Stephen Roach: It's Still Bet On China, Not India

Rumours of China's imminent demise are much exaggerated (see Roubini on the overinvestment thesis, for instance)--or so says Stephen Roach (inveterate PRC fan). In a new al-Jazeera op-ed, he addresses the alleged seeds of China's downfall alike excess real estate investment (the PRC's subprime moment?) and excessive lending of state banks by official diktat to marginal projects:

[I]t is a serious exaggeration to claim, as many do today, that the Chinese economy is one massive real-estate bubble. Yes, total fixed investment is approaching an unprecedented 50 per cent of GDP, but residential and non-residential real estate, combined, accounts for only 15-20 per cent of that - no more than 10 per cent of the overall economy. In terms of floor space, residential construction accounts for half of China's real-estate investment. Identifying the share of residential real estate that goes to private developers in the dozen or so first-tier cities (which account for most of the Chinese property market's fizz) suggests that less than 1 per cent of GDP would be at risk in the event of a housing-market collapse - not exactly a recipe for a hard landing.

As for Chinese banks, the main problem appears to be exposure to ballooning local-government debt, which, according to the government, totalled $1.7tn (roughly 30 per cent of GDP) at the end of 2010. Approximately half of this debt was on their books prior to the crisis.

Some of the new debt that resulted from the stimulus could well end up being impaired, but ongoing urbanisation - around 15-20 million people per year move to cities - provides enormous support on the demand side for investment in infrastructure development and residential and commercial construction. That tempers the risks to credit quality and, along with relatively low loan-to-deposit ratios of around 65 per cent, should cushion the Chinese banking system.

Contrast China to India, which (yawn) Roach again emphasizes has a more serious structural bias towards an external deficit (alongside its still-marginal infrastructure):

India is more problematic. As the only economy in Asia with a current-account deficit, its external funding problems can hardly be taken lightly. Like China, India's economic-growth momentum is ebbing. But unlike China, the downshift is more pronounced - GDP growth fell through the 7 per cent threshold in the third calendar-year quarter of 2011, and annual industrial output actually fell by 5.1 per cent in October.

But the real problem is that, in contrast to China, Indian authorities have far less policy leeway. For starters, the rupee is in near free-fall. That means that the Reserve Bank of India - which has hiked its benchmark policy rate 13 times since the start of 2010 to deal with a still-serious inflation problem - can ill afford to ease monetary policy. Moreover, an outsize consolidated government budget deficit of around 9 per cent of GDP limits India’s fiscal-policy discretion.

Still, it will take a pretty serious external shock to knock either one of these off-track in a significant way in 2012:

While China is in better shape than India, neither economy is likely to implode on its own. It would take another shock to trigger a hard landing in Asia.

One obvious possibility today would be a disruptive break-up of the European Monetary Union. In that case, both China and India, like most of the world's economies, could find themselves in serious difficulty - with an outright contraction of Chinese exports, as in late 2008 and early 2009, and heightened external funding pressures for India.