Moneycontrol Pro Weekender | China’s Minsky moment 

While a stimulus could limit the downturn in the economy, it will also add to total debt, which is over 250 percent of GDP. The Chinese government knows this very well, which is why every dose of stimulus these days is accompanied by a warning that it shouldn’t be overdone. After all propping up a property sector dependent on a ‘build, pause, demolish, repeat’ strategy can hardly continue for long.

The crux of the problem is that China’s household consumption, as a percentage of GDP, is one of the lowest in the world, at 38 percent in 2020. On the other hand, gross fixed capital formation is 42 percent of GDP. By way of contrast, compare India, where household consumption to GDP was 59 percent in 2021 and gross fixed capital formation 29 percent of GDP. The upshot: massive over-investment in China.

In a recent article for the Carnegie Endowment for International Peace, Michael Pettis, professor of finance at Peking University’s Guanghua School of Management, points out that the situation in China today, after decades of over-investment and piling up of debt to reach growth targets, is similar to what the economist Hyman Minsky had warned about. Minsky’s famous dictum was that stability breeds instability. What he meant, says Pettis, is that, “After many years of stable or improving exchange rates, monetary consistency, declining inflation, rising collateral values, and/or expanding liquidity, financial institutions begin to structure increasingly risky financial activity that implicitly or explicitly assumes away these risks.” Moreover, it’s not just financial institutions that are lulled into complacency, but all economic agents, including households, businesses as well as governments, both central and local. That is why it becomes exceedingly difficult to change the paradigm.

How will the end game play out for China? Pettis believes China will not have a financial crisis, but growth will slow substantially, as happened to another investment-led economy -- Japan.

One consequence of China’s slowdown is a fall in commodity prices. This augurs well for lower inflation across the world, and especially for commodity and oil importers such as India, although the jury is still out on crude oil prices. While China’s steel output fell in July, this article talks of the Indian steel market: “A recovering automobile and real estate market is indeed good news and if the capex cycle kicks in, it will be the icing on the cake.” While India’s improving real estate market is a study in contrast to China’s, there’s also a lot of optimism about the cycle finally turning for private capital expenditure. And unlike China’s debt-fuelled growth, or the mess that our neighbours are in, prudent policies have resulted in the Indian economy remaining relatively unaffected from the turmoil in the rest of the world. Our Economic Recovery Tracker shows that consumer sentiment is recovering and unemployment is coming down. And as far as reforms go, the Centre is trying some shock therapy in the power sector.

On the debit side, the prospects of IT companies are not looking good and recent pay cutbacks in the sector could affect urban consumption growth. While the two-wheeler giants get ready their electric play, it’s a tough ride ahead. Our Monsoon Watch says “the distribution of rainfall is uneven and erratic”. This in turn poses a risk to the farm inputs sector.  The proposed uniform branding of fertilisers is another negative. And while we do have large forex reserves, a big chunk of that is funded by flows that are not very durable.

What does all this mean for investors and markets? Is the bear market rally finally over? The only certainty in these volatile markets is uncertainty. However, a sectoral analysis of Indian equity markets shows that “there is a clear demarcation between the performance of stocks focused on the domestic economy, against those focused on the global economy”. For example, we recommended a neutral stance on Vedanta. Among domestic stocks, we analysed Endurance Tech, DCB Bank, Minda Corp, Garden Reach Shipbuilders and, of course, Associated Alcohols & Breweries. Asset managers are returning to expensive growth stocks, but this is the time for remaining flexible and adopting a style-agnostic approach to investing.

While the Indian economy may be on a good wicket, large sections of the equity market already reflect that. Valuations, therefore, are critical while investing in these uncertain times. We said that valuation comfort is not available for stocks such as JSW Energy and Pidilite Industries, while stocks such as Control Print and Hikal are cheap.

Among our regular features, we had The Eastern Window on the emerging power equations in China; in Personal Finance, we looked at target maturity plans and fixed maturity plans; and in Start-up Street, we considered the funding boom in environment ventures.

The RBI is looking to tighten the screws on rogue digital lenders, but it may not have done enough. And while the government has declared UPI a digital public good, it may be an expensive one. Caught in the midst of this disruption is SBI Cards.

This week, we weighed in on the freebies debate from a Modern Monetary Theory perspective; on bank privatisation; on why ASEAN is critical to India’s geopolitical future; why we badly need data on Indian households and how the ethanol push sweetens the sugar sector.

Finally, we need to remember that the Ren Zhengfei memo also said, “the world economy is unlikely to improve in the next three to five years”. And Minsky’s thesis also applies to the advanced economies that have seen all kinds of excesses resulting from massive monetary stimulus. The task of central banks now must be to wean economies and markets off the monetary methadone that they have been doling out for decades. That will inevitably lead to withdrawal symptoms.

Cheers,
Manas Chakravarty