Asia's century?

Asia's century? Yes. But not its decade

There is a sell-off across Asian emerging markets and renewed confidence in developed markets

by Abheek Barua / February 2, 2011, 0:26 IST


Before all of us get terribly spooked by the sharp sell-off in the stock markets, it might help to keep a few things in mind. The markets haven’t suddenly woken up to the fact that there is a problem with governance in India; nor do investors believe that growth is about to fall off a cliff. The ripple here is part of a bigger wave. There is a sell-off across Asian emerging markets and renewed confidence in the so-called developed markets, particularly the US. So the carnage in the markets could be more the result of the re-allocation of funds than a “thumbs down” for India’s domestic issues.

The underlying problem has, of course, been the phenomenon of two-track growth that the global economy found itself in since the end of 2009. Emerging markets like China and India led the global recovery and the US and Europe lagged. The cost of high growth has been rising inflation in Asia abetted partly by the easy monetary policy followed by the developed markets that ramped up global commodity prices. To cut a long story short, the dominant view among global investors is that Asian central banks need to hike rates a lot more. That, in turn, will adversely impact growth and profits of companies. The US, on the other hand, finds itself in a sweet spot. There is increasing evidence that growth is beginning to pick up – an unemployment rate of 9.4 per cent notwithstanding – as the effect of monetary and fiscal stimulus kicks in. Though the initial traction, quite surprisingly, is in consumer spending, investment expenditure could also pick reflecting in part the impact of a liberal depreciation allowance announced by the Obama administration.

The fact that US assets are relatively cheap isn’t quite helping the emerging markets’ case either. A senior hedge fund manager who runs money both in the emerging markets and the developed markets told me recently that he had bought a “synthetic” stock, which is basically a bundle of stocks of 15 of the bluest chip US companies. Its valuation was roughly half that of the Indian market. Thus, the new trade that seems to have emerged in global markets appears to be “sell emerging markets, buy US”.

Solace lies in the fact that these trades are unlikely to go on forever. As the emerging markets correct, their stocks will seem attractive again. The supply of liquidity for the US and Europe is likely to be easy across markets and neither the Fed nor the European Central Bank is likely to reverse monetary policy soon. As Indian stocks begin to look cheap, fund managers will again focus on the fact that, the US’ recovery notwithstanding, India’s growth is likely to beat the US by a mile. The Reserve Bank of India’s (RBI’s) rate hikes will have to stop at a point as inflation gets on a leash sometime in 2011. Markets are, mercifully, known to be fickle. Interest could return to the emerging markets by the middle of the year.

The niggling worry is if investors use this phase of bearishness on the emerging markets as an opportunity to re-evaluate the China-India story. Let me start with China. I hear a growing murmur of voices that seem convinced that China and its markets will see a major correction, if not a crisis, in the next few years. Ken Rogoff, former International Monetary Fund chief economist, explained the China risk rather succinctly in a television interview from Davos. China, he claimed, is becoming a more “normal” economy as the government and central bank find it imperative to use conventional economic policies and market-based policy instruments to manage their economy. Normal economies, Rogoff pointed out, have rarely seen decade after decade of uninterrupted high growth. Thus, it is quite likely that China will enter a slowdown if not an outright recession in the foreseeable future.

Besides, one has to be blind not to notice asset bubbles in the Chinese economy. In Beijing, the ratio of house price to average income in the city (a common measure of affordability) is over 25. The norm in most developed markets is four to five. An email circulating in China’s cyberspace and reported in the Financial Times presents some interesting calculations. I quote the Financial Times, “Prostitutes, the e-mail says, would have to entertain 10,000 customers — a marathon feat requiring them to service one customer a night from the age of 18 until the age of 46 without an evening off to afford a place of their own.” The problem with bubbles is the fact that they are known to burst suddenly without notice or warning — investors will have to factor in this risk in their decisions.

As far as India goes, inconsistencies in the “double-digit growth soon” view of the future are becoming somewhat starkly visible. I have argued in a number of places that the current episode of food inflation should be treated as a symptom of “overheating” rather than as a series of supply shocks. The implication is that the Indian economy might not be able to cross the 8 to 8.5 per cent growth threshold without spawning some pretty serious imbalances that can manifest either as consumer price inflation, escalating white collar wages, or the shortage of key infrastructure (clogged ports, power outages). The efficacy of jugaad or on-your-innovation to circumvent some of these problems seems to be diminishing as the pressure of growth builds up. The relentless parade of scams and exposé of graft seem to suggest that the robust institutions that we keep touting (“China might have the hard infrastructure but we have the soft infrastructure” is mandatory in all India investment spiels) might not be so robust after all.

These problems are unlikely to disappear overnight and will impinge on growth in the medium to near term. I won’t be surprised if investors slowly begin to price in some of these risks of investing in Asian markets. This might well be Asia’s century. But will it necessarily be Asia’s decade?

The author is chief economist, HDFC Bank
source;Business Standard