There are some good reasons for buying India. For one, companies there should improve their earnings at a healthy pace. Profit estimates, according to Credit Suisse, should compound at 12 per cent annually over the next two years. That compares well with the broader emerging markets at just 3 per cent.
Another reason: portfolio managers have relatively few options. India is the fourth-largest among the investable emerging markets. The largest three — Hong Kong/China, South Korea and Taiwan — represent more than half of the index. Each has strikes against it, either due to China’s perceived economic weakness or Japan’s more competitive currency. Add in commodity-dependent markets such as South Africa and Brazil, and almost two-thirds of the index looks unattractive to those seeking some decent growth.
India, on the other hand, has plenty of technology and service companies, relatively little China exposure and few commodity companies clogging up its index. Yet fund managers already own a lot of India. Relative to the MSCI emerging markets index, the average emerging market portfolio holds double the benchmark of 9 per cent.
Moreover, the price for that added earnings pace looks a tad high. MSCI India trades at 17 times estimated earnings, a 60 per cent premium to the broader emerging markets index that is near five-year highs. Fifteen years ago the market demanded a discount.
India’s equity market has some appeal for those wearing rose-tinted glasses. Unfortunately, that allure seems fully priced into shares.
The world economy is locked on a course towards an emerging markets crisis and a renewed slowdown in the US, despite the Federal Reserve’s decision last week to hold off on a rise in rates, according to one of 2015’s most successful hedge fund managers.
John Burbank, whose Passport Capital has placed lucrative bets against commodities and emerging markets this year, forecast that the Fed would eventually be forced into a fourth round of quantitative easing to shore up the economy.
In an interview with the Financial Times, Mr Burbank said years of QE had caused a misallocation of capital across the world, while the end of QE last year triggered a dollar rally with consequences that were only now beginning to be realised.
“The wrong people got the capital — emerging markets countries and corporates and a lot of cyclical companies like mining and energy, particularly shale companies — and this is now a major problem for the credit markets,” he said.
Mr Burbank was speaking days after the Fed decided against raising US interest rates from their present near-zero levels, warning of “global economic and financial developments” and the damage these could do to US growth and inflation.
Emerging markets have accumulated $7.5 trillion of external debt and are acutely vulnerable to a rapid rise in US interest rates, regardless of whether they borrowed in dollars or their own currencies, Fitch Ratings has warned.
The credit agency said international markets are pricing in a much slower pace of US monetary tightening than the US Federal Reserve itself, risking a potential financial upset in East Asia, Latin America and Africa if Fed hawks refuse to bow to market pressure over the next two years.
Fitch said the Fed has signalled a rise in rates to 3.8pc beyond 2017 but investors simply refuse to believe that this will happen, with futures contracts implying rates of just 1.4pc over the same span – an unprecedented gap of 240 basis points, and one that is fraught with risk.
The US Federal Reserve risks triggering “panic and turmoil” in emerging markets if it opts to raise rates at its September meeting and should hold fire until the global economy is on a surer footing, the World Bank’s chief economist has warned.
Rising uncertainty over growth in China and its impact on the global economy meant a Fed decision to raise its policy rate next week, for the first time since 2006, would have negative consequences, Kaushik Basu told the Financial Times.
His warning highlights the mounting concern outside the US over the Fed’s potential “lift-off”. It follows similar advice from the International Monetary Fund where anxieties have also grown in recent weeks about the potential repercussions of a September rate rise.
That means that if the Fed’s policymakers were to decide next week to raise rates they would be doing so against the counsel of both of the institutions created at Bretton Woods as guardians of global economic stability.
Such a decision could yield a “shock” and a new crisis in emerging markets, Mr Basu told the FT, especially as it would come on the back of concerns over the health of the Chinese economy that have grown since Beijing’s move last month to devalue its currency.
The question of when to apply this thumping description to the unravelling of EM fortunes is more than academic. The word “crisis” has a way of fixing perceptions among investors, executives and policymakers while displacing nuance from analysis.
But the word is starting to surface. Dominic Rossi, global chief investment officer at Fidelity Worldwide Investment, which invests $290bn for its clients, referred to an “emerging market crisis” in the Financial Times. Also last week, the Institute of International Finance (IIF), an influential industry association, issued a report saying the fall in EM equities and currencies has “reached crisis proportions”.
Other analysts demur, while even some of those who use the description are keen to qualify it. The big difference, they say, between the current bout of EM frailty and the “Asian crisis” in the late 1990s — the last economic meltdown to originate in the developing world — is that this episode has evolved over many months, whereas the Asian crisis was an eruptive shock.
“In medical terms, the patient’s condition is chronic, not acute,” said David Lubin, head of emerging market economics at Citi. “EM has a persistent problem that results from two irreversible shocks. One is the end of an era which saw rapid, investment-led growth in China. And, two, the collapse of global trade growth to levels unseen for a generation,” he added.
Things were already bad enough for emerging markets going into August. Persistently low commodity prices, slumping demand from China, depressed global trade, and a “diminutive” septuagenarian waving around a loaded rate hike pistol in the Eccles Building had served to put an enormous amount of pressure on the world’s emerging economies. And then, the unthinkable happened. No longer able to watch from the sidelines as the export-driven economy continued to buckle from the pain of the dollar peg, China devalued the yuan. What happened next was nothing short of a bloodbath. In short, the devaluation drove a stake through the heart of the EM world by simultaneously i) validating concerns about weak Chinese growth, thus guaranteeing further pressure on commodities, ii) delivering a staggering blow to the export competitiveness of multiple emerging economies, iii) depressing demand from the mainland by making imports more expensive.
While virtually no emerging economy has escaped the pain, some countries have suffered more than others due to their particular sensitivity to trade with China and idiosyncratic political circumstances. One of the hardest hit EMs has been Brazil, and to be sure, we haven’t been shy when it comes to documenting the country’s troubles, which can be summarized as follows: 1) twin deficits on the current and fiscal accounts, 2) political deadlock which makes closing the budget gap with austerity next to impossible, 3) a plunging currency, 4) the worst stagflation in over a decade, 5) a recession that’s projected to last for many quarters to come, 6) street protests, 7) a President with an 8% approval rating, 8) an embattled finance minister, 9) allegations of government corruption. And we could go on.
Given the above, we weren’t surprised to see Brazil at the top of RBS’ EM heat map which is presented below and should serve as a helpful guide to who’s hurting the most in the wake of China’s “surprise” entry into the global currency wars.
Indian leaders have struggled to contain a surge of hope and national pride as they contemplate the recent meltdown of China’s markets and calculate the opportunities for the relatively small but fast-growing Indian economy.
Adi Godrej, patriarch of the Godrej conglomerate, called it “a great time for India, especially in manufacturing, to shine”, and noted that the rupee had fallen less than the currencies of most developing economies after the China crisis sent shockwaves through world markets.
Arun Jaitley, Indian finance minister, portrayed India as a new engine to power the world economy as China slowed, while Arvind Panagariya, who heads the new Niti Aayog state planning body, said the scope for India to capture export markets from China was “potentially huge”.
New Delhi said yesterday that India’s economy in the June quarter grew 7 per cent, year on year, exactly the same as in China. That suggests that India is overtaking China in terms of growth and is poised to become the world’s fastest expanding large economy.
Only a week after China’s “Black Monday”, however, some economists are already warning of the dangers of Indian schadenfreude and complacency.
As a big oil importer, India benefits in the short term from the global collapse of commodity prices, and the country is also likely to receive further inflows of portfolio and direct investment from funds and industrial groups wary of more vulnerable emerging markets. But that does not mean that India can take full advantage of China’s woes — India’s transport infrastructure is undeveloped and the country remains a hard place to do business — let alone become a vibrant new motor for the world economy.
Capital is cascading out of emerging markets as investors, companies and financial institutions lose confidence in developing countries. The outflows, which have risen towards $1tn over the past 13 months, hold a significance that extends well beyond the frailties of the countries themselves. The dynamism of developing nations helped restore the world to growth in the aftermath of the 2008-09 financial crisis. It is now dissipating fast.
Their vitality is being sapped by a vicious circle of cause and effect. Capital outflows add to pressures on emerging market currencies to weaken against the US dollar, thus inhibiting import demand, damping economic growth and spurring further outflows. If the cycle cannot be arrested, the risk is that a growth slump in developing countries — which account for 52 per cent of global gross domestic product in purchasing power parity terms — could pull the wider world into recession.
The resilience of emerging markets may be critical. But the prognosis is poor. To an extent, the growth model that generated rapid economic expansion over the past three decades appears to be broken. David Lubin, head of emerging market economics at Citi, says three key engines of GDP growth — exports, public domestic spending and private domestic spending — are all sputtering.
Exports are hobbled by a collapse in the growth of global trade. Public spending is weak because many countries are too nervous to loosen fiscal policy, fearing a loss of sovereign creditworthiness at a time when capital inflows are scarce. And private domestic spending is hampered by the fact that credit markets in many countries are in “post-boom” mode: neither domestic lenders nor borrowers have much appetite for risk, Mr Lubin adds.
The MSCI Emerging Markets Index has fallen to a four year low according to Bloomberg, as large outflows from EM funds continue amid fears that EM equities will keep sliding along with currencies and economic growth.
Emerging markets have been struggling on several fronts this year, as currencies fall to multi year lows, growth stagnates, stock markets wobble and now bonds are showing the first signs of pressure.
Last week outflows from emerging market equity funds continued for a fifth week, pushing the total outflow for the year to $31.9bn.
Drooping emerging market currencies have roiled markets and helped spur outflows, and the situation was compounded last week by China’s decision to allow its currency to devalue. Large outflows in turn are putting further pressure on currencies, creating a negative feedback loop.
The JPMorgan Emerging Markets Currency Index has fallen to its lowest level since it was founded in 2000.
Hong Kong listed stocks, which account for a large bulk of the MSCI index, do not paint a pretty picture. The Hang Seng Index is down 0.7 per cent today and has dropped 10 per cent since its year high in May.