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Economy

India versus China: A race that looks like it is already won. Why India could be a powerhouse

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It should not come as a controversial statement (at least within the context of this article) that the world is set to suffer from a slowing-population problem as well as an ageing population problem.

We are already seeing the growth rates slow drastically across key economies, which is mostly due to a combination of a falling birth rate (less people choosing to raise large families) and a slowing death rate (people living longer). The migration rate also plays an important role, although is variable depending on the country in question.

India is a stand-out over the next 15 years

Overall, India remains well placed in absolute terms, with their population expected to grow at approximately 1.0% for the 2016-2030 period. To put the importance of this in context, China appears set to see its population growth slow to just 0.2% as a consequence of their historical one-child policy (the change in policy is not expected to help for decades), and worse still, is set to fall nominally in 2026. Australia remains quite small and nimble on a global scale, and despite an overall population increase from 7.4 million in 1945 to close to approximately 25 million today, is expected to continue growing close to 0.9%pa over the coming 15 years.

India versus China is looking like a one-sided issue

The population trend between China and India is remarkable, although needs to be considered in the context of household spending if it is to impact economic growth.

In India, the population trend is one of the best globally, which works very well given the structure of the economy, whereby household spending accounts for 58.0% of GDP (more than Australia but less than the USA). It could also be argued that India are set for greater household effectiveness, especially given the low GDP per capita baseline (relative to mature economies) and an intense focus on education standards. On this basis, it seems to be a glaring opportunity for Australia to redirect its exports; however, this won’t be without challenges as India is far more self-reliant than China and does not have the same need for iron ore or coal.

China on the other hand, has a far worse population trend despite the scrapping of the one-child policy. However, it is also important to realise China are far less reliant on household spending to drive economic growth. In fact, Chinese household spending accounts for only 37.4% of GDP, meaning a falling population may have a smaller impact if trade continues to grow. There is also scope to grow GDP per capita by a significant margin, which could add to total GDP beyond the concerning population trend.

Deeper analysis of the working population

An added advantage for India is that they have a young population. This means more workers and less retirees, which by extension implies a greater ability to earn more income and hence increase household spending. There are many ways to explain this concept, but one of the most important from an investors perspective is to view the ‘prime’ working population, defined by 45-64 year olds. Some people are calling this the “peak spender theory”.

 

What can we learn from the above?

Based on this evidence, a falling population growth rate could have substantial implications for the future economy. A living example is Japan, where a falling population has created the “lost decade(s)” despite some of the strongest growth rates in GDP on a per capita basis. For many of the key economies, including the USA and China, this falling population growth rate could have material implications and be deep-rooted as a structural headwind to long-term growth.

Whether this causes an economic disaster is a much harder question. On face value, there is enough evidence to suggest that falling population growth rates are severe enough to substantially increase the risk of an economic demise. This logic follows the path that lower growth increases the risk of periodic recessions and hence creates potential for social unrest and debt-fuelled policies (we are already seeing this in the USA, Europe and Japan).

However, there is insufficient evidence to suggest the inevitability of an economic demise on the basis of population trends alone. On this note, it is important to reiterate the difference between a falling population and a falling growth rate in the population. The latter is far less severe, which would explain the difference between Japan (which has suffered a falling population), versus the USA (a slowing growth rate).

 

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Recession risks: what are 10 of the top indicators to watch and why it works.

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IMG_1116 (640x477)What does it take to identify an impending recession? Obviously, this is an extremely complex question. However, there are at least 10 factors that have had a strong historical track-record of identifying recessions, and below we outline ten metrics to add to your watch-list:

  • Household spending – The amount of money households spend on everyday goods and services is the number one determinant of economic growth. It represents more than half of GDP at 55.7% and is thus a directly attributable indicator and of significant importance to any GDP insight. Household spending changes tend to change instantaneously with the rate of economic growth, however given that consumer confidence tends to go in cycles it is still a useful tool to foresee future recessionary risks.
  • Business investment – Technically called ‘private fixed capital formation’, business investment is a direct line in the GDP calculation and thus has a direct effect on recessionary conditions. Business investment accounts for 20% of GDP so it’s thus seen to be a very important component and indicator for future recessions. Apart from its direct impact, it is also a clear signal of business confidence which has flow on effects for future GDP results.
  • Dwelling formation – Dwelling formation refers to the activities involved in new and used private houses, including alterations and renovations. It now accounts for 5.3% of the entire economy and is thus seen to be strongly correlated with the overall economic growth rate. Similar to household spending, it is seen to be an indicator of consumer confidence and thus has the ability to act as a leading indicator for economic growth. An encouraging signal involves a positive and/or growing rate.
  • Corporate earnings – Corporate earnings refer to the aggregate profitability of businesses and is a data series produced to gauge the health of the corporate sub-set of the economy. If the average company is highly profitable, it makes sense that the overall economy will be expanding. With this logic, we can see a strong correlation between the current status of corporations and the future growth rate of the country. The risk of recession is seen to increase when corporate profitability is deteriorating on average.
  • Yield curve – The yield curve simply refers to the difference in ‘borrowing rates’ on 10 year bonds versus 5 year bonds. If the 10-year bond pays a higher rate than the 5-year bond, this is seen to be normal, however when the opposite occurs it is seen to be the markets way of pricing for a recession. Across the globe, there has been a very strong long-term connection between the shape of the yield curve and the risk of recession. The link in Australia has been relatively weak but remains an insightful measure of risk.
  • Historical GDP growth – It makes intuitive sense that the risk of recession is higher if the economic growth rate is off a lower base. For example, it would seem highly unlikely for a recession to occur from a base of 5% or more, but would be far more plausible to slide into recession from a growth rate of 2% or less. This momentum effect is a powerful force behind economic growth, and for this reason the historical GDP growth rate can be an insightful measure for future recessionary risks.
  • Worker productivity – The driving force behind an economy is the workforce. The more people work, or the more efficient they become, the stronger the economy tends to be. There are many useful measures to track workplace productivity, however the most useful measure tends to be the total number of hours worked as this factors in population growth and demographic changes. A low and/or falling work ethic increases the risk of recession, whilst a growing rate is a positive sign for the future economy.
  • Retail sales – Retail sales is a vital component of household spending and is a very useful measure of the future direction of the economy. If consumers aren’t shopping and money isn’t passing through people’s hands, the economy is unlikely to be growing with conviction.
    If retail sales are falling, there is a reasonably high likelihood that a recession could be impending as consumer confidence becomes dented. History has shown that this connection with GDP is strong.
  • Housing starts – The process to build a house begins with a housing approval or ‘housing start’. This commitment is a clear sign of confidence that the economy will hold up, and marks the commencement of a long list of transactions that eventually push the economy forward. The new housing starts data is subject to volatility, however, if more people are committing to build a new home, more people are signalling their confidence in the economy. This reduces the risk of a future recession.
  • Employment growth – Similar to the workforce productivity indicator, the employment rate is of vital importance for the future prospects of the economy. The total employment growth figure is a more useful measure than the unemployment rate because it accounts for new additions to the workforce. While the employment growth figure tends to have a strong instantaneous correlation with GDP, the indicator has also proven to be an effective measure for future recessionary risks.

Of course, this list is not conclusive and there are an array of other important economic fundamentals that will impact the likelihood of a recession. In reality, there is no such thing as a perfect model, simply because the economy is so dynamic.

Creating a view from the data

Despite the limitations, an individual that wants any form of success should be trying to formulate a view based on the “known-known’s” while acknowledging the inability to predict the future with any precision. On this basis, the Investing Times opens up this research to help its readers, and produces a global recession risk report that is freely available to the public via the link below. This is a value-add service at no cost that covers at least five of the major global economies.

To give readers an idea of what to expect, the chart below is a historical view of the “recession trackers” ability in Australia, with a strong connection between the leading indicators and the future GDP growth rate.

Recession tracker performance

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