Emerging markets have been battered this year when compared with developed markets; where do you see this trend heading?
Developed markets went through a period of terrible financial crisis and recession. Some of the emerging markets are seeing a rough time now. The major developed markets are accelerating—Europe has come out of recession and the US, which had substantial headwinds from a tight fiscal policy, is likely to grow faster this year, while Japan has the advantage of Abenomics, although there is still a risk there of recession from upcoming tax increases. On balance, the developed world is looking reasonably strong while the emerging markets, for now, are going through a period of weakness. In the longer term, it is the emerging world that will still grow disproportionally because they are still catching up with the developed world. So we can’t write off the emerging world.
Is India one of the few bright spots for emerging markets in 2014?
Yes. I think it is slightly because the growth in the other major emerging markets has been relatively slow this year. It will take time to reverse that. India has had a very tight monetary policy, and in the process, suppressed inflation and stabilized its currency. Obviously, going forward, a lot will depend on the elections, and not just who wins, but also the nature of the coalition that will be put together and whether it can implement the reforms that need to be done. If major reforms are carried out, it will have a big impact on growth for next year.
Investors who are betting that the BJP and its prime ministerial candidate Narendra Modi will come to power have pushed India’s stocks to record highs. Are investors getting ahead of themselves?
This has the hallmarks of a temporary bubble. Certainly there is some euphoria about the prospects of a reform-minded government coming in...there is a bandwagon effect. If investors perceive that other investors are going to buy equities because of the euphoria, then they will also buy equities hoping to profit from the run. It is tough to revive growth in India and that will require a lot of things. A lot of regulatory and monetary issues need to be addressed—fiscal issues also need to be addressed. At the same time, India has a lot of potential over China. India has a more youthful working age population. It has a reasonably good financial system that channels funds to entrepreneurs far more efficiently than it is in China. There is a lot to build on for India, but there are also a lot of obstacles. I am optimistic that India can grow rapidly, but whether it will depends on a lot of things that will happen when a new government comes in. The current surge in markets is likely to be extended. Most of the other emerging world is experiencing sizeable slowdown this year. Those countries that may have somewhat more prolonged slowdowns are the ones that have a lot of external debt.
But compared to where India and Indonesia were last year, are you surprised that these two countries have been relatively unscathed in 2014, even as other emerging markets have been volatile?
In the case of India, there was substantial tightening of monetary policy and this has had a big positive impact on the currency. The governor of the RBI (Reserve Bank of India) has been determined to restore confidence and tackle inflation. Given these measures, I am not surprised to see how India’s markets have behaved.
Recently, US Federal Reserve chief Janet Yellen indicated that rate hikes could happen as early as the second quarter of 2015—this can lead to a stronger dollar, which, in turn, is not great for emerging markets.
It goes both ways—when emerging currencies were rising, emerging countries were complaining against Fed policy, and when Fed policy reversed and the emerging currencies went down, they complained as well. But, as far as Fed policy goes, we don’t know if short-term rates will be increased. In her formal testimony, Janet Yellen she said she wants to continue the Fed policy of keeping the benchmark interest low and added that they would look at a broader range of labour market indicators before taking any decision on hiking rates. Later at the press conference, she was asked when this might happen and she said it could be as early as six months from now. I don’t think that was the answer she intended—I think she was just trying to indicate some flexibility. I don’t think that anyone really knows when rates will go up. The dollar will move according to a variety of indicators—inflation expectations, pace of the Fed tapering, growth of the economy, what happens in the rest of the world and geopolitical reasons. The dollar is still seen as the safest bet and so long as there is uncertainty, the dollar will benefit.
So far, the debate has been how a slowing China impacts both emerging and developed markets. But for countries like India, don’t you think that a slowing China can be beneficial as commodity prices will come down?
Certainly, China has started to slow down and this has had an impact on global commodity prices and most of the commentary has been focused on countries that are exporters being impacted negatively. But obviously, if you are a net importer of commodities, a slowdown in China is beneficial. But a slowdown in China has a negative impact not just on commodity exports, but all other kinds of exports too—it could have an overall negative impact on global growth and it is therefore hard to say which impact will be greater.
Can India and other Asian countries use a slowing China to their advantage—these countries don’t have overcapacity. China has overcapacity. Does a slowing China offer the likes of India the opportunity to revive its manufacturing base?
These countries will benefit not because of China’s overcapacity. China’s overcapacity is in big heavy industries, where it is not globally competitive; but in areas like in apparel, electronics, textiles, footwear, where China is competitive, we are seeing an increase in wages and also increase in costs and this has hurt the competitiveness of Chinese exports. We are already seeing some producers shift from China to other low-wage countries like Indonesia, Vietnam and the Philippines. Theoretically, India should be on that list, but we have not seen any shift take place. While India has abundant supply of cheap labour, it has problems of transportation, infrastructure and electricity generation. China had the same problems 30 years ago when they began to build a manufacturing base. India is potentially well positioned to benefit as China moves up the value chain and shelves its low-wage and low value-added jobs. Those jobs should go to India—that should be a good way for it to grow and absorb people who are moving from farms to factories. Obviously, all the people in India cannot be working in offshore IT businesses. Manufacturing should be a critical component for India’s future growth.
Do you see defaults in China rising?
There have almost been no defaults so far, except one, but I think that will change. There have been indications from its government officials that it will be beneficial to have more defaults because then you will have less risk-taking. Then you may have more sensible pricing of risk. If there is no chance of a default, the lender does not have to be very responsible. We will see more defaults, and the problem is that this will expose banks and it could ultimately require government bailout of financial institutions. The government has made it clear that they want to slow the growth in shadow banking and create more market-based system of financial assimilation.
Will Beijing’s financial firepower alone be enough to ensure that China does not face major market instability?
If there is a crisis, the Chinese government has sufficient firepower to protect and prevent the collapse of financial institutions. It is not like what happened in the US in 2008. Instead, what could happen is that the central government would be forced to bail out financial institutions, if there is a crisis, and as part of that, they would probably require that they cut back on lending—so you could see a contraction in credit growth that would have a negative impact on overall economic growth.
You are in Singapore for the World Retail Congress Asia Pacific. How do you see the retail market when you compare India and China?
Despite operating for decades in China, most big retailers are not making profits there. There is not enough published data, but big retailers continue to expand in China. There are some regulatory concerns in China, but they see that market as an opportunity to develop on a large scale. It is a long-term play. They see China as a potential, vast middle-class market where there are still tremendous opportunities—the top 100 retailers in China have only about 12% of the market. The retail segment is very fragmented—very large part of it is driven by street market or by state-run department stores, and there is plenty of room to bring modern retail because it has a competitive advantage over street markets, and so, they see huge growth potential. Eventually, with the economies of scale and the size of the Chinese market, big retailers can be profitable.
After India revised its policies for retail, so far, only Tesco has announced an investment. Do you see the others coming in—what are the major concerns for foreign retailers? Is policy a deterrent even with simplified rules, or is the federal structure of India, where states have the final say on retail, putting off foreign retailers?
Many more (foreign retailers) will come and they were waiting for this regulatory change and this environment for many years. There is still uncertainty on the regulatory part—whether India will backtrack. After the elections, there may be greater clarity on the regulatory part, and if there is confidence that liberalization process will continue, then we will see more (foreign) retailers coming in. I think that there are two concerns—first, state regulations may change with a change in government and, second, because different states have different rules, the advantages of economies of scale for big retail are lost.