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Another week, another panic. Dreadful economic news from the US sent markets around the world sliding again. Hong Kong finished the week down 6.5%, Singapore 5.5% and Japan 5% – and they were among the better performers.
India was especially weak: unlike most Asian indexes, the Sensex slid to a new low for the year. After being one of the region’s stronger performers in the first half of the year, the Indian market is finally catching up to reality and accepting that it can’t shrug off the problems in the rest of the world.
Investors often think that India is more self-contained than other countries like China and will suffer much less in the global recession. That’s true up to a point – the economy is certainly much less dependent on making cheap goods for export. We’re not seeing Indian toy factories closing in thousands.
But India’s dependence on the West might have been underestimated. The difference is that it’s business spending, not consumer spending, that it needs to worry about …
Outsourcing won’t escape the recession
Optimists on India always point to its thriving software and business outsourcing sectors as evidence that it’s following a smarter path than China. Instead of using cheap labour to make cheap goods, it’s specialising in skilled work and building a knowledge economy. But while India’s IT sector is very impressive, it isn’t recession-proof.
Business investment is cyclical – much more so than consumer spending. The outright contraction in US consumer spending that we’re seeing now is unusual. But business spending contracts in every recession. A big slump like the one we’re in will cause plenty of firms to put off new investment in software and computer systems.
Maybe that will be outweighed by firms outsourcing more functions to cut costs – but I doubt it. Sure, there will be cost-cutting and outsourcing drives in some industries. But much of India’s existing business comes from the financial sector, and many of these firms will be dropping divisions, merging and even going out of business altogether.
The software sector probably provides a very high percentage of high-paying jobs in India. Labour market data are pretty sketchy, but surveys suggest that the IT sector directly provided around 50% of graduate jobs in the first half of this year, according to DBS, while it seems likely that large numbers of jobs in other sectors are created as a result of the sector’s growth. This suggests that the health of IT probably has quite a big impact on India’ domestic economy and a slowdown in IT is likely to spill over.
China will find it easier to boost the economy
Of course, if you substitute manufacturers for IT, the same applies to China – loss of export jobs and lower investment in new factories will spill over into the rest of China’s economy. But China has more scope to boost government spending and more ability to order companies to keep investing than India does.
Two weeks ago, China announced an RMB4trn ($585bn) package to boost the economy. To be clear, much of that money had already been announced – Beijing was just flagging up its intentions in an effort to boost confidence. But should things worsen and China have to add another four trillion to that, it can afford to. This weekend there were reports that we’ll soon see a second package aimed at boosting consumption.
India has much less flexibility: while China’s budget is in a slight surplus, India is running a deficit of around 6.5% of GDP. And it’s not just the government that’s been borrowing freely. India has also been a big beneficiary of international money recently: foreign capital inflows have been rising relative to overall investment in the last few years. The inflows have been especially significant this year, as you can see in the chart below from Citigroup.
With credit tighter around the world, it’s a good bet that these inflows will slow down for a while. The majority of investment has been relatively long-term debt, so the risk of a rush of money out of the country is probably relatively small. But lower levels of new foreign investment will mean slower growth.
India is very dependent on foreign money
The impact on companies could be substantial: around 40% of new corporate debt was raised from foreign sources this year, twice as much as three years ago. So even if local banks continue to lend, companies face something of a credit crunch. And it’s by no means certain that local banks will be lending as freely as before. The chart below shows the Indian overnight interbank lending rate – the spikes in September and October suggest some strains in the system.
The Reserve Bank of India has already loosened monetary policy in the last few weeks to combat this, and more cuts will no doubt follow, but it’s unlikely that this will compensate fully. And since India has seen domestic loans grow far more rapidly than China in recent years, a credit crunch in India is likely to see the economy slow quite significantly. (Compare the yellow line (India’s loan growth) with the green line (China) on the chart below (the white line is Indonesia).)
Stocks are only now starting to price this in
Of course, India is not alone in facing these threats. No Asian country will avoid a sharp slowdown as a result of the global slump. And none of it harms India’s long-term prospects. The country is still an excellent investment story: its relatively low starting point means there’s vast potential for improvement and its very young population means that its demographics are better than China’s.
But it’s taken a while for Indian stocks to reflect the near-term risks. Investors often think that India’s market has been relatively sedate compared to China’s bubble in recent years. As you can see in the chart below, after the Shanghai composite (the green line) rose six-fold from mid-2005, the Sensex (orange line) was up less than three-fold.
Nothing by comparison, is it? But as ever, what we see in a chart depends on our starting point. Chinese stocks had a multi-year slump into 2005, weighed down in part by a huge overhang of non-tradeable state-owned shares that was finally removed that year. If we take the starting point back to when India began rising – mid 2001 – we can see the Sensex has actually risen considerably further than the Shanghai market over this timeframe.
The Indian bull market was definitely steadier and not all this growth was a bubble. But valuations became severely stretched, especially towards the end of 2007, and even after falling 60% so far this year, Indian stocks aren’t at rock-bottom prices.
On a price/earnings ratio of 9.5 times and a price/book ratio of two times, the Sensex isn’t expensive for long-term investors – but neither is it cheap enough to compensate for some serious earnings disappointments over the next year or so. Much as I like the long-term India story, I suspect it will be one of Asia’s worse performers in the nearer term.
Turning to the markets …
No Asian markets ended the week in the black, battered by a steady stream of bad news from the US. Local news was also weak: Japan ran a trade deficit for the third month in succession, while GDP figures confirmed that Hong Kong and Singapore are in technical recession (two consecutive quarters of negative growth) and Taiwan’s economy contracted in the third quarter.
Shares in China’s most popular internet search engine Baidu – which is listed in New York – plunged 40% after a TV programme claimed that the company allowed unlicensed medical firms to pay for higher rankings on its web pages. The company says it has broken no laws and in any case has now removed thousands of merchants from its pages and imposed tougher listing standards. However, after a number of Chinese health scandals, included milk contaminated with an industrial chemical, investors are rattled by any hint of problems in this field.
The shipping industry is bracing itself for tough times as Western demand for Asian exports shrinks. China Cosco Holdings – the country’s largest container shipper – and three partners will cut Asia-Europe routes by 30% from early December, while Singapore-listed Neptune Orient Lines – Southeast Asia’s largest line – said it would cut 1,000 jobs.
On the commodity markets, oil continued to fall, dipping below $50 a barrel to its lowest level since 2005. However, palm oil, which had been following crude down for most of the summer, seems to have stabilised; contracts for delivery in February closed the week at MYR1,460 a tonne on the Kuala Lumpur exchange, in line with prices at the end of October.
On the currency markets, the Indonesian rupiah closed down 4.4% against the dollar, while the Korean won fell 5.8%. The two are Asia’s worst performing major currencies this year, hurt by high levels of dollar-based borrowing in their economies at a time when dollar liquidity is tight.