Karl Marx said that history repeats itself “first as tragedy, then as farce”. Recent events in Europe bear out the truth of that insight, with Greece hovering on the brink of default, barely a year after supposedly being bailed out and Germany and France trying to get the country to swallow another painful dose of austerity in a frantic attempt to save their own banks, who have lent vast amounts to Greece. Quite a few people believe that the Euro ostriches, with their heads buried firmly in the sand, are desperately trying to kick the can down the road.
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But Greece is not the only worry for investors. Barclays Capital’s global macro survey for June 2011 shows that 57% of respondents believed that the biggest risk to global equities in the next three months was from slower-than-expected growth in the US and Europe. Both the Purchasing Managers Index numbers and the Organisation for Economic Co-operation and Development leading indicators show a weakening of the global economy, though opinion is divided on whether it’s just a soft patch. About 15% of those surveyed said the biggest risk was from public sector debt deleveraging in the developed world—a reference to the budget problems in the US. About 14% cited emerging market inflation and associated tightening as the major risk. Greece, it turns out, is not a big concern, with most investors believing the repercussions from a debt restructuring would be felt only in Europe.
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For emerging markets, 67% of investors said the biggest risk is a significant slowdown in China, with only 17% citing the European debt crisis. The saving grace is that 42% of investors believe that flows to emerging markets are likely to continue at a strong pace. But even here the all-pervasive uncertainty gripping investors is seen from the fact that 32% said inflows will continue to drip in, consistent with the prospects for what they consider a mature asset class. As the Barclays survey says, the deep uncertainty is seen from the fact that the responses to the questions were more or less evenly distributed. Moreover they also point out that “uncertainty is reflected in the amount of risk being taken this quarter: 40% of clients are running a light or very light amount of risk relative to capacity, up from 31% last quarter”.
What about India? A recent Morgan Stanley report says that their main overweights in emerging market are China, Malaysia, Russia, Korea and Brazil, in that order. The most underweight are Hungary, Mexico, Thailand, Indonesia and India, in the order of dislike. Why is India so underweight? Well, it ranks 15th out of the 20 emerging markets studied in trailing return on equity, 12th in earnings growth and 16th in terms of where the economy is in the business cycle.
Perhaps more interesting is India’s score on two measures—political risk and governance. According to Morgan Stanley, India ranks 13th on both parameters. On political risk, it’s behind China and Colombia, while in governance it’s behind Mexico and Turkey, as seen from the accompanying chart. The Morgan Stanley ranking shows what investors think of our political and governance systems and of the crying need for removing the all-encompassing fear of decision-making and of restarting the reform process.
But what’s really hurting the Indian market is the prospect of slowing growth, the result of the Reserve Bank of India’s (RBI) hiking interest rates. Most foreign analysts have been all praise for RBI, arguing that, among central banks in the region, it has the best record in trying to combat inflation. A recent report by Citibank finds that all Asian nations except India have expected real rates that are well below the historical average. It also says that Thailand and India have policy rates that are high relative to the estimated Taylor rule rate. The Taylor rule is a monetary policy rule that specifies how much the central bank should change the nominal interest rate in response to divergences of actual inflation rates from the target inflation rates and of actual output from the potential output. The Citigroup analysts say that India’s results vis-a-vis the Taylor rule are interesting given that “historically India’s short-term rates have consistently fallen below the monetary policy rule”.
The problem is that, in spite of all that tightening, India’s inflation is by far the highest among the Asian nations compared with RBI’s medium-term target. And while India’s inflation momentum has slowed, it’s still higher than that in many other Asian nations. The study concludes that, seen from this perspective, India’s central bank “appears the most behind the curve”. Simply put, what this means is that in spite of all the tightening it has done, inflation expectations remain too high for comfort and RBI has no option but to continue to tighten. And even if it decides to pause after hiking another 50 basis points, it might be a long while before rates come down, with liquidity continuing to be tight.
In short, risks have increased across the world. In the Barclays survey, only 31% of equity investors expect a return on equities of more than 5% in 2011, compared with more than 80% in the previous quarter’s survey.
Graphic by Ahmed Raza Khan/Mint
Manas Chakravarty looks at trends and issues in the financial markets. Comment at email@example.com