The current bull run in the market is based on two factors: a rising tide of liquidity and the hope that, because growth is still strong in countries such as India and China, liquidity will find its way to our markets.
The World Bank’s report on global development finance, released on Monday, agrees with the view that India and China will be lonely growth spots in the world economy. According to the bank’s estimates, the high-income economies will contract by 4.1% in 2009, while China will grow by 6.5% and India by 5.1%.
The rest of the emerging economies will in the aggregate contract by 1.6%. In 2010, while the high-income economies are estimated to grow by an anaemic 1.3%, the World Bank forecasts India to grow by 8% and China by 7.5%. The rest of the developing countries, excluding India and China, are forecast to grow by 2.5% in 2010.
These estimates indicate that it’s true that growth opportunities are available only in India and China. While growth has slowed in India and China as well, the differential between the growth rate in these countries and the growth rates in the high-income countries is increasing, as seen from the chart. Other things remaining the same, therefore, the attractions of higher relative growth should come into play and liquidity should flow into the Indian and Chinese markets.
Twosome awesome: The World Bank is optimistic about India and China. Ahmed Raza Khan / Mint
The question is: What is the prospect of liquidity flows to developing countries and to countries such as India and China? This is what the World Bank report has to say: “In 2008, total net international flows of private capital to the developing world fell to $707 billion (around Rs34 trillion, 4.4% of developing-country gross domestic product [GDP]) from the record-high level of $1.2 trillion (8.6% of GDP) reached in 2007. Net portfolio equity flows plunged by almost 90% from $139 billion to a mere $16 billion in 2008.
“Similarly, private debt flows declined substantially to $108 billion from $499 billion, driven by the sharp fall in short-term debt flows, which moved from $202 billion in 2007 into negative territory (-$16.3 billion), and in bond financing, which came to just $11 billion in 2008, compared with $85 billion in 2007.”
This data clearly explains the huge fall in emerging market equities on the one hand and the difficulties faced by developing country companies accustomed to easy access to foreign financing on the other.
What about the current year? The report says that international capital inflows are projected to decline further in 2009, sinking to $363 billion (2.5% of GDP) before recovering in 2010 in tandem with the recovery in global economic growth. In other words, the World Bank thinks that global liquidity will be lower in 2009 than in 2008. Much depends then on whether India and China are able to expand their share in global inflows, or, in other words, whether investors overweight these markets. And while it is true that these countries are growing more rapidly, valuations, too, are higher. The Indian market, for example, already quotes at a substantial premium to other emerging markets. The hope is that higher earnings in future will more than justify the premium.
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