Debt in India and China: Two contrasting stories — and the big picture

This article appeared originally in Gulf News: link to original article

Sustaining economic growth for a long period of time is great, but can the same be said about debt-fuelled growth?
To better understand this, I am looking at the top 20 countries in terms of GDP growth, updated last in February 2017 by World Atlas, and analysing that with five factors in mind — domestic credit to the private sector, household consumption, gross savings, real interest rates, and foreign direct investments.
I must mention here that for smaller economies, GDP growth is quite high because of starting from a low GDP base. That doesn’t mean that such growth cannot be sustained and increased, but only if properly planned and managed.
First of all, there are 10 Asian countries in the top 20 in terms of GDP growth. China and India are among those, with the data for each telling a different story.
Looking at the above mentioned five factors for China, the only concern is the high domestic debt that China boasts, and which has been increasing year-on-year.

Debt-fuelled growth

And so among the top 20, China is the only one that has a highly debt-fuelled growth. With the highest gross saving rates — and the Philippines trailing it — China could further spur growth using debt by cutting its reserve ratios further.
It can also do so by cutting interest rates, but that could heighten currency manipulation accusations and will add to debt, whether corporate or household.
Such high debt levels could be sustained for a few years with growth still being at an impressive rate, but debt will need to be paid back somehow.
Or a serious banking crisis will be an outcome that will affect all of China’s trading partners and others by rumours and speculation.
In the 2008 financial crisis, governments such as the US and UK had to bail out their banks by getting stakes in them. The next logical step for China would be to open up further for foreign ownership.
For a country that is actively investing its money across the globe, China enjoys a high positive net cash inflow which could be easily directed towards foreign ownership of its heavily indebted companies.
India and China: Contrastic stories

The last point brings us to India. India is at a better footing than China because its economy is better balanced towards household consumption, with domestic debt being 50 per cent lower than that of China.
Interestingly, China’s share of the world’s GDP is 5 times that of India.
India has higher interest rates than China and is keener on increasing foreign ownership.
In other words, India can stimulate growth via multiple factors, as long as it effectively balances between higher debt levels, lower saving levels, and higher household consumption.
Higher foreign direct investments should be invested in lifting more people out of poverty if household consumption and savings level are to be balanced while sustaining long term economic growth.
At its current economic levels, India is in an excellent situation to replicate China’s economic boom.
High domestic debt levels

Other Asian countries include Bhutan, Cambodia, Lao, Myanmar, Turkmenistan, Timor-Leste, and the Philippines.
Among those, Bhutan, Cambodia, and the Philippines claim the highest domestic debt levels, with Cambodia leading the way on debt growth.
This could be alarming if the trend continues, especially as they could attract more FDI and promote ownership of their companies to have some sort of an equilibrium on their debt-equity ratios.
Having high real interest rates provide ample monetary freedom to use debt when global economic conditions allow it and refraining when they don’t.
Whether it is the latter two or the other Asian countries, a stronger dollar could harm their FDI attractiveness.
But it could also encourage investments in their export sectors given the relatively cheaper currencies.
There are 9 African countries out of the top 20 with top GDP growth — says a lot, right?
Those are Chad, the Congo, Djibouti, Ethiopia, Ivory Coast, Kenya, Rwanda, Tanzania and Zambia.
I looked into the last five-year data and here is the conclusion: Generally, African countries enjoy low domestic debt compared to other developed countries, which could be justified partially by high real interest rates.
On the contrary, the same high real interest rates seem to be attracting FDI to countries like Ivory Coast and Zambia.
It must be noted here that high interest rates are common in Africa as higher returns are required for higher risks tolerated by investors. There are pros and cons here. First, high interest rates should encourage savings, which they are not.
Compared to other countries in the top 20, African countries enjoy much lower saving rates, with the highest (as percentage of GDP) being Zambia’s. This could be also blamed on lower income, and lower disposable incomes, of course.
How come there is no country from the Americas or Europe?
You may want to look at their economic conditions as being, broadly speaking, the opposite of what has been mentioned earlier.
The US jobs’ reports are getting better month-on-month, and Germany is understood to be at somewhat full employment.
If you look at other countries, they have either realised their growth potential, and so started to slow down, or may have missed the growth train — growing at a very fast rate and then slowing down to a more sustainable but impressive rate, such as the case with China.
Ageing populations

Given the ageing populations in Europe, growth would be very hard to come by. Not only that, but even when a few quarters show some growth, others completely diminish the impact.
What’s quite interesting is that one country among the 20 on GDP growth is among the top 20 in government debt-to-GDP for 2016 — Bhutan.
For China, whose GDP ranks second worldwide, a much lower government debt-to-GDP ratio than Japan and the US for instance, which reaffirms its toxic corporate debt situation, privatisation is one solution.
It is understandable to see the US among the 20 most indebted countries in terms of government debt-to-GDP ratio, given that it prints the world’s main trading currency.
Japan’s case though, and given that it ranks first among the 20 most indebted governments, is perhaps the most curious and complex.
Besides its foreign currencies reserves and huge sovereign wealth fund, Japan has today limited actions to take to spur growth.
Though it can lower its consumption tax to increase household consumption, the question is to how low that should be for domestic consumption to increase to a level to provoke inflation and set it on its way towards a 2 per cent target.
The other question is: Would the central bank then be able to continue its current assets purchasing binge — the classic equilibrium between government revenues versus expenditure?
As in Europe, Japan’s ageing populations hold further future trouble.
To conclude, countries with high growth and further growth potential seem to have a manageable domestic debt; a balanced household consumption; moderate gross savings as a percentage of GDP; positive net FDI inflow; and higher interest rates.
As the Fed keeps hiking interest rates, investments could hypothetically move from emerging economies to that of the US.
That, however, is not a given, especially as there is a long way for US rates to match any country in the list of top 20 GDP growth rates.
The investment environment is also improving in those countries, which is making previously unthinkable investments become attainable.
The last question that I want to leave you with: What drives growth in Papua New Guinea, which ranked first in the top 20 countries in GDP growth?