Time to lead the race

By Anand Mishra
In Economy
October 15, 2015
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India in a sweet spot to cash on the Chinese economic turmoil

stock market declineIn the middle of August this year, the Government of China devalued its currency over a span of three days in a bid to keep its exports intact. The step came after a series of bad news about the Chinese economy over the last few months. The move triggered a free fall in Chinese equity market, which spooked the world currency, equity and commodity markets. Such fast developments in the second largest economy of the world have obviously forced economists and policy makers globally to rethink the condition of global growth. On one side, there is unanimity that the immediate short term impact for the world economy is going to be negative, there are informed voices which claim that the current turmoil in China could benefit India over mid to long term provided India manages to cash the low commodity prices and pushes important reforms through.

Decelerating growth pulls down global confidence

That Chinese economy is slowing has been a known fact for over a year now. What has made headline is the pervasiveness and the mood of the nation. The latest estimates show that even if the Chinese economy manages to grow at 7 per cent, which is official estimate, it will be the lowest in over 25 years, lower than 7.3 per cent, the revised estimate of the Chinese government for the year 2014. Key industrial segments are showing disturbing signs. Factory output is up 6.1 per cent from the last year. Growth in fixed-asset investment has slowed to 10.9 per cent on a year-to-date basis which is a 15-year low. Manufacturing activity has come down to its lowest level in 77 months. The Chinese car market, the largest in the world is expected to contract for the first time in 17 years and global car majors like Ford and Volkswagen are staring a reduced shipments to the country in over a decade. Investment in the first quarter came down below 15 per cent, the lowest in over 15 years. The overall impression of the economy is that it is in for a hard-landing and that has implication for the rest of the world. The most immediate and visible impact globally was the fall in global stock markets. While that may have been a reflex reaction to the crash in Chinese markets, the underlying rationale could well be the realization that a slowing Chinese economy has the potential to pull down the global economy, and different countries may suffer different levels of pain. China is the second-largest economy in the world; it contributed 38 per cent to global GDP growth in 2014. More importantly though, a Chinese slowdown will directly affect a number of economies that trade heavily with China. According to the World Trade Organization data, the US, Japan and the EU exported $123bn, $194bn and $211bn respectively to China in 2013. Needless to say, these would feel the pinch of a consumer less willing to buy from them. There are other countries like Australia, Brazil, Malaysia and Indonesia who are big commodities producers and China is their largest consumer. These would also be badly hit. The global commodity prices have been declining on the back of a low Chinese demand and the trend may be accentuated moving forward, experts say. According to global investment banking major Goldman Sachs, the Yuan devaluation was important for commodity markets and it signaled that global macro conditions have changed. It further noted that China had joined a “negative feedback loop” that was pushing commodity prices down as growth slows and businesses and households, nervous about the future, reduce their borrowing and spending.

The Indian perspective

India stands as an outlier in the emerging markets back in one respect. Unlike most others, India is not a major commodity player. Unlike Brazil, Indonesia, Russia, etc., India does not earn a major part of its global income through commodity exports. Another fact about India is that despite getting more integrated with the world economy, India still depends on domestic demand for growth. Both of these facts together mean that the potential of Chinese contagion hitting India is not very high to begin with. On the other hand, there is a significant section of economy watchers, who feel that India could actually benefit from the current turmoil. As for exposure to China, exports to the middle kingdom accounted for only 5.2% of India’s total last year.

Jayant Sinha, India’s minister of state for finance, said this week the Chinese slowdown and its world-wide fallout could provide a chance for India to “take the baton of global growth.” His boss, Finance Minister Arun Jaitley, has expressed the desire of the government to “take advantage of the global slump and turn India into a sought-after destination for investments.”

As Chinese markets recede, India can be a place for foreign investors who may be interested in India’s domestic market. This is especially luring because India is recovering from a slowdown and consumer demand is expected to rise over the next few quarters, according to an economist with a public sector bank in Delhi. Because of easing inflation, there is an expectation that the RBI will cut rates, moving forward and that will also buoy demand for cars and consumer durables, among other things, he says. Outstripping China as the world’s fastest-growing large economy has given the government and investor confidence, even though the official figures are being seen with circumspection by market analysts. But the domestic demand data that grew by 7.8 per cent in the last quarter of last fiscal corroborates the rebounding economy.

And many global players are buying into the Indian story in the changed scenario. Foxconn Technology Group, the Taiwanese contract manufacturer that makes most of the world’s Apple Inc. iPhones, has expressed its intent to invest billions of dollars to build new Indian factories. Xiaomi, a Forconn client, has already started manufacturing in India. It is little wonder that PM Narendra Modi has been harping about bringing in foreign investment in Indian manufacturing, which goes to make his Make-in-India plan a success. Foreign investment in the country jumped 31 Per cent to $9.5 billion during the first quarter of the current fiscal, compared to the same period last fiscal.

However, most experts agree that for India to sustain the positive vibe, it would be necessary to undertake structural reforms which could make setting up and doing business in India easier. Foreign investments not only bring in foreign currency, they also bring the prospect of creating an ecosystem of local vendors who supply components, raw materials and secondary services. This in turn generates jobs which India so desperately needs for its millions that join the workforce every year.

But for all that to happen, India needs to create better roads, ensure availability of reliable electricity and most important of all, clear files in its officialdom fast. Bills like GST need to see the light of the say. This would not only create stronger domestic markets to support economic growth, but also make exports more competitive, with or without support from exchange rate depreciation. In the ultimate analysis, India needs to realize that in global economic environments, only those emerge winners who cash in the fleeting opportunities. The current turmoil has presented such an opportunity and India must not let it go unexploited.

Impact On Select Indian Industrial Sectors

Possible winners

  • Consumer goods: The fall in commodity prices will bring down the raw-material cost for consumer goods companies while domestic demand for their products will expectedly ride on the rebounding economy. An improving macro environment and lower input prices will drive strong profit growth for these companies.
  • Autos: Automobile manufacturers are in a sweet spot as lower oil prices and interest rates making it less expensive to buy and drive cars. Meanwhile, falling commodity prices will boost profit margins by lowering costs. Rise in discretionary income also would help.
  • Banking: Investors in India feel that RBI will cut interest rates to boost the domestic economy. This is increasingly possible with easing inflation. Banks are likely to be one of the biggest beneficiaries of a cut as lending growth will pick-up and their bad loan ratios will come down.
  • Downstream oil companies: Fuel retailers often have to shoulder losses in a rising fuel prices regime as they sell at government-set prices. As the prices of these commodities fall with oil, these companies are likely to benefit a lot.
  • Exports: Both technology and drug exporters have been outperforming recently as a weak rupee makes them more competitive abroad and lifts the rupee value of the dollars they earn.
  • E-commerce: Most of the goods that are sold by e-commerce companies are imported from China. They are likely to benefit big time from the fall in Chinese currency. They would see their costs coming down significantly.

Possible losers

  • Metals: like all global commodity players, Indian metal producers which have benefited by a surging Chinese demand, are now likely to see fortunes slide. They could see their exports decline. Also a Yuan devaluation would make Chinese dumping more likely.
  • Textiles: India competes most with China in global markets in textile sector. A Yuan devaluation may translate into tougher competition for Indian players in global markets.
  • Chemicals: Chemicals, both organic and inorganic are largely produced in India and China. While margins in complex chemicals are higher, base chemicals attract lower margins. Low crude oil prices have already affected final prices, but China lowering its prices will impact Indian players.