The developed world is playing out its last act,” said Manish Chokhani, director of Enam Securities Pvt. Ltd, at a seminar on capital markets in Mumbai last week as he surveyed the damage to the Western credit markets. The West, said Chokhani, has become more and more dependent on “overdone financial engineering just to keep the patient going”. The essence of his talk was that the heyday of the West is over and it is time for the East to rise.
That is fighting talk at a time when our market has been falling like a stone, but Chokhani had no difficulty bringing out the statistics.
Bric (Brazil, Russia, India and China) countries and the oil producers, he noted, accounted for almost 40% of global incremental GDP growth in 2004-07, compared with slightly more than 10% for the US; and US contribution to incremental demand for resources during 2005-07 was zero to negative.
As a clincher, he pointed to the record highs being made by the CRB commodity index although the US is already in a recession. He also pointed out that global liquidity is being supplied not by the US but by Asia and West Asia, whose excess savings are being intermediated by the US.
In short, it is the decoupling theory all over again.
It means, said Chokhani, that while the developed world is in a long-term bear market, the fall in the developing markets is “a cyclical correction in a larger bull market”. In the longer term, there is little doubt the markets will adjust for the fact that while China, India and the Asia-Pacific region account for 28% of the world’s GDP (in purchasing power parity, or PPP, terms), they have a weight of only 5% in the MSCI World Index.
In contrast, the US now has only 19% of world GDP (in PPP terms), but has a weight of 42% in the MSCI World Index. A rebalancing is certain.
So, what does this mean for investors?
There is a simple rule—invest in what India and China will consume and consume what India and China produce. Of course, Chokhani agreed, the bursting of the US bubble cannot be painless for the rest of the world. His rather unlikely knight in shining armour is Reserve Bank of India governor Y.V. Reddy, who must cut interest rates to prevent growth and employment from slumping.
How plausible is Chokhani’s argument?
In current dollars, US GDP was 27.3% of world GDP in 2006, compared with 12% for developing Asia and West Asia combined. The euro area contributed 21.9%. So, we are still a long way from world leadership. But we are going to get there.
Should institutional trades be margined?
The Securities and Exchange Board of India (Sebi) has decided that all institutional trades in the cash market will be margined from 21 April, which coincides with the commencement of short selling for institutional investors and the securities lending and borrowing (SLB) platform. Are the two measures related or is it mere coincidence that they will commence on the same day?
The introduction of short selling and SLB does not alter the settlement risk in the cash market. Even for institutions that short sell, they would have to honour their obligations in the cash market using borrowed stock. The position that remains open is that of the borrowed stock, but this leg of the transaction will anyway be margined separately in the SLB segment. Nothing changes in the cash segment’s settlement procedures for institutional investors, so it doesn’t make sense to impose margins on cash market transactions just because short selling and SLB is being introduced.
The more pertinent question is whether institutional trades in the cash segment should be margined at all. Till recently, they didn’t have to pay any of the margins other market participants bear. Given their large size and the fact that all their trades compulsorily resulted in delivery, a need for margining wasn’t felt. But even with delivery trades, there is a two-day interval between the trade and the settlement (T+2), during which clients can potentially default.
If one takes the stance that institutional trades needn’t be margined, it is essentially saying that institutional investors can’t go bankrupt, especially in a short period of two days. But, after what happened at Bear Stearns Companies Inc., that would be a dangerous assumption.
According to a financial economist, a prudent risk management system doesn’t distinguish between market participants but merely relies on appropriate margining and collection norms to safeguard the whole system against the risk of default. By that measure, there is no reason to leave out institutional trades. But, having operated for years without paying margins in the cash segment, institutional players will certainly feel the pinch from 21 April. They would soon have to leave some buffer funds with their custodians, which will add to their cost of operations.
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