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Business News/ Market / Stock-market-news/  China currency war fallout will impact India less: Roshan Francis Padamadan
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China currency war fallout will impact India less: Roshan Francis Padamadan

China has economies of scale working in its favour, but a currency tailwind will decimate competing industries in region, says Luminance Global Fund founder

China’s most powerful weapon is yuan devaluation because this would have the least domestic impact, given that China makes most of the products it needs. Premium
China’s most powerful weapon is yuan devaluation because this would have the least domestic impact, given that China makes most of the products it needs.

Singapore: India is less export-oriented than other South Asian or South-East Asian economies, and the fallout from China’s currency moves will have less of a broad-based impact on its economy than others, says Roshan Francis Padamadan, fund manager and founder of Singapore-based Luminance Global Fund.

According to him, China’s most powerful weapon is yuan devaluation because this would have the least domestic impact, given that China makes most of the products it needs.

“This has a devastating impact for export-oriented emerging markets (EMs) across Asia. Many of these markets are commoditized and work on razor-thin margins. China already has economies of scale working in its favour. A currency tailwind will decimate competing industries in South and South-East Asia," Padamadan added in an interview.

Edited excerpts:

You share the opinion that China may be the first big domino to fall. There are two ways of looking at China—one view being that its trajectory is similar to the other economies in East Asia that slowed after exhausting low-wage labour-driven growth and the other being George Soros’s recent comments that the conditions in China were similar to that of the US before the financial crisis due to a “parabolic cycle" of debt accumulation.

Don’t kill the sparrows. It is both, in fact. I met several underemployed youth and young students in China who face rising living costs and a challenging entry into the workforce.

China’s real GDP (gross domestic product) growth might be half of what is reported. The Great Chinese Famine (1959-1961) was caused by a culture of fear that meant that bad news did not reach the top, with all farming communes promising to meet their targets, while being way behind. The end-result was a massive surprise in the end, with no remedy.

There is also unintended consequences of actions. In the Great Sparrow campaign, farmers were encouraged to kill sparrows as they eat seeds, but this enabled a rise of vermin and locusts that grew unchecked and ate even more seeds. Fifteen million is the lower bound of the estimates of the people who died during this famine.

China has stopped private news reporting completely, recently enforcing a 2005 law. Now, only the official news agencies are to be used. I prefer to gather my own data, given that I do not expect frank reporting, both the culture and the structure do not allow for that possibility. Without the private sector sparrows, you need to have your ways of reading China.

China’s fiscal deficit might be closer to 10-11%—IMF (International Monetary Fund) and Goldman Sachs estimates—several times the reported number of 3%.

Always remember that governments have no money of their own. They either have savings, and earn from present and future taxes. China harbours a vast informal economy, and since it is difficult to tax these workers, VAT (value added tax) will be the solution—similar to India, where due to a massive underreporting of income, the government finds it easier and more efficient to tax consumption. This is not good for the poor, who would prefer progressive taxation on the rich. China’s VAT system may see higher and higher rates, in the years to come, pressuring consumption.

One should not count forex reserves as belonging to the country. It belongs to the exporters. Yes, the foreign currency stays with the bank that did the conversion for you, but it is not money the government can tap for spending. The government can only take what is taxable and spend only that part. China does not have $3 trillion just waiting to be released into the system.

In China, massive oversupply in commercial real estate is evident—for example, Guangzhou, which is a tier-I city with a population of 8.5 million, is seeing a 28% increase in floor space for Grade A buildings in 2016 and 2017, reversing the trend of the past few years when vacancy rates fell from more than 20% to below 9% earlier this year.

There is a time lag to all cyclical activity, and the credit boom of recent years may come to roost in the form of bad loans for banks, and poor returns for shareholders of such ventures.

Real estate is the primary collateral in banks’ lending, so a real estate price fall will also coincide with higher provisioning by banks, reduced lending, foreclosures and so on.

China does not have a proper bankruptcy framework and the sorting out of a credit crisis is unlikely to be smooth, or quick, or efficient.

What are the warning signs that you are picking up from China’s economy? How will this rub off on emerging markets?

Private sector investment is falling off a cliff. Only the public sector is investing, and we know that by definition, the former is focused on returns, while the latter follows the diktats of the government.

The one-way yuan appreciation story has stopped in its tracks, and reversed. China’s most powerful weapon is yuan devaluation.

This has the least domestic impact—China makes most of the stuff it needs—shoes, clothes, batteries, widgets. And this has a devastating impact for export-oriented emerging markets across Asia.

Many of these markets are commoditized and work on razor-thin margins. China already has economies of scale working in its favour. A currency tailwind will decimate competing industries in South and South-East Asia.

To see the impact in action, look at the number of anti-dumping duty cases against Chinese steel all across the world.

The difference between the marginal cost and full cost of production is so high that even after the duties, China can still compete and overwhelm domestic producers.

Going forward, what will drive emerging market growth? Considering that exports are lagging due to poor global demand, where will the push come from?

The smarter companies will keep investing in improving productivity. Robots and better manufacturing techniques (will be used) where possible. Soft skills and knowledge acquisition in people industries.

The world goes through periods of plateaus. We are in an era of evolution—few revolutionary elements are seen. Smartphones are one, and this has changed how business in done in a few advanced economies, and others will follow suit. We have entered an era of slowing export growth, decoupling of trade linkages—see Brexit—and for the next 5-10 years, I would expect global trade to grow well below GDP. There is no reason it had to grow forever faster than GDP; it has entered a period of cyclical and structural reversal—until further notice.

How do you look at the India story within the EM pack on an absolute as well as on a relative basis?

India has its own engines. That is both the good news and the bad news. It is less export-oriented than other South Asian or South-East Asian economies, and the fallout from China’s currency war will have less of a broad-based impact on the economy than others.

The INR will likely fall as China devalues its yuan. A weak currency will boost margins for Indian IT (information technology) companies and pharma companies, which have costs in INR but have USD revenues. The hedging programme does not matter. They hedge one year’s revenues at the maximum, while a step change in currency levels is a permanent jump in value which exceeds the hedge—they have not hedged all future cash flows, just the one year.

But how much is the India sentiment driven by GST (goods and services tax) coming through, more rate cuts, rural demand versus the global liquidity-driven rally? What are the key investment themes you like in India?

I am not sure what drives sentiment; it is hard to say without an investor survey. I pick stocks in India to support my thesis that a revival in infrastructure is due, but it is possible that I may reallocate to other ideas in other countries, for entirely stock-specific reasons.

Do you think the recent rally in the Asian markets, including India, is sustainable? How are the Indian equities placed among Asian markets?

The current rally is the most nonsensical of the last several years. China is in real trouble, but everyone seems to be pinning hopes on a China stimulus. Yes, China will do whatever it takes to keep its factories running, but that would include a massive revaluation downwards of the yuan, sending EM, especially EM in Asia, into a possible crisis. I am short an EM-focused asset manager.

India has seen a spate of initial public offerings in the quarter ended June, and in total they raised about $735 million—several new listings have been approved. What is your reading from this? Are these signs of an improving economy?

That’s not much. Uber China used to lose $1 billion in a year. India has not tackled the hard and necessary things. GST is a must, it must stop behaving that it is several different countries, with trucks waiting at each state border.

The people work reasonably hard, but a lot of them go outside India to achieve their potential. The brain drain has slowed down over the last 15 years, but it still exists.

Making it easier to open and run a business is the fundamental basis of an economy. India needs to get that right.

The current signs of recovery in India is led by public investments and private consumption, and not private sector investments. Won’t the latter be required to fund long-term sustainable growth?

The parallel with China here will help us understand.

Private sector wants returns, likes to take calculated risks, and would not invest if the probability of return is not high enough.

Public investments are driven by state agendas, and would be necessary where there is market failure—a private company will find it impossible to lay a cross-country highway, given the permissions required, etc. The US, the bastion of capitalism, benefited enormously from the interstate highway system-1956—this was government-funded. It is a question of where the government is investing—it is key infrastructure that has a multiplier effect on the economy.

China has invested heavily in high-speed rail, and their trains travel at 3x Indian trains. And now they will sell their trains to India. Not having invested in technology, India has no choice but to buy these trains. Directed public investment can be such a boon, but I do not see it at present.

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Published: 05 Aug 2016, 01:13 AM IST
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