The year started with lot of enthusiasm for Emerging Markets (EMs). With the world still struggling to come out from one of the worst recessions it had seen in the last many decades, EMs provided a ray of hope. A lot of portfolio money got re-allocated to EMs. All of a sudden, there were talks about a ?currency war? with some of the EMs like Brazil, Thailand and South Korea taking regulatory measures to stop hot capital inflows into their economies. India and China lead the growth for the EMs and were clearly identified to be the future economic powers of the world.
But, all that changed in the last few months. The high inflation coupled with rising interest rates threatens the growth momentum in all EMs. The black-swan event of unrest in the Middle East region increased the political uncertainty, which turned investors more risk averse. The yields in the US and Europe have gone up on the back of strong recovery in business sentiments. All these resulted in a net outflow of portfolio money from the EMs.
The series of scams have undermined India?s growth story in the minds of global investors. The world knew that corruption exists in India but the scale and the quantum of such scams had spooked most investors. The entire chain of nexus between politicians, industry and the middle-men has surprised many global investors. It is estimated that around $600 billion of black money generated out of India is residing in many tax havens. In one of my conversations, one investor told me, ?India is a benami economy, with all its national resources, whether under the ground or over the air, being sold by politicians at will.? The government seems to be caught unawares and had been very defensive in its response. Add to this, the concerns on inflation, trade deficit and fiscal deficit have come to the fore. Suddenly, you are finding the India story to be very weak.
China has its own problems. The easy money environment has created huge bubble in its real estate business. The government is conscious about its impact and has taken several steps to cool down its real estate markets. Despite strong pressures from the US and Europe, China refuses to appreciate its currency as it needs to keep control of its banking sector. China could open up its capital account and reduce its pace of reserve accumulation, which could result in losing control of its banking sector. This will again result in the real estate bubble ending up in a credit crunch affecting the whole economy. China needs to continuously focus on exports, which will create a huge employment opportunity for its youth; needs to keep the currency artificially low to make its exports competitive; needs to keep the real wages low in order to be competitive in the global markets; and needs to continuously use the banking system to fund large infrastructure projects (even if it commercially does not make sense) in order to boost investment and create employment. That is why James Chanos, a legendary New York investor, said that China is on a treadmill to hell. He thinks China?s real estate market is the biggest ?Ponzi scheme? in the world. Clearly, China needs transition from an investment-led growth to a consumption-led growth in the near future.
There are also some interesting demographic changes happening all around the world. The developed economies are ageing faster. Their structural problems in dealing with high government debt and social security/pension challenges are resulting in both job losses and an increase in retirement age. This is resulting in huge unemployment of the young population in those countries. Add to that, the traditional manufacturing sector, which created huge employment opportunities, moved to places like China. The new economy companies like Facebook, Twitter, Google, etc, creates little employment, even though they are huge companies by market capitalisation. So, the chance of unemployment coming down in the developed economies seems to be weak in the near future.
For countries like India and China, the focus should clearly be to keep their young population fully employed. They need the western markets to export and create employment in their home countries. The entire problem in the Middle East has more to do with the high unemployment of their young population. The growth per se will create that momentum on job creation; however, they need to balance their interest between inflation management and maintaining high growth rates.
Also, with high unemployment in the West, those economies could become more and more protective.
Clearly, what is good for the developed markets today is not good for the EMs. Their interests are different and highly divergent. The world was never so globalised and protective at the same time, as it is today. These are interesting times?
?The author is CFO of Infosys