India's Insulated Economy

By many measures, the economic picture in Asia looks pretty good. Despite subprime-induced global recession worries, stock markets from Hong Kong to Mumbai hang at dizzying heights and today's growth rates are faster than they've been in a decade. Of course, this prompts the question of whether the region is headed for a big fall—there's no avoiding the fact that cash-strapped American shoppers still undergird all the major economies. With one exception: India. As a credit crunch unfolds in the world's financial centers, the country of 1.1 billion is arguably Asia's most sheltered economy. The reason: "India is the only economy in Asia driven primarily by domestic demand," says Christopher Wood, chief strategist of the Hong Kong-based brokerage CLSA.

In short, India's weaknesses have become its strengths. The country's oft-lamented inability to challenge the Chinese manufacturing juggernaut means that today's growth isn't as tied to ever-increasing toy, apparel and electronics exports. The relatively high cost of borrowing in India is one reason its roads and bridges are so bad, but that looks almost like a plus compared with China's near-zero interest rates and widespread overinvestment. And India's vibrant service sector is more insulated against a global slump than Chinese manufacturing. Services historically fare better in down markets, because of their lack of inventory issues.

Not that India set out to become recession-proof. While China's boom was planned from the center and executed by state companies, India's welled up from the private entrepreneurial and business classes, set loose by market reforms in the early '90s. Unlike China, India never forced consumers to funnel their savings to state export industries. The result is more flexibility and more balance, with India's GDP growth running at a 9 percent pace in 2007 for the third year running, sustained mainly by domestic consumption and a burgeoning middle class.

Already, India's domestic market is larger than South Korea's, at about $370 billion. By 2025, concludes a recent study by the McKinsey Global Institute, its consumer class will swell tenfold from today's tally of 50 million, making it the fifth largest market on the planet. This year India's per capita income will break through the $1,000 threshold on its way to tripling by the late 2020s. "India's lower level of investment relative to GDP has meant that consumption has played a bigger role in its growth story," says the McKinsey study. "Consumption in India is closer, proportionally, to developed countries such as Japan and the United States than it is to China."

China's spending on construction of roads, factories, condos and other infrastructure is approaching 50 percent of GDP, compared with India's healthier 32 percent. China's trade surplus is also roughly twice India's in percentage terms and, in 2006, China took in $63 billion in foreign direct investment to sustain its manufacturing boom, whereas India grew slightly slower but needed just $16 billion from abroad to do it. The net effect is that India's economy will feel less pain should the global economy weaken. "India's exposure to the global trade cycle is one of the lowest in the region," concluded a Morgan Stanley report to clients, issued in mid-September, "and therefore the impact of slower foreign trade [on India's economy] is likely to be one of the lowest."

Policymakers deserve some credit. Reserve Bank of India has kept the economy on a lean burn, setting interest rates in the 6 percent range, which is low enough not to stymie economic activity but high enough to discourage profligate investments. Elsewhere in Asia, ultralow rates—be they 2 percent mortgages in Hong Kong or near-zero loans from China's state banks—have driven overinvestment in both real estate and industry. And whereas India's passbook savings rates of 3 to 4 percent encourages household savings, negative returns in China have driven money into the only high-yield option available to average households: speculative stock and real-estate plays. Because India's boom has not been driven by dirt-cheap money, analysts argue, it is therefore more resilient to global credit tightening.

Recent forecasts back up the picture of Indian economic resiliency. One from Citibank in September analyzed the likely impact of a U.S. recession on Asia's two giants. The bank estimated that its 2008 GDP growth forecast for China would fall from the 11 percent level to 8.5 percent, whereas India's would dip about half that amount, from 9.4 to 8.1 percent. A new study by the Organization for Economic Co-operation and Development concluded that, by further liberalizing its labor markets, India could push its sustainable growth rate above 10 percent by 2011. Pai Panandikar, president of the the RPG Foundation, a prominent economic think tank in Mumbai, wrote last week that a U.S. recession would hit goods exporters hardest, while driving American companies to cut costs with further use of Indian software and technology services. "It is possible that the growth of merchandise exports may dip, but the [demand for] service climb," he argues.

What comes next in the resilient India story? Ironically, it could be a manufacturing boom akin to China's in the 1990s. India's huge domestic market, ultralow average wages and potential as an export platform to the Middle East, Africa, and Europe are attracting interest like never before, as manufacturers seek to limit their vulnerability to future political or economics changes in China. A handful of foreign carmakers such as Ford, General Motors, Hyundai and Suzuki have already opened plants, aiming to service customers abroad, as well as India's own large and rapidly growing domestic market for small cars. Lucrative Korean electronics and white-goods ventures already dominate the local market. In a new survey of more than 300 global manufacturing companies released last week, European consultancy Capgemini found "very keen interest" in India as a manufacturing base, says Roy Lenders, the report's author, who predicts that "India could challenge China as the manufacturing center of the world in the next three to five years." Such a shift would soak up millions of surplus rural workers, thereby widening the country's already formidable consumer base. "Thinking of China as a benchmark for successful development is still very strong in India," says Shankar Acharya, an economist with the Indian Council for Research on International Economic Relations. China has been growing much faster than India, for much longer. But the eventual lesson of this period of global uncertainty may be that India should just build on its own strengths, not worry about China's.