PORTFOLIO POINT: I remain bullish on India, but on a 20–50 year time frame, which is useless to most investors. Better prospects lie in Europe, the US and Japan.
In recent weeks formerly contrarian theories of a Chinese economic crisis have gone even more mainstream with expectations of a trade deficit – China’s first in over seven years – being priced in for the first quarter of 2013, with the doyen of received economic wisdom, Nobel laureate Paul Krugman, now asking: will China break?
China’s inbound foreign investment fell 10% in November on the prior corresponding period, the first decline since the depths of the global financial crisis. There is also evidence the much talked-about trade war has finally heated up, with China imposing tariffs on US car imports of between 2% and 21.5%.
While I previously felt pretty lonely when writing about both the geopolitical risks (see Free trade on the bloc) and the economic risks (see Enter the dragon) to China’s continued ascendance, I’m now joined by none other than China’s Ministry of Commerce, which itself describes the country’s trade outlook as “very severe”.
And as China’s export model weakens on grim estimations of a recession in the EU (though one, however, I believe has already been priced in to European and US markets – see New Euro Order and Old World charm), its fixed-asset investment model – the other core contributor to double-digit GDP growth in recent years – looks weaker still.
Hong Kong-based property agency Centaline estimates that 22 months’ worth of newly built residential housing inventory remains unsold in Beijing, and notes that 100 local government land auctions failed last month. Residential construction and local government-financed projects have been the twin pillars of China’s economic resurgence to date, but already commentators like Patrick Chovanec, in this month’s Foreign Affairs (click here) are calling the bubble as popped.
With construction down 15% since June and transaction volumes down by more than 50% in cities like Shenzhen and Tianjin, it certainly looks that way for at least the residential side of the fixed asset coin. But as for local government financed infrastructure, the stats look even more worrying.
As for the other bullish argument – that China’s central government will ride to the rescue should it all go belly-up – that too is showing holes. With lower exports and an unwillingness to increase money supply following the destabilising effects of 2010-11’s ravaging inflation, even China’s massive cash reserves may be insufficient to bail out the LGFC (Local Government Finance Sector).
And with an unwillingness to take drastic action in a year where the Politburo will be handed to a new generation of leaders, Beijing may not even be able to stop the highly politicised creation of more debt and more LGFCs in the meantime. Indeed, analysts at SociÃ©tÃ© GÃ©nÃ©rale estimate that a further 7 trillion renminbi ($1.1 trillion) of loans may be yet needed for China to achieve the 2015 objectives of its latest five-year plan.
With all this data coming to the fore in recent weeks, I was happily unreachable in India, hence my absence from these pages. While not on business, however, it would seem to me on returning though that India is in no position to plug the gap should China’s economic growth decelerate and Australia (and the world) suffer for it.
Since being coupled with China in the Goldman Sachs acronym BRIC (which also stands for Bloody Ridiculous Investment Concept), India has been seen in recent years less for what it is and more for what it one day might be. Based on demography alone – the country has 1.2 billion people and may soon overtake China in population – that rise is inevitable, but with a 2011 estimated GDP of $US1.843 trillion in nominal terms, it is less than a third of China's nominal $6.988 trillion estimated GDP in 2011, not to mention a shadow on the United States, still by far the world’s largest economy (excepting the aggregate product of the EU at $US16,242 trillion).
Trapped in a web of red tape, tradition and poverty, outside the major business centres of Mumbai, Delhi, Bangalore and Chennai life is much as it was 10, 50 or 500 years ago. While it would appear nearly everyone now has a mobile phone, handsets are still charged at a diesel generator, and while satellite dishes appear on even the tiniest shack, the building itself is not electrified.
While not my first time in India, it was my first time outside the usual business circuit and beyond multi-lane highways. Yes, there is much that is stunning and impressive about India’s rural areas – often described by outsiders as BhÄrat, the country’s Hindi name, to differentiate it from modern, globalised India. Life in the villages, where 70% of the population still lives, remains difficult despite many positive government initiatives, especially since economic reforms begun in the 1990s.
School attendance, female literacy, healthcare and transportation figures have all gone up, but it’s still common to find entire communities existing at the margins of society, unable to advance economically due to religious or cultural custom, as much as geographical, financial or employment barriers. And compared to the villages of remote and rural China I visited 10 years earlier, India’s rural standard of living is still decades behind nearly everywhere else on the Asian continent.
India has been in the news recently in terms of Australia’s decision to export uranium there and closer defence cooperation amid a shifting state of alliances following Pakistan’s diplomatic fallout with the US. One of the biggest stories in geopolitics this year was not so much the Arab Spring, but India’s military build-up: India is expected to spend $US45 billion on warships alone over the next 20 years, versus $US25.1 billion for China and $US17.7 billion for Australia. Between 2006 and 2010, India accounted for 9% of the world’s global arms trade, according to the Stockholm International Peace Research Institute.
Yet behind these headlines there’s still the news of a country lacking answers to even the most basic development questions. Beyond the now daily protests against government corruption led by opposition figure and neo-Gandhian Anna Hazare everyday Indians are losing faith in not just government but all institutions of civil society, this month’s disaster at a Kolkata hospital – where doctors and nurses escaped leaving scores of patients to perish in a massive fire – being only the most recent example.
And while millions are being lifted out of poverty through innovative microfinance products (see Under the radar: Microfinance), even that has been gamed by corrupt and ruthless operators, creating a mini sub-subprime disaster in the state of Andhra Pradesh earlier this year. It’s a similar story in other development initiatives, too, whether siphoned irrigation and fertiliser subsidies, corrupt infrastructure tenders or blatantly ineffective and inefficient make-work programs.
Only in India, I thought, when standing next to a water pump powered by an old man and a bullock we saw the vapour-trail of yet another communications satellite launch: no doubt the product of a demand illustrated by barefoot children taking photos of us amid the cows, goats and stray dogs with their Nokia smartphones.
India, the clichÃ© goes, is a magnificent place of contrasts, but one that presents as many pitfalls as opportunities for the direct investor, as well as the macroeconomic investor hoping to ride the country’s coat-tails to further economic development.
Due to political opposition built on misplaced arguments of competition and employment last month, foreign retailers were once again blocked from investing in India, leaving the country still without a national cold-storage supply-chain or recognisable supermarket brand in the year 2012. Some will no doubt celebrate this, but it won’t be the average Indian consumer. GDP growth, meanwhile, has fallen to 6.9% in the latest quarter, with industrial production declining 5.1% on the previous period. Inflation, running at 9%, still precludes stronger central bank intervention, yet belies the massive fall in the rupee, despite the continued strength of currencies like the Australian dollar, which, ironically, is based on supposed growth in emerging markets.
Like China, India also has an urban residential property bubble, with prices for basic housing now well out of reach of the middle class. Yet unlike China, the bubble has been more a case of withheld supply, rather than out-of-control credit. While bad debt, as with the case of Andhra Pradesh’s microfinance micro-crisis, certainly exists, as a portion of total debt, and in turn, as a portion of total GDP, it is tiny.
Unlike perhaps China, India’s problems are eminently solvable within the country’s own democratic (and thankfully, largely peaceful) framework, but the solutions that exist lack political will in a parliament that’s under siege from street populism on one side and corrupt inertia on the other. Still, reform and investment remain the only way forward.
India doesn’t have an oversupply of infrastructure or housing – far from it – and it has still barely begun to exploit the capital markets, let alone become over-dependent upon them for growth. The Indian equities market is as risky and as volatile as any emerging economy, but its debt market shows promise, especially with plans to float a $US1 billion infrastructure fund in February – a drop in the ocean of what’s necessary to bring the country’s cracked highways, creaky bridges and crowded cities up to international standards.
Don’t get me wrong, I’m bullish on India. The thing is I am bullish on a 20–50 year time frame, which is pretty much useless for most investors. India, I believe, will one day achieve its potential as a global leader in virtually all fields of economic endeavour, but that won’t be anytime soon. And while it will be a useful ally, trading partner, cricket opposition and travel destination for Australians, it won’t solve any problems in our economy should China’s growth decline or stall.
In the meantime, as I’ve said before, when it comes to value and near-term return, I still believe the best prospects lie in the otherwise moribund economies of the rich world, especially northern Europe, the United States and Japan. These economies might not have as much spice, as it were, but with low price/earnings multiples, strong corporate governance standards and more predictable earnings, they won’t make you sick either.
When looking to India for your portfolio’s growth, be careful where you invest and make sure you read the fine print of any products that will invariably be built around it as an investment thematic. Many companies – ranging from Leighton Holdings at the blue-chip end, to eServglobal at the small-cap end (see Under the Radar: The new pay-phone) – will continue to do well in India, but many won’t. Like with anything on the subcontinent – whether riding on the roof of a train, the back of an elephant, or a truck with three wheels – you’ll either come out well or you won’t.