Over the past two weeks, this column has dealt with major aspects of the less than invisible hand that has been impacting markets?first dealing with the likelihood of sustained monetary tightening and higher interest rates in the US, and the second on the splendidly well organised slide of the US dollar against major currencies since mid-February 2006. The upshot has, not unexpectedly, rushed through asset markets like a tsunami moving east to west, creating pretty havoc. Given that the major share of cross-border holding in equities originates in the US, meaning thereby that the home balance sheets and net asset values are in US dollars; meaning that if other currencies start sliding against the dollar, all other things being constant, the tendency will be to preserve dollar value and that means to liquidate stock at the margin.
Then again, all other things are far from being constant. Actually, most of those uncertainties do not bear adversely on the outlook for the US economy ?and if there is indeed an ?economic fundamental? on the basis of exchange rates, as the G7 ministers held forth so unambiguously only last month?then that should translate likewise vis-a-vis the dollar. The euro-zone and Japan are not exactly in any shade of healthy pinkness, and the US economy appears to have accelerated in the first quarter of 2006, growing at a seasonally adjusted annual rate of 5.3% with respect to the last quarter of 2005. So maybe people will need to go back and revise their assessments about 2006; maybe the US economy will grow at a pace comparable to last year?s 3.5%.
That might mean people will need to revise their assessments as to when Chairman Bernanke might begin to ease on the upward march of US interest rates, even if he has sought to correct any public perception about being more ?hawkish? than ?dovish? (on inflation), after an imbroglio involving casual conversation over dinner at which journalists were present. And what happens if interest rates rise beyond, gosh, maybe well above the 5% that most had taken to be the outer, outer limit?after all everyone knows the chap is a dove. In the immediate short-term, as people try and take their bearings from hard analysis, invariably coloured by the misapprehensions and rumours that often pass as ?fact,? there will perhaps be more, rather than less, of wobbles.
But the fact remains that economic growth in the US or across the world, particularly in the emerging markets, is not in any particular peril. That the ?great imbalance,? which recently prompted the head of the IMF to argue for higher interest rates, is not going to be fixed in a hurry. Certainly not as long as the US does not mend its fiscal deficit and low personal savings rate and the Chinese are content to build up might-numbing trade surpluses and invest the proceeds in US securities. And in the foreign exchange market today, there is no real choice. You have the dollar and the anti-dollar; the latter being the euro, to some extent strapped together with the yen and sterling. And of the robust health of the euro, there is little evidence in favour of, though painfully plenty against.
Then there is the fact, unfortunately, of logic, which is as robust, as often times the fanciful wishes of policy makers are not. If US interest rates rise and are higher than in the rest of the world, textbook logic tells us investors (in fixed income securities) will buy more dollar-denominated assets and the dollar will strengthen. Since money does not descend like manna from heaven, to finance these purchases they will have to sell securities (or other assets) denominated in other currencies, thus pushing these down. It will take powerful worlds of persuasion and illusion?of truly heroic proportions?to make investors believe they should go short on dollar assets while US rates continue to rise. It is, no doubt, possible to engineer such an outcome by knocking the bottom out of the credit quality of the dollar, but I doubt there will be any takers for such an adventure.
Before we close, some facts and the role of local factors. For calendar 2006, up to May 10, which marked this year?s high of equity prices, at the head of the league table was Russia, which saw its index gain by 44%, followed at some distance by Indonesia (34%), then by China and then India (both 32%). Further behind were Poland and Brazil (23% each), South Africa, Philippines and Argentina (22% all). Other markets were way behind?15% and lower. Most markets recovered from lows in the days that followed, but by different degrees.
A quick way to assess the intensity of the melt is the extent to which markets came down between May 10 and May 26. India won that race with a loss of 14.3%, ahead of Russia (14.2%), Indonesia and Poland (both 14.0%). In some contrast, the Brazilian market was down only 7.5%, Philippines by 9.1% and South Africa by a mere 3.7%. The outstanding exception was China (Shanghai) which gained 4.4% in this period.
So, yes, there was a global melt, it did effect emerging markets more than mature ones, but we got whammed more than did others and there was a local overlay on what was broadly a global development. We surely need to try and keep the local jokers out of the pack being dealt, for plenty of investment that is lined up needs a positive equity market to get ahead. For starters, we could begin the process of lifting the unsavoury control regime that has enveloped the refined petroleum product industry and create conditions where competition can bring to the citizen, fuel at the lowest price that reality permits.
The writer is economic advisor to Icra