The economic might of China and India has long been established, yet the question of what’s next for these two economic powerhouses has become pivotal. Facing headwinds in the form of slowing growth with concurrent opportunities for structural change and economic rebalancing, the ability of these two nations to navigate the changing economic landscape will shape the fortunes of the global economy.
In a lively panel discussion at the 2014 European Investment Conference, Russell Napier, ASIP, an independent strategist at and co-founder of Electronic Research Interchange (ERIC), contended that investors should be more optimistic about India than about China. His central thesis was that China’s export-driven growth model is not sustainable and its financial infrastructure is ill-equipped to support a shift toward domestic consumption as the driver of economic growth. He believes that although China’s banking system remains state controlled and ostensibly set up to fund production, India’s banking system comprises a larger share of private commercial banks and is thus equipped to fund consumption. Moreover, he added, there are three big structural factors in the United States that will eliminate China’s competitive advantage as a producer and exporter, namely:
- The emergence of shale oil and gas
- Demographics (specifically, deleveraging by the baby boomer generation in the United States)
- The newly competitive American industrial sector based on cheap energy, land, and labour
Napier illustrated the reversal of the trend in the current US account deficit (a barometer of China’s trade surplus) to underline his point that “the game is up” for China.
Wei Yao, China economist at Société Générale, reflected similar sentiments on China. She commented that it is inevitable that China’s over-indebted private sector will endure short-term pain. This situation, she argued, has not been helped by the government’s control over the financial system and its distortionary effect on market signals — illustrated, for example, by the returns offered by shadow banking products of 10%–15% without ever experiencing default. Wei surmised that China has a chance to rebalance, but it must improve its investment efficiency.
A contrasting viewpoint was put forward by Ng Kok Song, adviser and chair of global investments at the Government of Singapore Investment Corporation (GIC) and an adviser to the Future of Finance initiative at CFA Institute. Ng acknowledged that China is entering a transition period in its economic development, but he contended that it will succeed in making the shift from export-led growth to domestic consumption. Ng argued that China has a rising share of middle-class consumers and thus domestic demand will inevitably grow. Despite likely slowing growth in the interim as China makes this transition, stock market valuations provide big opportunities for long-term investors who can ride out short-term difficulties.
Ng Kok Song (left), James Mackintosh (center), and Wei Yao at the European Investment Conference
With all panelists acknowledging China’s economic rebalancing, the discussion turned toward the issue of exchange rate policy. Napier questioned what would happen to China’s monetary policy stance (based on a relatively fixed exchange rate) as China makes its transition toward a consumption-led economy. Ng suggested that parallels can be drawn with Japan, where the JPY/USD exchange rate went from around 360 a few decades ago to around 100 today. Japan’s economy managed to sustain itself in spite of this appreciation of the yen; China could therefore endure an appreciation of the renminbi. Moreover, Ng said that labour productivity in China is just one-seventh of the OECD average; he suggested that China can increase labour productivity substantially and thus won’t have to devalue the currency to remain competitive.
In concluding remarks, Napier returned to the notion that India is best positioned to be relatively more prosperous given the greater flexibility of its economy, the country’s more flexible exchange rate, and the structure of its banking system. The panel acknowledged that the new political administration in India has the opportunity to enact structural reforms, but this process will take time. Regardless of the views held about China or India over the longer term, it seems clear that both countries are on the cusp of big change.
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