer than 100 million individuals and its economy is nearly as big as Germany’s so markets can ill afford to underestimate its potential value over Brazil, Russia or China.
India, the Golden BRIC
India is faced with several headwinds but growing deficits in the current account and the government’s budget present the biggest challenges. Given the deficits, the Indian Rupee had fallen to a record low against the U.S. Dollar, with the devaluation almost 20% since 2004. Inflation has been stubbornly high, and the central bank has been ineffectual at stimulating the economy. Even so, Indian growth was much better than most of its peers, and substantially better than BRIC peer, Brazil.
To restore market confidence and attract foreign investment in the short term, it is essential that the government address the twin deficits and the weakness of its currency but that is achievable with several specific technical measures.
But in the longer term, I see great potential for growth, far more than from the other BRICs and urbanization is one of those reasons. While China and Brazil have already urbanized to a great extent, India is still only in the early stages of the process. That urbanization, alongside the existing and still growing hi-tech industry, means unparalleled potential growth, making India, in my opinion, the Golden BRIC.