China and India will be two of the three largest economies in the world by 2025. That’s according to Haiyan Wang, managing partner of China India Institute, and her assertion is supported by the International Monetary Fund and long-term GDP forecasts by the Organisation for Economic Co-operation and Development.
At the 71st CFA Institute Annual Conference in Hong Kong, Wang examined the forces that each country must harness, and the barriers that they will need to overcome, to realize their full potential.
Wang began by listing the “growth boosters” that are driving India’s economic activity and increasing its productivity. The Goods and Services Tax (GST), implemented in 2017, is one example. “What GST does,” Wang said, “is essentially unify India to become a United States of India.” Trucks can spend an additional six hours on the road each day, she explained, because they no longer need to clear interstate checkpoints or comply with other bureaucratic restrictions that were previously in place at the state level.
The GST is one of Prime Minister Narendra Modi’s most successful financial reforms, according to Wang. She expects it will allow manufacturing companies to capture economies of scale across the country. As an added benefit, the registration requirements for businesses in India will drive down tax evasion and boost tax compliance. Early analysis has already shown a 50% increase in indirect taxpayers in India.
In addition to financial reforms, Wang said that digital commerce will propel India’s GDP to greater heights in the coming years. With India’s 580 million mobile phones and 480 million bank accounts linked to biometric IDs, a country-wide mobile payment system could catalyze a wave of consumer activity, according to Wang. “Mobile payment will be as ubiquitous in India as [it is in] China today,” she declared. “Although China has the largest size, India is the fastest growing.”
The question is whether India can overcome its economic challenges. “There are several,” Wang warned. One of them is the country’s high percentage of non-performing loans. Early in 2018, Reuters reported that India’s bad loans have nearly doubled in the past four years, but the Reserve Bank of India has announced new rules for dealing with defaults that may bring discipline to the banking sector.
Another challenge for India will be its unemployment rate, particularly among younger workers. “It can be a destructive force,” Wang said, especially if the country does not see the 7%–8% economic growth required to create the 12 million jobs necessary to accommodate younger entrants to the workforce.
After her assessment of India, Wang shifted her focus to China — a country that is already one of the world’s top economies. Experts have debated whether China’s GDP would surpass that of the United States by 2020. A big question today is whether the country’s economic trajectory will fall victim to major disruptions.
One challenge Wang identifies is that “The old model of credit-fueled growth can no longer hold.” The urbanization that drove the country’s expansion in previous years has slowed down. The remaining gains are being made in smaller city centers, Wang said, where they absorb productive investment less effectively and generate lower returns.
Another concern is the debt in China’s financial system, Wang said. The pace of new debt issuance is one component of that, but so are “the complexity, and the fact that the corporate sectors have taken on so much debt, and a lot of this debt is by the state-owned enterprises, and nearly half of the debt is somehow connected to real estate.” However, China’s president Xi Jinping has equated financial security with national security, and Wang is optimistic that government efforts will mitigate systemic risks.
President Xi has pledged to make China one of the most innovative countries by 2020. Additional innovation may help the country maintain its moderate growth while spurring the structural adjustments that its economy needs. Wang cited many of China’s advantages in pursuing innovation: The country is the second largest contributor to global R&D spending and has a large pool of foreign and domestic venture capital funding; a strong education system focused on science, technology, engineering, and math (STEM) skills; and many large, established tech companies, such as Tencent and Lenovo.
But China’s innovation efforts also face headwinds. One challenge is the country’s uneven intellectual property rights landscape. Intellectual property laws in China are strong, but enforcement is weak, Wang said. This could change over time — once domestic companies become more innovative and compete with each other more aggressively, they could start applying pressure internally to improve the regulatory environment.
Innovation is also challenging in a hierarchical society with an education system that emphasizes rote learning, Wang said. It can be difficult to exercise critical thinking skills in an environment where criticism is unwelcome. “Top-down forces are good at moving mountains,” Wang observed, “but it is very hard to cultivate the soil” where innovation can take root.
Financial professionals are sensitive to shifts in the economic environment and “China and India are at the epicenter of the global economic restructuring,” Wang said. In her opinion, the forces at work in these two countries are irreversible. In the coming decade, investors may find that a pivot to Asia is “not an option, but a strategic imperative.”
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