The world's most vulnerable emerging market
There is cause for concern about runaway growth in both China and India, says John Stepek, but India is clearly more of an immediate risk.
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In 2004, India's ruling BJP party unsuccessfully campaigned for re-election under the slogan "India Shining". Today "India Boiling" is starting to look like a more appropriate tagline.
The latest statistics point to a country in grave danger of overheating. GDP growth came in at 9.2% year-on-year in the second quarter, significantly more than expected. The economy has now grown by more than 8% in six quarters out of seven and is on course to beat 8% for the whole year for the fourth successive time.
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Compared to China, which is still posting double-digit growth, that may not look excessive. But while there some cause for concern about runaway growth in both countries, India is clearly more of an immediate risk than China...
Take inflation. In China, consumer price inflation apparently remains muted at around 1%-2% year-on-year and seems to be on a declining trend (although it's always wise to be sceptical about Chinese statistics). India's trend is upwards and inflation is currently running in the 6%-7% year-on-year bracket.
There are signs of asset inflation as well. Share prices are booming: the Bombay Sensex stock index has quadrupled since 2003 and is one of the few markets globally to have seen price-earnings ratios expand over the last year.
Property is also looking frothy, as we noted in a recent piece in MoneyWeek. House prices in big cities have doubled in two years, home loans are up 54% in the year to June and commercial property loans have risen 102% (you can read the article in the latest issue, available to subscribers to download at /file/11557/latest-issue.html ).
Other obvious areas of concern include high private-sector credit growth, a current account deficit of around 3% (from a surplus in 2003) and a far-too-high combined state and federal budget deficit of about 10%. Those, you'll note, are the three big sticks generally used to beat the US and the US, for all its faults, is still a more stable economy than India.
The fact that many reforms seem to have stalled in recent years and transparency remains a big problem should also be a warning signal. Of course, China also suffers from severe deficiencies here, but at least it suffers less from a more pressing problem infrastructure and labour bottlenecks. A combination of poor infrastructure and skilled labour shortages (India's literacy rate is 68% vs China's 95%) mean that India's sustainable rate of growth is lower than China's.
There's widespread talk about a pending investment boom, but little evidence that it's underway on a scale that will make India's breakneck pace sustainable in the near-term. Further ahead, "the mother of all capital-spending cycles" could make India one of the world's best growth stories (for just some of the reasons to be a long-term bull on India, see China or India: whose economic growth will prove more durable?) but for now India looks both expensive and vulnerable to us.
If that sounds harsh, cast your mind back to the Sensex's 30% peak-to-trough plummet during the global sell-off in May and June. As Martin Hutchinson recently put it on Breakingviews.com: "Anyone preparing a list of emerging markets prone to crisis in a world liquidity crunch should put India close to the top."
Of course, India's problems are quite the opposite of America's. As Indian growth surprised to the upside last week, the US did the opposite. We caught up on the latest round of gloomy news on Friday morning, but it's worth noting two bits of data that came out on Friday afternoon.
The ISM index came in a far-below-consensus 49.5, denoting that manufacturing contracted last month for the first time in three years. Meanwhile construction spending dropped a worse-than-forecast -1% in October after a downwardly-revised -0.8% in September. And it's not just the housing bust that's hurting construction; there are early signs of contraction in non-residential construction as well.
With all this evidence piling up, it's getting hard to see how the US will avoid a recession next year. The currency markets certainly seem to be thinking that way: the dollar/sterling rate dipped below $1.98 at one point on Friday.
To us, that trade looks faintly delusional. It doesn't appear to be the done thing to point this out at present, but we will anyway: the UK has many of the same structural faults as the US (substantial current account deficit, bloated budget deficit, gargantuan housing bubble, huge consumer debt, uncompetitive manufacturing) with few of the advantages (gung-ho ethic, good demographics).
If the US economy tanks, it's hard to see how the UK can avoid the same fate, particularly given the two countries' tight correlation in the past. Despite robust recent growth here, the chances of a recession in late 2007/early 2008 must be rising.
And on that note, it seems a good time to turn to ways to preserve your wealth. There's lots of speculation about what Gordon Brown is likely to say in his Pre-Budget Report on Wednesday, but there's one thing you can be sure of - raising the inheritance tax (IHT) threshold to anything resembling a fair level is not on the agenda. So if you're at all concerned about your potential IHT liability, you may want to be tuned into the MoneyWeek website at 1pm this Thursday, when we've got Anne Young, tax expert at Scottish Widows, answering questions on IHT.
If you've got a question for Anne, please go to the Webchat page (/file/22407/iht-web-chat.html) and submit your question, and Anne will try and answer as many as she can.
Turning to the wider markets
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In London, the FTSE 100 closed 27 points lower on Friday, at 6,021, after a morning slump on Wall Street pulled the index back from an intra-day high of 6,087. Cairn Energy was the biggest riser of the day, its share price climbing over 4% due to higher crude oil prices and the forthcoming flotation of its Indian arm. For a full market report, see: London market close.
Elsewhere in Europe, the Paris CAC-40 closed 73 points lower, at 5,254, whilst the DAX-30 ended the day at 6,241, a 68-point fall.
On Wall Street, data revealing that the manufacturing sector had contracted for the first time in three years led to renewed recession fears. Stocks closed down, but well off intra-day lows. The Dow Jones was 27 points lower, at 12,194. The Nasdaq closed 18 points lower at 2,413, a change of almost 1%, as the technology sector was hardest hit by losses. The S&P 500 ended the day at 1,396, a 3-point fall.
In Asia, the Nikkei closed 18 points lower, at 16,303.
Crude oil remained above $63 this morning, last trading at $63.13, whilst Brent spot was at $63.46 in London.
The weak dollar pushed the price of spot gold as high as $£647.70 today, but it had fallen back to $646.60 this morning.
And in London today, makers of Branston pickle, Premier Foods, agreed to acquire RHM Foods, home of Hovis and Mr Kipling cakes, for £1.2bn. Shares of RHM had risen by as much as 40% this morning, with Premier foods stock as much as 12% higher.
And our two recommended articles for today...
Could the world's largest oil company go bust?
- By refusing to adopt the Peak Oil view oil giant Exxon Mobil could end up broke in twenty years time, says Justice Litle. To find out why he thinks Exxon - and Big Oil in general - will be in serious trouble within the next twenty years, read: Could the world's largest oil company go bust?
Why further dollar weakness is inevitable
- Jeremy Batstone of Charles Stanley warns that further dollar decline is not only inevitable, but also likely to be more severe than even the most pessimistic forecasts. For his seven reasons for further dollar decline, click here: Why further dollar weakness is inevitable
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