This can blow big bubbles in emerging markets

Jun 8, 2010

In this issue:
» 100 m more to be added to India's poverty list
» EU announces US$ 1 trillion 'shock and awe' package
» India's GFP growth pegged at 8-9% over next 2 years
» US housing market is not getting any better
» ...and more!

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The scenario in the developed and the developing world could not have been further apart. While the former is grappling with deflation, the latter is trying to curb the ill effects of inflation. Having said that, in the longer term, inflation is also expected to pose a problem to the rich world. Especially if the expansionary monetary policy continues for too long. So on being asked which is the greater of the two evils, inflation would probably get more votes.

The interesting thing to note here as elucidated in the Economist is that many governments have had experience in tackling excessive price increases in the past couple of decades. But deflation (a scenario of depressed prices) has been much harder to deal with. Classic example in this case is that of Japan. Not just that, deflation in the developed world is also increasing the risk of bubble formation in the emerging markets. As most of the US and Europe are sticking to lower interest rates, investor money is being channelled into emerging economies for better returns. This has fuelled asset bubbles in many of these economies. In this case, China is a classic example. Already property and stock prices in the dragon nation have run way ahead of fundamentals.

Deflation in the rich world is also impacting India. Ever since India started showing visible signs of recovery, foreign investors have been pumping money into Indian equities. And they have been doing it at a faster pace. This has caused valuations of many companies to look rather rich. What is more, abundant liquidity in the system also means that inflationary pressures loom large. This means that in an increasingly globalised world, even stronger emerging countries could find it harder to keep their economies stable if deflation continues to persist elsewhere. The most obvious solution is to tighten monetary policy. India has already started doing that. But in the longer term, a close watch will have to be kept on how the rich world manages to pull itself out of the slump.

 Chart of the day
2010 seems to have begun on a robust note for the emerging countries particularly China and India. Both these countries continue to leave their peers way behind when it comes to the growth in every quarter of their respective economies. But today's chart of the day also shows that some semblance of a recovery however miniscule is being witnessed in the US as well. The latter especially has had to deal with some very tough quarters in the last couple of years. Although the Euro zone has managed to grow its GDP this quarter around, the worsening debt crisis could very likely hit these economies hard.

Data Source: The Economist

Are the issues troubling us today the same as those which troubled us in February 2010? Certainly opined Ajit Dayal, Director of Quantum Mutual Funds and Founder of Equitymaster, in a recent WebSummit hosted by Equitymaster. Ajit believes that the US still continues to remain a cause for concern. China many not be a bubble but it would be difficult for China to grow at the same scorching pace as it did before the crisis unfolded. Whether gold is a bubble is another question to be considered.

But more importantly, central bankers seem to have lost control over the money that they are printing with stimulus packages being announced by the dozen. Plus, there are concerns with respect to inflation, oil and bad politics. To all of this, one more worry has been added in the form of the worsening debt crisis in Europe. As a result, stockmarkets in India have been pretty directionless in the past couple of months. But despite these hiccups, Ajit still sees value in Indian stocks provided one is careful about the stocks that are picked and who they are purchased from.

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Several green shoots have already begun emerging from the Indian economy in recent months. Take the case of record sales of automobiles for instance. The pressure on food prices is also a fall out of higher demand from urban as well as rural areas that is outstripping supply. The World Bank believes that these cues suggest higher than expected growth for the Indian economy in the coming fiscals.

A business daily reports that World Bank has pegged India's growth at 8% to 9% over the next two years. The growth in private demand is the basic premise for this projection. Sufficient liquidity in the banking system is also seen as a comfort factor despite lower credit growth. Volatility in capital inflows and inflation shocks could however play spoilsport.

Poverty is relative. Hence, there exists no uniform definition of how a person gets classified as poor. Take India for instance. Nearly 28% of India's population is poor as per the current definition. However, the country's planning commission feels that the definition is not proper. And thus if you change it and use the new definition developed by the commission, a whopping 100 m more people will get added to the national poverty list. And this is no small number by any stretch of imagination. If implemented, it would lead to further ballooning of the amount that the Government spends on social schemes and development.

But the question is whether we really need a reworking of the old definition. What about the fact that we have not been able to do enough justice to the people already there on the poverty list? Thanks to massive loopholes in the system, a fraction of what is intended for the poor reaches it. Thus, without improving the efficiency of its existing welfare programs, precious little will be achieved by bringing more poor people on its rolls. Sadly, this is only going to lead to more robbing of taxpayer Peter to pay poor Paul.

The economic environment in the US has a huge influence on the state of the global economy. Not surprising then that most investors have been relieved at the hope that the US housing market is at least somewhere on the road to recovery. But an eminent IMF economist has been recently reported to have said that the US housing market is not getting any better. And is in fact getting worse. That is because in past housing slumps downturns lasted 18 quarters, with prices falling 22% from peak to trough. However, the current housing slump has lasted only 14 quarters, while prices have dropped only 15% yet. Thus, going by this metric, there may very well still be some pain left in the US housing market.

Regulators never learn. The success of the US bailout program is questionable. Yet, Europe has also resorted to a similar approach when faced with a sovereign debt crisis. A 'shock and awe' financial rescue package from the European Union and the IMF will total 750 bn Euros (US$ 1 trillion). It can be lent to any indebted euro zone nation risking default. It is also meant to counter investor fears that Spain, Portugal or others could follow Greece in requiring a bailout to meet debt repayments. In our view, while this move will help tide over short term concerns, in the long run, you cannot solve problems of bad debt by throwing more money at it.

In the meanwhile, the Indian markets were trading well above the dotted line, however amidst some volatility. Gains were seen in stocks across sectors led by FMCG, auto and power. However, select stocks from the realty and oil & gas space were amongst the key losers. The market sentiments in other Asian regions were also positive with Japan, China and Hong Kong trading higher in the range of 0.1% to 0.4%.

 Today's investing mantra
"Regardless of the impact upon immediately reportable earnings, we would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share. Most corporate managers prefer just the reverse, and have no shortage of stated rationales for their behavior." - Warren Buffett

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2 Responses to "This can blow big bubbles in emerging markets"

Ravendra Prakash

Jun 8, 2010

Today's write-up is intelligent & informative. By putting evolving events in proper perspective it makes for sound understanding of the situation.



Jun 8, 2010

If more people are added to the POOR category ,the politicians would be the happiest lot would be programme implementing officials..they would have more in the Aid kitty toswindle!!!..that is india..

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