India v the US By John Stepek, May 29 2009 They're two of the world's biggest capitalist democracies. They've both just had elections whose results were greeted with jubilation and hailed as turning points in their countries' respective histories. I'm talking about the US and India. So where do they go from here? And which will turn out to be a better bet for investors? At first, it seems a no-brainer. The US is the world's largest economy hands-down and the only remaining superpower. Despite the continued excitement about the Brics economies (Brazil, Russia, India and China), India only ranks as the world's 12th-largest economy and only the third-largest in Asia (behind Japan and China). Despite a growing and increasingly wealthy middle class, around 80% of India's population still survives on less than $2 a year. But sometimes it isn't size that matters, it's direction. Right now, things are looking up for India. The US, however, may be heading for an abyss, which its leaders don't quite seem able to see. All the latest on the global economy India's future looks brighter India's economy grew by 5.8% in the three months to March 31, matching growth in the last three months of 2008. It's a big slowdown on the 8.6% GDP growth seen at this time a year ago, but it was significantly better than the 5% expected. Along with the recent stock market bounce, it's enough evidence for some commentators to proclaim that India's now seen the worst of the recession and everything is champagne and fireworks from here. I wouldn't go that far. India is still part of a globalised economy, facing the worst recession since the second world war. People talk about India being less export-dependent than other Asian economies, but IT outsourcing is just as impacted by demand from the west as toy manufacturing in China. India also faces a rather nasty budget deficit at more than 10% of GDP (if you include state government spending). That's almost as bad as the UK and the US and as a developing economy, India is arguably more vulnerable to foreign investors taking fright and fleeing if it looks like government borrowing is going to soar out of control. The good news for India That's the bad news. But the good news is India's recent election result. The dominant United Progressive Alliance (UPA) party, under prime minister Manmohan Singh won a far more significant majority than anyone had expected. That means he can now push through reforms that were previously blocked by India's communist parties. This includes freeing up sectors such as retail and insurance to more foreign investment (so the likes of Tesco and Wal-Mart will find it easier to operate in India for example) and also the sale of stakes in state-run companies such as National Hydroelectric Power and Oil India. Such sales could help the country fund its spending without pushing the budget deficit to unsustainable levels. The election has also bought India breathing space on this point. Credit ratings agency Moody's said the country's "unexpected election outcome provides scope for rationalising spending, pushing ahead with disinvestments and key reforms". Meanwhile, what money India is spending on 'fiscal stimulus' is going into things the country really needs, such as new roads, ports and other much-needed infrastructure. In short, India might be facing the same tough global conditions as every other economy, but it's moving in the right direction: from being a bureaucratic, stifled economy to a more liberal one. And government spending is being directed in a way that should improve productivity, rather than simply preserve the status quo. America is on the wrong track Prospects for America on the other hand, aren't as rosy. In the first three months of the year, the economy shrank by 6.1%, following a 6.3% decline the previous quarter. That's the worst six month showing since the 1950s. Of course, this sort of rapid collapse won't continue: it can't, or you'd have no economy left. But Americans may have to get used to far less rapid growth than they've been used to. "This is going to be a new era of frugality," said David Rosenberg of Gluskin Sheff & Associates. The problem is America's dependence on consumption, which drives about two-thirds of the country's economic growth. Consumers simply aren't going to be spending as much. They can't afford to. As a percentage of net worth, household debt (including mortgages) stands at 27%, the highest on record. This debt pile, combined with fears over unemployment and plunging house prices, has seen US consumers jack up their savings. The personal savings rate (which actually went negative towards the peak of the boom years) has now climbed to 4.2%. The US economy has grown at a shade under 3% a year for the past 30 years. But as consumers start living within their means, the economy will grow more slowly too. Mohammed El-Erian, chief executive of US bond fund giant Pimco, told Bloomberg that by this time next year "the market will realise that potential growth for the US is no longer 3%, but is 2% or under". This readjustment is necessary, but it won't be very comfortable for a population used to seeing thrift as a joyless vice rather than a virtue. All over for Uncle Sam? It's far too soon to write the US off, but that won't stop people trying. Writing off the US has been done so many times it's almost a cliché (remember how Japan was going to take over the world in the 1980s?). But America's ultimate strength is the flexibility of its economy and its hard-working, entrepreneurial population. Unfortunately, this strength is being hampered by the government's increasingly large share of the economy. I have no strong views on party politics in the US. The Bush administration seemed to make all the same arrogant mistakes our own Labour government did: cheerleading an unsustainable boom, indulging the super-rich at the expense of the middle classes, riding roughshod over civil liberties (and I won't mention the war). But Obama Barack's not shaping up to turn things around. While India's fiscal stimulus is aimed at improving infrastructure for the entire population, much of America's stimulus focuses on saving the financial industry's bonuses at the expense of ordinary taxpayers. And the US doesn't have any sort of credible plan for repaying its debts. It looks increasingly as though America will at some point have to be held to account by the markets, as lenders demand higher interest rates on government debt. The possibility of the end of the dollar's status as the world's reserve currency has rarely been more tangible. Why Obama is doomed to economic failure So where should you invest now? Making any sort of predictions, particularly long-term ones, is a mug's game (I've been made to look a mug often enough to know). But in 10 years' time, if you invest in India now, will you have made money? I reckon it's highly likely. Can I say the same for the US? I find this hard to believe, but I can't. I'm not saying you won't. But over the next decade, I'm more confident that India will stay on the right track to create a better standard of living for its own people and a greater investment opportunity for outsiders, than the US. Once America as a nation grits its teeth and realises that there's no free and easy way out of this, that bigger government and increased protectionism aren't the answer to this crisis, I'm sure it'll turn things around. But it might take a further painful shock before the new reality strikes home. Right now, too many people still think we'll be going back to business as usual any day now. Certainly, as in the UK, there are individual defensive stocks that I'd be happy to consider (such as Warren Buffett favourite Johnson & Johnson or telecoms group Verizon). But I wouldn't buy a US tracker fund right now, particularly not as a sterling investor. On the other hand, I do think it's worth having some broad exposure to India. Don't stick your entire net wealth in there obviously, this is still an emerging market we're talking about. And now may not be the best time to buy. The benchmark Sensex Index has risen by around 20% since the election result. There's every chance the stock market will fall back in the near-term, particularly if there's another global sell-off, and I suspect we've got some really hairy moments ahead of us before all this is anywhere near over. So you might get better opportunities later this year. But keep your eye out for a good entry point and when you do decide to buy, one of the easiest ways in is via the JP Morgan India investment trust.