Where will global growth come from?

22 MARCH 2014

Several stockmarkets are at highs, fuelled more by excess money supply thanks to quantitative easing, than to expectations of global economic growth. Will the global economy pick up, to justify investor faith, and, if so, where will the growth come from?

Legendary investor George Soros opines that the Eurozone is going to stagnate, like Japan did, for the next 25 years . The monetary union is not working, and has caused immense grief to the peripheral, weaker, economies of Greece, Spain, Portugal and Italy, which have been forced, by their indebtedness to the stronger countries like Germany, to impose austerity measures. These measures have led to unemployment levels of 40-50% amongst their youth under 25 years of age, and have reduced impetus for growth.

Abenomics is not working to push up growth in Japan either. The economy continues to stagnate, and to age. It may chug along, growing at around 1% but will not be an impetus to global growth.

China has been the economy that has provided that impetus so far. It has grown its economy by over 9% a year, for several years, by heavy capital investment in roads and other infrastructure, which aided economic growth. However, its capital productivity is now going down, as per this blog and it now requires 4 units of capital to produce 1 unit of GDP.

To quote from the blog "There is evidence that this debt growth has become excessive and non-productive. It now takes 4 renminbi (RMB) of debt to create 1 renminbi of GDP growth from a nearly 1:1 ratio in the early and mid-2000s. After the massive stimulus and more than doubling of new bank loans in 2009, the government attempted to stabilize credit growth, but the growth of the shadow banking system exploded instead. Shadow banking now accounts for more than a fifth of total credit in China-or about 40% of GDP from a base of 12% just five years ago."

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The shadow banking sector has provided money to several infra companies, through 'trusts', which were marketed by the big banks, thereby lending credibility to the instruments being sold. These instruments promised higher returns than did bank deposits. There is a spate of repayments falling due, and the expected defaults can lead to a banking crisis in China.

On the positive side, though, China has large unexploited reserves of shale gas, but does not as yet have the technology prowess of America to extract it and still needs to import LNG in a big way. Interestingly, China may benefit from the Crimean crisis! The US and some of the Eurozone have imposed sanctions on Russia, its leader Putin and his cronies. Putin may retaliate by depriving Europe of the gas it supplies to the Eurozone. He would need a buyer for that gas. The buyer could be China. Putin probably contemplates writing 'Crimea Sans Punishment' as a sequel to Dostoevsky's 'Crime and Punishment'.

So China is expected to slow its economic growth engine from 9% growth to between 5-6%, as its banks are heavily exposed to companies who lack the ability to repay them.

The US is the world's largest economy, at $ 15 trillion, and a growth of 3% for an economy of this size is equal to a growth of 9% for an economy of China's size. The growth is primarily due to two factors. One, the US has squeezed out growth from productivity. It has been a jobless growth. Unemployment is rising, and officials statistics present a picture that is less worse than actual. When a person stops looking for a job, or crosses a threshold age, he is removed from the roster of those seeking employment. Two, the US has refined the technology of horizontal drilling, to frack oil and gas trapped in shale formations.

Now here's the thing. In order to simply maintain its current production of shale oil/gas, the US has to invest some $ 30-40 b. annually. In order to attract providers of capital to give that money, a return must be generated on the investment. This return requires prices of crude oil to remain above $ 100/barrel. So if crude oil prices fall below that, production of shale oil/gas in the US would drop.

Some of the largest US banks such as J P Morgan Chase, Bank of America, Morgan Stanley and Goldman Sachs would suffer massive losses in a financial crisis, as per stress tests carried out by the Federal Reserve. What could cause another crisis?

Well, if Russia and China were to agree, during Putin's China visit in May, on a gas deal, they may also agree to a reduction in Chinese holding of US Treasuries. China is the world's largest holder. Were it to start selling, it could trigger a big financial crisis and jeopardise US banks.

Another factor would be an environmental disaster, towards which mankind, in its inexorable quest for growth and for ravaging the earth to attain it, is hurtling towards. The last stable edge of Greenland's icesheet has melted thanks to global warming. This can eventually lead to flooding in, and maybe even submergence of, low lying countries.

In India there is an ongoing controversy over pricing of gas, and the Aam Aadmi Party (AAP) has petitioned the Election Commissioner to put on hold the gas price increase announced by the UPA, until the new Government is formed and reviews it. This is reportedly being considered by the EC.

The issue of pricing of gas can perhaps be obviated by simply avoiding it. The Government gets its share of gas, as per the terms of the production sharing contract, and sells it at whatever price it wishes to, to whomsoever it wishes to, and the operator gets its % share of gas, to sell at whatever price it wishes to. The sale proceeds are accounted for, and reported to the Government, for calculation of the recovery of capital invested.

India, too, needs to see whether it has pools of untapped energy sources, conventional or unconventional, and to have in place enough incentives to attract entrepreneurs to look for them.

Looking to all this, GMO's strategist, James Montier, feels that global stock markets are overvalued by 50-70%

How about India?

India has the capacity to be one of the economic growth engines, provided it has good governance. This is what global investors are banking on the coming elections to provide.

Over the years, Indian politicians have destroyed the institutions of democracy. Although India has a high savings rate, the Government does nothing to protect its investors. The CBI has just filed an FIR against NSEL. The EOW (Economic Offences Wing of the Mumbai Police) has attached properties of defaulting borrowers, but has not liquidated assets. It seems that the existing law for money laundering needs to be modified. Why should a Government take so long to bring criminals to justice, and what does such laxity do for encouraging savings and investment?

And this is not only for equity investors, which account for 2-3% of household savings. The bulk of it goes into bank deposits. Are investors safe putting their money in banks, public or private sectors? Consider that the heads of public sector banks, in which the Government owns a majority stake, are compelled to lend to political cronies, and are left saddled with problems of bad loans, euphemistically termed 'non performing assets'. It is the Government that is non performing.

Perhaps because of its apathy towards the investor class the Government finds it difficult to sell its holding in public sector companies (PSUs) and arm twists Life Insurance Corporation (LIC) to bail it out by emerging as the white knight buyer. This happened again last week, when LIC appeared as the largest buyer of sale of Government-owned SUUTI (Specified Undertaking of the Unit Trust of India) holding of 9% of Axis Bank. The Government raised Rs 5,400 crores from this sale. Now, Axis is one of the best run and best performing banks and sale of its stock ought not to have required the intervention of LIC. But it did!

This sale raises another question. SUUTI was formed when the Unit Trust of India made a mess of its flagship scheme US 64. It made a mess by fixing the sale and repurchase price of units of this mutual fund, not on the basis of its net asset value, but by arbitrary announcement. In essence, US 64 became a ponzi scheme, with new entrants paying a higher price to purchase the units, and the money being used to pay off earlier holders who demanded repayment, as the net asset value was far lower than the repurchase price. When this scam burst, the Government, which fully owned UTI, forced unit holders to sell their units at a substantially lower price than what they the last announced sale price, and put 3 of its big holdings into a box called SUUTI. Axis Bank, ITC and L&T.

Now it has sold part of its holding in Axis Bank, the question is, should the original holders, who were forced to take a loss, not be entitled to a part of the appreciation?

If not, would investors trust Governments?

The destruction of institutions also includes destruction of honest people who run them. In the NSEL case, the CBI has made an error of judgement in instituting, and publicising, a preliminary inquiry against two former SEBI officials, CB Bhave, the former Chairman, and K M Abraham, former Executive Director. Far from helping the scam tainted Financial Technlogies group, Bhave and Abraham, both upright and honest individuals, had sought to declare them not fit and proper to run exchanges.

Last week the BSE-Sensex dropped 56 points to close at 21,753 and the NSE-Nifty lost 11 to end at 6,493.

Investors are placing great hope on a change in Government leading to better governance with less corruption. Results will be declared mid May. Should the electorate give a party clear, or near, majority, the market would cheer. But then those who bought in anticipation of this result would be selling, so the rally would be short lived. Its continuation would then depend on the new Prime Minister and his capacity, and willingness, to provide good governance. India has the potential to provide good economic growth, and has attracted foreign investors because of this potential.

Will a change in Government finally result in its tapping that potential?

Hopefully, yes.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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4 Responses to "Where will global growth come from?"

Sultan Fazelbhoy

Mar 23, 2014

Global growth is hampered by unproductive expense on armaments and destructive wars = wars based on relgious differences whilst all divine personalities preach compassion and "love thy neighbour" No wonder no alien has visited our messy planet so far -- they are more intelligent than humans to want to enter our political "circus" of corruption, non-governance, religious riots and killings, and exploding population ...


sultan fazelbhoy

Mar 23, 2014

One of the best analysis -- thanks. I am hopeful of Modi if and when he becomes PM. The indications are favourable and his campaign is brilliant. The questions in my mind is whether he will be a victim of arrogance, whether the other political sharks will refrain from planning his downfall, whether he will be true to his message of 'EQUALITY FOR ALL REGARDLESS OF CASTE, CREED OR SEX" We need a "modern" India with liberal attitudes, more inclusivenss and less religion. Will Modi be able to 'tame' his RSS backers ??? Will the Ram temple again lead to divisiveness ? I am thinking of India 50 years hence and not just the life span of 5 years for the new Govt. Do answer these matters FROM THE Hip next time ...



Mar 22, 2014

Yes its all about hope! Line up the corrupt politicians and shoot them.
Let the educated Indians go out and vote in large numbers and not sit at home and complain when adverse results come out.


Abraham Daniel

Mar 22, 2014

There is no doubt that India has the potential to grow like China which has much better infrastructure than ours. However bad politics are doing more damage to the economy as law and order is bend to suit these people like the NSEL case with Mr.Bhave and Mr. Abraham. We need a strong government that builds infrastructure, educates its people and provides safety and security. All Indians want what they are entitled to: good governance and opportunities.US economy has great scope to grow with new technologies which will benefit all countries.

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