China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

India – A Promising Nation for the World

September 5, 2012

India is a promising emerging market for the world today. The world output is expected to grow at around 3.5% in 2012 where the major contributors are likely to be emerging economies like India and China. Indian and Chinese economic growth rates in the past five years inspired investor’s world over to consider them as the next investment destination. Despite, the low growth rates of 6.5% last year in India and lower growth rate projection of 5.5% in 2012 in India and about 8% in China, the future seems to be hopeful yet challenging for both these countries.

India is a young nation that promises much more than what is evident in the through international lens of statistical barometers. It is presently going through the legislative reform process for making it a more accountable and transparent nation to its people through introduction of several pending bills. Adaptive to the global developments, the country has advanced its governance structure in a reformative manner that is approachable by the common man by means of e-governance.

The right to information act has empowered the common man. Further, the introduction of Value Added Tax, Direct Tax Code and e-filing has enhanced the transparency into the system, bringing it closer to the international standards. The government incentives like the NREGA scheme and national policy for manufacturing or schemes for social sector development and infrastructure development schemes is likely to give boost to the economic growth. Fiscal measures taken by the government are made keeping in mind their commitment to the fiscal responsibility and management bill.

Serious credit crunch
India despite such fiscal measures is unable to achieve its potential levels of growth in industry, agriculture and services sector. They need the necessary credit impetus to grow. Credit flows are needed in each sector to enhance the investment multiplier promising higher growth rates. Indian banks have been resilient to the global financial crisis but today face serious liquidity crunch. The central bank of India while reviewing the third quarter’s economic situation has identified that inflation rates are high for the given low economic growth rates, high current account deficits and high fiscal deficits. Given the challenges the bank has decided to keep the CRR (Cash Reserve Ratio) to 4.75% and SLR (Statutory Liquidity Ratio) to 23% so as to induct liquidity in the Indian market.

Lately, the chairman of one of the largest PSU banks in India, SBI, has demanded that CRR requirement may be scraped providing greater liquidity to the banks. It is difficult to believe that such a demand could be made by the country’s largest public sector undertaking (PSU) bank. CRR is an essential liquidity maintained by the central bank that acts as a bulwark for the financial system. Removing the CRR requirement would put the banking sector into great danger. Banks need to monitor their investment and act in a more socially responsible manner especially the PSU banks. There is a need for the banks to participate in the economic development process by initiating and encouraging investment in areas with long gestation periods or less than market benchmark returns.

The Reserve Bank of India alone cannot do much to improve the situation. The banks need to adopt a socially responsible role by making credit available at low cost. The agriculture, industry and services sector is unable to achieve its full potential due to lack of low cost credit. The actions of the Reserve Bank of India with respect to CRR and SLR are less likely to yield results given the deregulated state of banking in India. Banking priorities presently are not aligned with the economic development priorities especially when PSU banks take pride in declaring their profits over their declaring their contribution to the economic growth through credit disbursal. Unfortunately, the government units are not defining their performance through their contribution to the social benefits which is an area less researched in the world.

Disinvestment and deregulation are good for a country as long the directed flows do not cause market imperfections or inefficiencies of oligopoly or monopoly causing a dead weight loss to the economy. It is a myth to believe that monopoly and inefficiencies only arise in government sector. They may develop well in private markets as well, to reduce such inefficiencies it is needed that government may introduce competitive market structures and monitor them carefully.

Regulations in the Indian banking sector were dropped primarily with the belief that the competition in the sector would enhance the consumer’s position. However, despite the deregulations and entry of new players, the market continues to be supply driven rather than being demand driven. Banks have become large conglomerates with forward and backward linkages. Banking is the need for all economic transactions today but has the country provided for a sufficient competitive market structures that that support credit growth.

Necessary policy improvements
India is one country that has a large set up of informal financial markets that still continues to support the economy. To achieve a higher growth potential it is needed that markets may be made more competitive, regulations more stringent, contracts enforceable and government set ups more accountable. To aid this it is needed that there is consolidated effort of fiscal and monetary policies to support economic events. Political and economic will to align sectorial growth rates with economic development priorities.

How do we do it all? The government needs to bring back its disinvestment agenda to reduce its fiscal deficits with proposed conversions of retained earnings into equity shares. Plug all leakages of savings that go into unproductive investments like speculative investment in real estate or investment in gold or foreign currency. Tap the flow of income even the smallest by making banking a habit.

Demonitise the economy, it will reduce black money and ills of the parallel economy! Make transactions accountable by necessitating the use of income tax number known as the PAN number even in the smallest transaction! Direct the flow of saving to banking channels by removing the KYC norm on small balance account holders with low or no banking transactions!

A mere deregulation in diesel prices or reduction in subsidies would not help much in the fiscal position of the government. It would be better to concentrate on the economic issues rather than industry specific issue or specific transfer payments. Tax evasions need to be controlled. Tax incentives to motivate investments need to be given. Government needs to control cost and time overruns in infrastructure and other projects that increase government expenditure and inflation. Banks need to be reminded of their main business of lending and must not play with the public money by investing or speculating in the stock market. Legal systems need to promise foreign and domestic investors protection for their investment and manpower. Imports of unproductive resources like gold need to be reduced or curtailed. Make governance more easy and accessible through e-grievance addressal cells.

The potential
India with its young population size, highly qualified manpower, rich political base, progressive outlook and rich natural resources needs more unity and coherence in its economic growth and development story. One sector alone cannot push the growth rates. Agriculture needs another green revolution. Industry needs a fresh line of credit and services needs newer and higher grounds of performances to develop. Further, a future recovery in the world economy will bring greater hope for India as trade and investment ties would improve.

 

 

 

 

Yamini Agarwal
Professor and Vice Chairman (Academics)
Indian Institute of Finance (IIF), Delhi

 

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China’s Housing Market is on the Mend

China’s housing market is turning the corner. Sales have risen, inventories are coming down, and prices have firmed slightly in many cities. Slow new house-building will remain a drag on the economy for some time yet, but should begin to add to GDP growth in 2013. The key drivers of the turnaround are greater affordability and an easing of financing constraints.

Divining the state of China’s housing market is not easy. China has 16 cities or conurbations with a population over 5mn and a further 20 with populations over 3mn, and conditions vary. What is happening in Shanghai and Beijing in the luxury sector does not necessarily represent what is happening elsewhere. Official data on housing is improving, but remains limited and, as with all China’s data, sometimes misleading.

To supplement the available data, at Standard Chartered we have conducted a regular survey of thirty developers in eight Tier 2 and Tier 3 cities, with populations from 3-8mn. Our most recent survey confirmed official data suggesting that the market is improving. Developers are seeing more sales and are beginning to plan increased construction.

Owning property is a powerful ambition in China. For many men it is a pre-requisite for finding a wife given the gender disparity and cultural expectations for a dowry from the male side. And despite the building boom, the vast majority of people in China have still not made the move to a modern apartment block, but would dearly love to. There is a huge underlying demand that is rising with continued urbanisation, and is set to remain rapid for a few more years before levelling off.

China’s housing market is also widely used for investment. Opportunities to earn higher returns on savings have improved for wealthy investors in recent years, with the rapid growth of trust companies. But the stock market is languishing at low levels, so property is the preferred asset class for many.

New apartments in China are typically sold unfinished, with internal walls and electric outlets, but not doors, floor coverings, kitchens or bathrooms. Investors generally leave them unfinished. Buyers in China have a strong preference for new apartments and any chosen kitchen or bathroom might be unfashionable a few years later.

This is a key reason for the frequent observation of empty apartments; usually they are sold, but just left empty. These apartments are effectively treated like a land investment, rather than as an income-generating asset. One implication is that a property investment boom in China does not necessarily reduce rents as it might in the West, which slows any natural rebalancing.

Large investor holdings could be a problem if everyone tried to sell at the same time. But there has been limited distress among owners in this housing cycle because loan-to-value ratios are generally low and many investors have no mortgage at all. They can afford to wait it out.

The spurt in home completions in late 2011 on projects started during the post-2009 bubble phase is slowing, while the amount of floor-space under construction is deep in negative territory. Meanwhile our survey finds buyers returning, attracted by lower prices and local easing in financing conditions. Over time these trends will bring down unsold inventories, which are still high.

I say “local” because the central government has resisted easing up on the housing sector. It is afraid of a sudden return to bubble conditions, particularly given the easing in monetary policy generally to combat the economic downturn. Some cities that tried to loosen regulations too much have apparently been over-ruled. But overall, the evidence is that it has become somewhat easier to get finance than a year ago, at least for owner-occupiers.

Prices seem to have fallen in the range of 5-20%, with a greater fall in new-build than in the secondary market, as is typical after a boom. This may not sound like much, but wages are growing 15-20% in many cities. Encouraging wage growth is a deliberate part of the government’s strategy for boosting consumption, but it also means that housing affordability has considerably improved over the last two years.

Price is the key issue. While prices in Shanghai and Beijing often look breath-takingly high, arguably this reflects their “world city” status. In ordinary cities, prices were also becoming high relative to earnings a couple of years ago, sparking social discontent. The signs are that the slowdown over the last couple of years has corrected this, to some degree. But it would not take much to open up a gap again. Hence the government focus on restricting investors, by limiting people to one property only, while encouraging first-time buyers. As the market recovers, expect an increased focus on ways to prevent prices rising too fast, including property taxes and financing restrictions.

 

 

 

 

John Calverley
Head of Macroeconomic Research, Standard Chartered Bank, Toronto

 

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China and the European Crisis

When I visited China in early May this year, I really got the impression that China was strongly interested in a European recovery as soon as possible. China cares about the EU and EMU – probably mostly for its own sake (which is a normal emphasis and reaction). This includes that China really wants to have a strong economic counterpart to the U.S. in the Western hemisphere – and that it has been investing a lot of money in the Euro since its start.

China’s worries about the economic development of the EU/EMU have been confirmed in recent months statistically, too. Chinese exports have slowed down visibly – particularly what concerns exports to Europe. And the problems that are linked to the crises in mainly Southern Europe have not declined either since spring.

Chinese GDP is now growing slightly below expectations (q2: 7.6 %). This causes concerns since the current president Hu Jintao and prime minister Wen Jiabao certainly do not want to leave the economy to the next generation of political leaders in a worrisome shape. The situation in Europe contributes substantially to the worries.

It is not very common that the Chinese give policy advice to leaders of other countries when they visit China. For this reason, it was quite illuminating that prime minister Wen Jiabao recently explained to the German chancellor Merkel that countries in certain situations cannot solely concentrate on structural fiscal recovery – but also have to rely on traditional Keynesian policy if economic growth is fading too much.

Wen mentioned that China has been very successful in this respect. To some extent, he may be right (at least without regarding the risk of overinvestment). But what China neglects is the point that China has not deregulated cross-border financial flows like the affected EMU countries have – and, consequently, cannot be hit sharply by global speculation. Furthermore, China had – and still has – the advantage of a positive current account balance. This means there is no real need of net borrowing abroad. In other words: Conditions for Chinese expansionary fiscal policy are very different from conditions in Southern Europe (apart from the non-transparent issue of the real size of the Chinese government debt).

Another reason why China is very unhappy about the European debt crisis is of a more financial nature, i.e. the capital losses that derive from the weakening Euro. China wants to diversify its currency reserves from the U.S. dollar to a higher of the Euro. Currently, however, such a strategy is counteracted by the weakening Euro. Despite the ongoing challenges, however, China still invests in the Euro (example: according to the statistics of the EFSF, around 14 % of its funding comes from Asia, Japan excluded, which should be about Euro 5-6 billion of Chinese origin – which on the other hand is not an amount that is really supportive to the Euro).

Altogether: China cares a lot about Europe, the EU and the Euro. But there is not very much China can do or will do to dampen the European crisis more significantly.

 

Hubert Fromlet
Professor of International Economics
Editorial board

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