India Growth Does Not (Yet) Herald End Of China’s Economic Reign


For the first time in history, the International Monetary Fund (IMF) has noted that the growth forecast for India exceeds that of China. But although the IMF expects India to grow at 7.5% in 2015, relative to China's forecasted growth of 6.8%, it would be premature to envision China being toppled from its position as the global economic giant, says Avien Pillay, Head of Research at Old Mutual Wealth.

“While India certainly appears to be the world’s next China, it is currently not in a position to compensate for dwindling commodity demand from China anytime soon,” he says.

“A simplistic interpretation could lead one to believe that an approximate 7.5% growth from a one billion-plus populated country could easily compensate for declining demand from another billion-plus populated country. However, we need to recognise that the bases of these two countries are very different.

“China grew at a significantly high rate - above 10% GDP growth some years - for more than a decade to get to this position. Chinese GDP has increased by more than five-fold in US Dollars over the past decade, while China's GDP per capita is more than double that of India.”

Pillay says the above point is further emphasised if one looks at the commodity market.

“Commodity prices are collapsing given China's reduced appetite and the excess supply which was being mined in anticipation of continued infrastructure growth in China. Demand for iron ore, a vital commodity in the construction industry, has declined by almost 60% over the last year from over $120 per ton to $48 per ton.

“In anticipation of growing demand from China, a number of major global commodity producers developed new production. This production happened to come on stream at a time of declining demand.”

Pillay says that if India was in fact going to replace China as the new growth engine, the real question was when this would happen.

“We need to look at the figures to get a better idea of the time scale involved. In 2014, China made up over 58% of total iron ore demand. The rest of Asia, including India but excluding China, Japan and Korea, together made up 7.1% of global demand. Even if we assume that India comprises 70% of the demand of this group, this equates to 5% of the iron ore demand from India relative to just over 58% of the demand from China. The numbers over the last five years also point to erratic growth for the ‘Other Asia’ region as opposed to an upward trend.”

This means that, while there is agreement on India’s position as the new growth engine, the impact is unlikely to materialise in the short- to medium- term.

“The lack of an equivalent consumer to replace China has implications even beyond the iron ore sector,” says Pillay.

“Looking at commodity cycles over the last hundred years, it’s clear that the length of a typical commodity cycle is approximately fourteen years. The end of the last commodity cycle is not very clear given the impact of the banking crisis, however we do know that commodities have been in a bear market now for 5 to 7 years and if the past average is representative of a typical cycle, the commodity bear market can last another 5 to 7 years.

“The weakness has been further compounded by the excess supply that was brought on stream towards the end of the last commodity bull market. Countries like Australia have increased output more than ten times over the course of the cycle. Until this increase in supply is absorbed by the market, commodity prices will remain in a downtrend.”

The US Dollar strength over the last year has worsened the drop in commodity prices given that commodities are priced in US Dollars, and the commodities re-priced (at a lower level) to reflect the stronger US Dollar. Even if the US Dollar weakened from this level, this may only provide short term relief for commodities given that it does not address the weak demand and oversupply situation, Pillay says.

“The world has been a big beneficiary of China’s success, however this success has also become a bit of a curse given that the scale of the success means that no other country can easily step up to the plate.

“Commodity prices have dropped significantly over the past few years and may look very attractive relative to historic levels, however until equilibrium is restored investors should not expect to make a profit.”