Global Outlook

The slowdown in China could adversely affect India

Contributed by Nirmal Bang

A Chinese central bank adviser recently said growth in China may witness a slowdown, sending markets in a tizzy. Song Guoqing, an academic member of the People’s Bank of China monetary policy committee said economic growth in China may slow down to 7.4% this quarter, causing anxiety among global and domestic investors.

China and India are always seen as two leading and emerging economies of Asia. They are usually a part of the emerging market asset allocation pool. So, when global portfolio managers allocate funds to emerging markets, these two countries usually take a bigger pie. However, with news of China likely to witness a slowdown, what needs to be seen is whether global investors will reduce the asset allocation to emerging markets as a whole? If that happens, India too will lose out foreign investment through outflows, which will further deteriorate investment sentiments. And if global portfolio managers redirect some of the funds pulled out of China into the Indian markets, then it will boost the Indian equity markets.

Through this article we will assess the current situation of the slowdown in China, reaction of global money managers and its possible impact on the Indian economy or the market.

As China slips, the second-half performance for many emerging market mutual funds might soon follow suit. In recent months, investors have been pulling hundreds of millions of dollars out of stock funds that invest mainly in companies associated with the big four emerging market nations of Brazil, Russia, India and China (BRIC).

But it is China that is causing most of the worry for fund investors, amid signs that the world’s second-largest economy is slowing more sharply than expected. Even emerging market bull Jim O’Neill, chairman of Goldman Sachs Asset Management, who famously coined the BRIC acronym, said he’s been a bit surprised by the slowdown in China.

One sign of the Chinese slowdown is China’s purchasing managers index, which dropped to 50.2 in June after hitting a year-long high of 53.3 in May. The growing concern about China and slower growth in other BRIC nations is also starting to show up in the performance of some US emerging market funds and hedge funds focused on Asia.

Mutual fund industry tracking firm Morningstar says US emerging market funds were up 4.61% as of 30th June compared to a 5.51% gain for non-emerging market stock funds. China-focused US mutual funds are up 2.9%, lagging behind the 4.15% gain recorded by diversified emerging market funds, as per Morningstar. The benchmark S&P 500 index, meanwhile, is up by 7% this year.

Some Asia-focused hedge funds that go long and short stocks are posting mediocre numbers. HSBC Private Bank reports the Chilton China Opportunities Fund was up a little under 1% as of 22nd June, while Pinpoint China Class A Fund was up by nearly 1.3% over the same period.

The second-quarter was not kind to the so-called BRIC-focused stock funds, with investors redeeming $787 million during the period, according to fund tracking firm EPFR.

China-focused funds were hit particularly hard, with investor redemptions totaling 88% of the $1.6 billion in new money those funds took in during the first quarter. The rush of money out of Chinese funds come as institutional investors are reworking growth estimates.

Now the worry is that with China’s economy slowing, emerging market funds may see further losses in the second-half of 2012, especially if other BRIC nations experience even slower growth. For a BRIC country like India, one of the two fastest-growing large economies in the world even at the current pace, the coin can turn either way.

Multinational corporations and financial investors are sitting on large pools of liquid money. Before investors send money into India, they need policy predictability and a steady march toward further liberalization of the economy. However, this scenario looks less likely in the next one to two years.

The current economic paralysis may continue due to political complacency in India. Some of the key economic points described here indicate that we are not in an advantageous position compared to a slowing China.

The first quarter of this year saw India’s economy grow a mere 5.3%, the slowest rate in nine years. The central bank (RBI) increased the benchmark interest rates by more than 4% in the last two years to control the 9% to 10% inflation rate.

Though the inflation rate has come down, it is still not in the comfort zone. Also the infrastructure and manufacturing sector has cooled off significantly. Another concern is fiscal deficit that the government has been unable to control.

And there are other issues too like the government’s inability to take strong reform policy, cases of corruption and scandals, etc. With general election around the corner and current issues with coalition partners, the government is unlikely to take any bold steps towards economic reforms.

In lieu of all this, India may not act as an investment substitute for China, which is still expected to grow at 8.2% in the calendar year 2012, much higher than the anticipated 6% growth rate for India during the same period.

On the other hand, the slowdown in China will reduce the global growth rate. This will reduce the global demand for goods and services. All this along with the current Euro crisis will worsen the current economic environment further.

And this will have a spillover effect on the Indian economy and in no way boost global investors’ confidence. In such a scenario, global fund managers are unlikely to reallocate the money pulled out of China towards India. But there is a chance, very little though, that this belief may turn out to be wrong. If the Indian political front can get its act together, this could be a golden period for the country.

Some steps that require attention are opening up of more industries to FDI, mainly in multi-brand retail and aviation. Some other steps are the implementation of Goods & Services Tax, ending uncertainty caused by its proposal to levy a retroactive capital gains tax on transactions in Indian assets by foreign entities. These are just a few examples. In fact, there are many other steps the government needs to take to reverse the trend.