The Chinese economy is now a $10 trillion giant and China is the second largest economy and the largest exporter in the world. China is the largest trading partner for most of the large economies of the world and has a mammoth $3.65 trillion of foreign exchange reserves. The incredible Chinese growth rate of around 10 per cent annually for three decades is an enviable triumph. The sustained high growth rate of China created a commodity super-cycle that benefited commodity exporting nations. But in the process of sustaining this incredible growth rate, China amassed a debt of around $25 trillion. Economic history tells us that a debt-GDP ratio of 250 per cent is unsustainable. When the going is good, it won’t be a problem; but when the economy slows down the consequences can be bad. The recent woes of the dragon are spreading fear and panic in global markets.
The devaluation of the Chinese currency Renminbi Yuan took global markets by surprise. The devaluation is seen by the global markets as the symptom of a much serious disease. The disease is that the Chinese economy is slowing down much faster than everyone thought. It is important to note that China has been the engine of global economic growth having contributed 33 per cent to global growth during the last decade against 17 per cent by the US and 10 per cent by Europe and Japan put together. It is natural that when this $10 trillion economic giant slows down, it impacts global growth. Fears of a ‘China led global recession’ spooked the US market on Friday and Monday and panic and fear spread fast bringing global markets down. Developed mature markets crashed by more than 5 per cent on Monday, a rare event. In India the Sensex crashed by 1,624 points on Monday but recovered 290 points on Tuesday. Global markets witnessed a sell off in 3 segments: equity, emerging market currencies and commodities. The currencies of commodity exporters (Brazil, Russia, West Asia and South Africa) and those with high current account deficits (Turkey) were impacted. Though INR depreciated marginally it is relatively very stable. The INR, after depreciating on Monday, recovered smartly on Tuesday. Commodities including crude crashed further. The equity sell-off in emerging markets was mainly due to FII selling triggered by the global risk-off. In the developed markets, fears of another recession triggered the sell off.
The markets are likely to stabilise soon. A global financial meltdown appears unlikely. Though global growth in 2015 will be less than expected, another global recession appears unlikely. The US is growing at around 3 per cent and the US can again don the mantle of the global growth engine. The Chinese monetary authority has room to provide further monetary stimulus to the economy. If, in spite of all these, the Chinese crisis aggravates and leads to a hard landing of the economy resulting in a global recession, then it is bad news. Otherwise, the turbulence is likely to be transient.
India is likely to emerge from this turbulence stronger than most emerging economies. India will have one of the best growth rates, perhaps the best growth rate, among the large economies of the world this year. Even if global growth is muted this year, India is likely to clock a growth rate of 7.5 per cent. When sanity returns to the market, global investors will recognise this. As the RBI Governor said, “India will be back on the radar soon as one of the best investment destinations in the world.”
The commodity crash, particularly crude crash, is a boon for India. In fact, India is the biggest beneficiary of the crude crash among large economies. This has substantially improved our macros and the saving on crude crash will be around `80,000 crores this year. From the macro perspective, India is in a sweet spot. During the ‘taper tantrums’ of July- August 2013, India was impacted seriously because India was clubbed in the group of ‘fragile five’ (Brazil, India, Indonesia, Turkey and South Africa) which had huge fiscal and current account deficits with high inflation and rising interest rates. Now India is included in the group of ‘fabulous few’ with strong macros. Therefore, India is not vulnerable now as she was in 2013. Also, a slightly weak currency is a booster for India’s globally competitive IT and pharmaceuticals industries. India is already in the early phase of a cyclical recovery and leading indicators reflect green shoots of economic recovery. In the first quarter of this year, indirect tax collections are up by 37 per cent. Since this has substantially reduced the fiscal deficit, the government is now in a position to provide a much needed fiscal stimulus to the economy. Other leading indicators like HCV sales point to economic recovery.
Presently, India is the only large economy which is in a position to cut interest rates sharply. This is possible since inflation is sharply down and expected to trend down further. Presently the CPI inflation is 3.84 per cent and the trend indicates that it will under shoot the RBI‘s target of 6 per cent by March 2016. Therefore, the RBI has the elbow room to cut interest rates very soon. Since the Fed is unlikely to start monetary tightening in September due to the turbulence in global markets, even the otherwise conservative Raghuram Rajan will be emboldened to provide the monetary stimulus. Once the turbulence dies down, the FIIs will cease selling in the bond market and may add to the purchase. This is because the interest rate differential between the US and Indian bonds is the biggest in emerging markets. The Indian 10 year bond yield is at 7.8 per cent while the US 10 year yield is at 2 per cent. This is a highly attractive yield differential which is rare in the large economies.
Even though the US is coming back to respectable growth, the Euro Zone is likely to clock muted growth this year. With China slowing down, Japan struggling and the commodity exporters reeling under commodity crash, the global economy is likely to witness growth scarcity this year. Since India is in a cyclical and structural uptrend, the ROE (Return on equity) in India is likely to witness an upgrade. In India, the ROE is 16 and rising whereas in other emerging markets it is 11 and falling. This will certainly make India an attractive investment destination.
Opinion is divided on the consequences of the woes of the dragon. After market hours on August 25, the Chinese central bank announced another round of monetary stimulus by cutting interest rates and lowering reserve ratios. Will these measures halt the slow down and revive the Chinese economy thereby facilitating a global economic recovery? Let us keep our fingers crossed.
The author is an Investment Strategist, Geojit BNP Paribas E-mail: vijayakumar_vk@geojit.com