A Quarter of the World’s GDP Is Undergoing Big Experiments

India, China and Japan are each pursuing radical economic policies. Here's an overview of how things are going in these important countries.
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Radical. That’s probably the single adjective that best covers the disparate economic policies being pursued in Asia’s three largest economies. In Japan the government of Shinzo Abe is embarked on the 2.0 iteration of his program to break out of the country’s deflationary slump. In China, President Xi Jinping’s government is in the midst of a supertankerlike turn toward domestic consumption. In India, well … Modinomics. These three countries hardly make for isolated laboratories for such experiments. ­Together they’re home to 40 percent of the planet’s people and churn out 24 percent of the world’s gross domestic product. Here’s a roundup of how things are shaping up in these important economies.
 

India
Fully 27 percent of the 1.28 billion people who inhabit the world’s fastest-growing major economy are under age 15. Many of that 350 million-strong cohort will be joining the country’s workforce in the next decade. That’s surely not lost on Prime Minister Narendra Modi as he continues to hammer away at the inefficiencies that plague the Indian economy.

Since taking power in 2014, Modi has pursued a set of ­policies that aims not only to revive the economy, but also to make it resilient to external shocks—and increasingly competitive with the developed world.

Reforms under Modi started off incrementally. In 2014 and 2015 he slowly massaged an economy that was showing signs of grinding to a halt. A first priority was to attract foreign investors to set up manufacturing hubs, and Modi made almost 40 trips overseas during his first two years as prime minister. The result: foreign direct investment commitments of more than $75 billion in 2014 and 2015. Last year an additional $33 billion of FDI flowed in. Clearing the way for these businesses to be set up, Modi took a slew of steps to ease entry barriers. Among them were instituting a one-stop shop for clearances, hastening the permit process, and relaxing government restrictions on a host of sectors.

Modi’s other major focus has been to manage government finances better and plug leaks in the system that derail efforts to get benefits to the poorest Indians, the 22 percent of the population who fall below the official poverty line. To wring corruption out of the system, the government linked the unique biometric-­based ID issued to Indians—Aadhaar—with individual bank accounts and mobile phones. It uses this channel to transfer benefits ­directly, an application of technology that has been among Modi’s most successful projects.

Recent reforms have been even bolder. The demonetization of large-denomination rupee bills was meant to tackle tax avoidance and corruption and move India toward becoming a cashless society. In addition, a national goods-and-services tax, which would subsume 14 separate central and state taxes into one uniform structure, aims to broaden the tax base and reduce compliance costs and tax-induced inefficiencies in the transportation of goods across the country. Both initiatives have faced stiff opposition.

The results of Modinomics have been mixed. Economic growth picked up to 7.3 percent in the third quarter, up from 5.8 percent in the first quarter of 2014. Inflation cooled to 3.4 percent, a drop that was aided in part by softer prices of many commodities that India imports. The central bank has cut interest rates by 175 ­basis points since 2014, making credit cheaper for companies and bringing bond yields down to 6.4 percent.

On the other hand, starting or running businesses in India ­remains difficult. When the World Bank compiled data on the “ease of doing business” in 190 countries last year, it ranked pretty far down the list: No. 130. To chart India’s ranking, run {EASEINDI Index GP <GO>} on the Bloomberg Professional service. Since Modi took office, India has moved up 10 places in the ranking, but it’s still significantly below regional powerhouse China.
 

China
In the past two years the most populous country on earth has transformed from being the world’s factory to a maturing ­economy. President Xi’s government has focused on steadying China—­especially on controlling excessive leverage and the spillover onto foreign exchange, rates, and stocks.

Economic growth, which ran at a rate of more than 10 percent as recently as 2011, has leveled off. In 2016, GDP increased 6.7 percent. China’s 13th five-year plan, which covers 2016-20, projected a base GDP growth rate of 6.5 percent.

Investment, once a key driver of China’s growth, is dropping. Net monthly foreign direct investment, which had gradually declined after peaking in 2007, turned largely negative in 2016 as an outflow of funds weakened the currency. The yuan depreciated against the dollar by 6.5 percent last year. For most of 2016, the spread between onshore and offshore yuan pricing was remarkably stable and narrow. To chart the spread, run {.CNSPRD Index GP <GO>}.

Interest rate policies, meanwhile, have been cautious. While some market observers expected China to aggressively lower rates to kick-start the economy, the country’s seven-day repo fixing ended the year higher—at 3.24 percent. The reason for ­applying the brakes: China wants to rein in leverage and asset inflation.

The country’s equity market underperformed the world in 2016. The onshore benchmark CSI 300 Index lost 9.3 percent in total return. The offshore MSCI China Index gained 1.2 percent. Both lagged the MSCI World Index, which climbed 8.2 percent. For global investors, the main concerns are slowing growth and yuan-­devaluation risk. Although China equity valuations don’t look particularly lofty, investors are underweighting China as they see downside earnings risk.

Faced with limited investment opportunities, dismal returns, and the prospect of a weaker yuan, onshore investors are looking overseas for opportunities. Chinese corporations are ramping up cross-border mergers and acquisitions. Individual investors are snapping up overseas assets including insurance products and real estate. 

Beijing wants to promote the internationalization of ­China’s financial markets but remains concerned about the potential impact on stability. The high volatility seen in the onshore equity market in 2014 and 2015 has made regulators more cautious. However, the general trend is toward more opening up of financial markets. A trading link between the Shenzhen and Hong Kong markets opened in November, joining the Shanghai-Hong Kong Stock Connect.

So China’s agenda this year isn’t exactly simple: It has to balance slower growth, interest rates, FX, global fund flows, and its pace of opening up markets. And that’s before adding in a couple of wild cards that are out there. (Cough) trade wars (cough), anybody? Interesting times.
 

Japan
Prime Minister Abe unveiled Abenomics 2.0 in September 2015. This iteration of his four-year-old reform agenda aims to break the vicious deflationary cycle that has afflicted the Japanese ­economy for two decades. To do that, it seeks to foster confidence and a sense of security, putting the country back on track to nominal GDP of 600 trillion yen ($5.2 trillion) by 2020. That would require growth of 3 percent a year. In the third quarter, Japan’s economy grew at an annualized pace of 1.3 percent.

Despite unprecedented stimulus from the Bank of Japan aimed at supporting consumer confidence, the country isn’t ­exactly looking up. Consider manufacturing. The diffusion index shows only a slow recovery in the sector, particularly among the small and medium-size enterprises that account for the largest part of Japanese employment. Run {JWCOMANU Index GP <GO>} to graph results of the monthly survey that asks managers at Japanese manufacturers about how current conditions are changing.

In addition to boosting short-term economic activity, Abenomics seeks to finance long-term goals such as fixing pension systems and improving social security. Part of that involves raising taxes to trim Japan’s mountain of debt. Consumption taxes and individual income taxes account for the largest portions of the nation’s revenue, each representing almost 30 percent. Corporate taxes account for about 20 percent—relatively high compared with peer countries. Japan is easing corporate taxes while keeping income taxes ­untouched. Thus, without a substantial increase in economic activity, a consumption tax hike would be crucial to make up lost revenue.

However, the government last year deferred raising the consumption tax until 2019, taking into account the fragile economy and uncertain global environment in the first half of 2016. A challenge for Abe now is how to maintain the positive momentum until the introduction of the new consumption tax rate. In the next Party Convention, scheduled for March, the Liberal Democratic Party will likely approve the extension of its presidency tenure to nine years from six, enabling Abe to remain as leader of Japan until September 2021. Even given that time frame, Abe’s task may be to provide “floors” to the economy, rather than pursuing the remarkable economic growth that he advocates—at least until the consumption tax rate hike.

The BOJ will likely continue to pay the costs of such floors. The central bank already holds almost 40 percent of Japanese government bonds. Through its buying of exchange-traded funds, the BOJ will become the largest shareholder of 25 percent of the companies in the Nikkei 225 Index by the end of this year, according to a Bloomberg estimate.

The biggest risk for the government and the central bank is yen appreciation. The “Trump shock” weakened the yen by almost 10 percent from the time of the U.S. election through the end of 2016. That pushed Japan’s stock indexes into positive territory for the year—and helped Abenomics.

Abe may need more such luck.
 
Saxena is a market specialist at Bloomberg in Mumbai. Li and Giang are market specialists in Shanghai. Uchida is a market specialist in Tokyo.
 

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