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Faster GDP growth and high inflation suggest that India may be overheating
Faster than expected GDP growth in the June quarter and high inflation suggest that India may be overheating. In terms of the economic cycle the overheating stage of an economy is met by interest rate increases if the monetary authorities are serious about controlling inflation. In India the benchmark rate has increased since March 2010 by 325 basis points to 8% triggering recent weakness for JP Morgan India Investment Trust (LON:JII).
In much of the West the economic problem is too little demand and an underutilisation of economic capacity. By contrast the issue in the fast growing parts of the developing world is that growth is leading to excess inflation as all available economic capacity is utilised.
With the wholesale price inflation rate above 9% since December 2010 the onus on higher interest rates remains and the Central Bank is likely to continue raising rates. With high inflation it is no surprise that economic growth has largely held up with a 7.7% expansion in the three months to the end of June - this was slightly ahead of expectations.
However, high interest rates and the prospect of further increases have had a negative effect on stocks. This is typical for this stage of the economic cycle as higher rates increase the cost of borrowing, increase the attractiveness of holding money in bank accounts and reduce expectations for future growth in turn lowering profit growth.
It is easy to forget however that India is the fastest growing major economy after China. Strong GDP growth in the long run will translate into strong corporate earnings growth serving to support stocks. In part strong GDP growth is also inevitable simply due to the demographic dividend of having around half the population under 25.
It may also be the case that India is starting to address corruption issues which have blighted the current Government. Following scandals related to telecom licensing, and the Commonwealth Games, legislation is being enacted to minimize future corruption. Further pressure is also being put on the Government from activists with tackling corruption now a key public issue.
Indian economic growth in 2011 is expected to be around 8% but this figure may be undershot given economic weakness in the West and higher interest rates. Liberalisation would support higher growth in India and the signs were promising when the current Government got into power on a strengthened mandate.
Sceptics may point top the fact that India has been growing at a slower rate than China despite being at an earlier stage of development. However in our view this is offset by the better corporate governance in India facilitating better capital allocation in the corporate sector.
Clearly interest rates could jump significantly still as the increases so far haven't reduced growth inflation. However, the strong corporate earnings growth and lower equity market valuations following the market sell-off serve to offset this, auguring well for the country’s stock market and shares in JP Morgan India Investment Trust.
This report was produced by Senior Research Analyst, Aamer Nawid
