While the US economy is crawling back to normalcy, uncertainty prevails in the euro zone regarding growth rates, likely default by some member-countries and high joblessness. China’s economy is also slowing as the country’s central bank has been gradually raising interest rates. Geoffrey EJ Dennis, Managing Director, Global Emerging Markets, Equity Strategist, Citigroup Global Markets Inc, spoke with Malini Bhupta and Vishal Chhabria on issues haunting the global markets and how the Indian markets compare with other global markets. Edited excerpts:
At the start of this year, the prospects of US growth looked very bright. Do you believe that things look very different now?
There are two temporary factors that have affected US growth. If you look at sales in the US, of Japanese autos, they were down by a third in April/May, while those of non-Japanese automakers were down only 3 per cent. This gives a hint that US consumers want more fuel-efficient cars. Auto production also factored weak in May. Supply chain issues have had an impact on the US economy. Another aspect that impacted growth is the sharp rise in gasoline prices earlier in February and March. However, some of these issues will fade as we move forward, as the US economy is better placed than a year ago. Job growth is higher and confidence in consumer spending is returning on a relative basis. These things minimise risk.
It’s widely believed that the US is exporting inflation to the rest of the world by injecting large amounts of liquidity. What are the chances of a QE3 after QE2 ends in June?
Quantitative easing does distort financial markets as it perpetuates the sense that the US economy is kept on a drip. The US stock market is behaving like a drug addict who needs infusion continuously. The Fed feels that it will be better to take QE2 off even if it means growth comes off. While many believe the current situation is like 2007 — the end of an economic cycle — and that there will be a financial crisis and a recession, we think it is very unlikely.
A slowdown in the US will impact other economies too, right?
Effective slowdown in the US will impact emerging economies. Though some of the reasons for slowdown should eventually reverse, it will be a sub-par recovery. Citi estimates two per cent growth for the Developed Markets (DMs) as a whole, 6.3 per cent for Emerging Markets (EMs), over 9 per cent for China and eight per cent for India. However, emerging economies are now less dependent on the developed economies. Nevertheless, those that are dependent on the US, like Mexico, may be affected. There is no reason to believe that India will slow, even though the FY11 fourth-quarter GDP numbers were weaker than expected. We expect the RBI to raise rates at least three more times by the year-end. If that happens the economy will have a solid equilibrium. India’s long-term constraints are micro — on infrastructure, energy, etc.
What is your target for the Indian markets?
Our Indian strategist has a 15 per cent upside on the markets by the year-end. India has two good things going for itself. Some months ago, India was the most expensive emerging market, but now that premium has gone. Also, earnings growth is expected to be around 20 per cent in 2011, stronger than the EM average.
Do you think scams impact investor confidence?
For investors, corruption is always an issue. But, corruption in overall terms is a lot less serious than it used to be 15 years ago. What the evidence of corruption does is that new investors may dither investing in the country. However, given the pro-growth nature of the economy, I think you can argue that if India ends up with a political paralysis in the short term, the market does not have to be negatively impacted to a significant extent. I don’t see this as a sustained negative, the caveat being that this scandal resolves itself in the short to medium term.
What is India’s biggest challenge?
The biggest challenge facing India is structural. India faces micro-economic challenges — like power, transportation, and overall infrastructure. If corruption slows micro-economic reforms, then it’s a problem. One needs to see how long this period of paralysis lasts.
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Given that the preference to emerging economies is increasing, what kind of inflows can an emerging economy like India expect?
It’s been an interesting year. Until you get an upside breakout by the markets, inflows will be weak. Funds flow data are a lagging indicator. Flows don’t drive markets, markets drive flows. If growth holds up, the markets should rebound. Fundamentals are very good in the emerging economies and that should bring back money into EMs. Emerging market fundamentals have never been better relative to developed market fundamentals.
What will act as a positive trigger for Indian markets?
A confirmation that you are close to the peak of interest rates, the other thing would be better macro data from the US. This will ease fears of a double-dip.
Data show that the demand for emerging market assets outstrips supply. What can EMs do to deepen financial markets?
No doubt, the market capitalisation to GDP ratios are lower in EMs. However, we do not find this a useful metric. There needs to be an increase in listings. This is a natural evolution process. Nonetheless, there needs to be a change in the attitude of companies. In Brazil, for instance, there is a flood of IPOs even when markets are not trading well. Market-friendly listing regulations and build-up of a local pool of money could deepen the financial markets. You have to nurture the best conditions for demand and supply.