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Who's next?
It's only logical to wonder after the 9% plunge in China's Shanghai stock market led to a global sell-off on Feb. 27. That ended with the Dow Jones Industrial Average ($INDU) down 416 points on the day.
There are the usual suspects, of course:
- The U.S. markets, if the crisis in the submortgage market spreads to the rest of the debt market.
- Japan, if investors panic at signs that the economy might be slipping back toward recession after the latest interest rate increase.
- Russia, if investors decide that the country's booming stock market -- up 51% in 2006 -- and state-controlled economy too closely resemble the Chinese market that just blew up.
- The $345 trillion derivative market, if some of the math whizzes that carve up risk sent too much risk to the wrong investors.
But I've got another candidate: India.
It's as big as China. It's growing just about as fast. Its economy is in more danger of overheating. And it's more dependent on speculative hot money. The Indian stock market suffered through a 30% drop in May and June of 2006, so similar volatility in the days ahead is certainly a possibility. And the country looks like it's on the road to a genuine economic and political crisis.
And, of course, with the global financial markets as spooked as they are after the Feb. 27 meltdown in Shanghai and the subsequent global sell-off, any short-term blip in a major developing market such as India could set off big ripples across the globe.
In the long term, however, I think India might be the most attractive of all global stock markets: Its population is younger than China, its educational system is expanding and improving, and its companies are more focused on creating wealth for shareholders.
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Do the long-term rewards outweigh the short-term risks? Should you buy in now, determined to weather any storm, or wait for the rain to fall and the clouds to clear? Let me lay out the short-term risks and the long-term potential.
First, the short-term risks
- Asset prices are high, so high that they show all the signs of a classic asset bubble. The market valuation of the main Indian stock market in Mumbai, despite that 30% downturn in 2006, had climbed to $836 billion in mid-February from $121 billion in April 2003, an increase of 591%. Property values have soared, with the value of prime office space in Mumbai up 70% in the last year.
- Those high asset prices depend on a flood of easily withdrawn overseas hot money. Flows of capital into the Indian stock market climbed to $12.5 billion in fiscal 2006, up from $2 billion in fiscal 2002.
- India is very dependent on global cash flows. Unlike China, India runs a trade deficit and only showed a total capital account surplus in fiscal 2006 because of that $12.5 billion from overseas investors in stocks, foreign direct investment of $6 billion in 2006 and rising corporate borrowing on international capital markets (about $6 billion in fiscal 2005). India was relatively untouched by the Asian financial crisis of 1997, but it is much more vulnerable to changes in external cash flows today.
- Bank lending is out of control. Over the past three and a half years, bank credit outstanding has jumped by 76%, according to Morgan Stanley.
- Inflation is out of control. Nationally, inflation recently hit a two-year high of 6.7% and is running even higher -- about 9% -- in the rural areas where two-thirds of Indians live. Inflation at the wholesale level has increased to 6% from 4% last spring.
- The Reserve Bank of India, the country's central bank, raised its benchmark interest rate to 7.5% at the end of January without noticeably slowing either inflation or the lending boom. Finance Minister Palaniappan Chidambaram has thoroughly undercut the central banks efforts by urging banks not to pass on interest rate increases to lenders.
My short-term prognosis: A big domestic credit crunch -- caused when lenders stop lending and borrowers can't get the cash they need to run their businesses -- causes India to fall far short of current forecasts of 9% to 10% annual growth. Foreign investors begin to withdraw money from the Mumbai stock exchange, producing another 30% "correction." The current Congress Party government loses power. After stumbling with politically motivated attempts to reduce food and fuel prices in rural areas, a new government bites the bullet, raises interest rates and cuts bank lending enough to slow inflation and the economy. Overseas cash begins to return.
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Video: Is India the next domino?The Shanghai stock market plunge on Feb. 27, 2007, was due in part to fears that an upcoming election could bring changes to the way citizens invest in China's stock market, says MSN Money's Jim Jubak. He notes that U.S. investors should now keep an eye on India, where the effect of election-year politics could also cause a sharp decline in the economy.
It won't play out exactly like that, of course. I don't know how deep any credit crunch might be or how much the Reserve Bank of India might have to slow the economy to reduce inflation to its 5% to 5.5% comfort zone. I don't know how long the Congress Party government might be able to cling to power. I don't know how other global markets would react to a big drop in Indian stocks.
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