Column : Good but not good enough

Written by Deepak Gopinath | Updated: Dec 29 2011, 08:40am hrs
As investors start their holidays after a tumultuous year in global markets, theres only one thing they can count on in 2012: a continuation and deepening of the European crisis and another volatile year for markets. Slowly the reality is beginning to sink in that there will be no easy or quick resolution to Europes problems and that its crisis could drag on for years. And that will have significant impacts on investors in both developed and emerging markets.

With Germany staunchly opposed to any type of bailout for its economically weaker neighbours, it is looking increasingly likely that in the near term, over the next six months or so, we will see a partial break up of the eurozone as it sheds some countries in its periphery, most likely Greece in the first instance. Other countries, think Italy and Spain in particular, on the periphery will swear to meet requirements of the new fiscal union and thereby gain a little breathing space.

However, fiscal belt-tightening will not put peripheral countries on the path to growth, and in the longer term these countries will eventually face mounting social and political pressures to exit the euro and devalue their currencies to get back onto a growth path. So the crisis will drag on with an austerity-ravaged Europe falling into what could be a multi-year depression. Deleveraging by European banks to meet more stringent capital requirement rules will intensify the continents downward economic spiral.

So what does this scenario mean for emerging markets, and for India in particular Within India, the mood has shifted sharply from over-optimismremember the heady talk of overtaking China and double-digit growth ratesto pessimism, with some commentators ruminating about a possible return to Hindu rates of growth. There are plenty of reasons to be downbeat about Indias prospectsthe list, starting with the stalled reforms, high inflation and fiscal bleeding, is by now so familiar to Indian investors that it doesnt bear repeating.

However, the reality may be less dire than the pessimists predict. The Indian economy remains relatively insulated from global shocks, consumers are still spending, infrastructure investment is picking up and, even though growth may be slowing, it is still around 7%. Rather than an outright collapse, the most likely outcome for India is one of continued high inflation, coupled with stagnant growth of 6-7%.

While a high inflation, moderate growth scenario may not look too bad from a domestic context, especially when compared with the prospect of a return to Hindu rates of growth, it doesnt make the grade from the international investors point of view. And that is what counts in terms of investment inflows and the prospects for Indias financial markets. Thats because global investors look at India relative to other emerging markets and, by that metric, India is just not that attractive an investment destination.

In the course of next year, investors will start to feel crisis fatigue and begin to look for investment opportunities in emerging markets. And when they do so, they will find many more attractive investment destinations than India. In looking to enter emerging markets, investors are seeking to reallocate capital from stagnant and dysfunctional developed country economies to well-

managed, higher-growth economies. Why then would they choose a dysfunctional, badly-managed and stagnating India

Now consider some of the alternatives. Indonesia last week regained the investment grade sovereign credit rating it lost during the 1997 Asian financial crisis, when Fitch, one of the three major global credit rating agencies, raised its sovereign rating to BBB(-). Moodys and Standard & Poors are likely to follow next year. The move creates a positive outlook for the future and will help the country attract new investors. The upgrade reflects resilient consumer-driven economic growth of 6.5%, a debt-to-GDP ratio of just 25% and competent macroeconomic management. And, in sharp contrast to India, Indonesia has recently been able to push through a major reform. The countrys Parliament last week approved a long-awaited land acquisition Bill that will give the government the power of eminent domain and help it develop its overburdened infrastructure.

The outlook for Russia and China are also relatively positive. Chinas growth is likely to slow less than expected to just under 8% next year as the government implements targeted fiscal and monetary stimulus. Chinese equities will look relatively attractive against a backdrop of declining inflation, cheap valuations and monetary easing. And in Russia, despite the heightened political risk following revelations about the falsification of the recent Duma election results, we are seeing stable growth and relatively low inflation in an economy that is less vulnerable to European crisis than most investors appreciate.

India, because of its home-grown problems, will likely be reduced to the role of spectator as crisis-weary investors begin reallocating assets towards emerging markets. Perhaps the prospect of capital whizzing by on the way to more favourable climes is just the impetus India needs to embark on the structural reforms required to tackle inflation and lay the basis for more sustainable growth in the future.

The author is global markets director of the emerging markets research service, Trusted Sources.