Jan Lambregts, managing director, global head of financial markets research, Rabobank International and Adrian Foster, director, head of financial markets research, Rabobank International, talk to Puneet Wadhwa about the European debt crisis, the slowdown in India and China and other issues related to the macroeconomy in an interview. Edited excerpts:
The problem in the euro area seems to be marked by two extremes – optimism given the stimulus hopes on the one hand and fears of Euro zone collapse on the other. Do you think the Euro zone will eventually disintegrate?
Lambregts: The Euro zone and the investors in the Euro zone travel in hope. We firmly believe the Euro zone will survive and we have two key reasons to believe that. One line of argument is the economic rationale where we believe that Euro zone is ultimately worth it; and even if there are issues, they can be resolved.
The other is a political rationale behind this. One should not under-estimate the political will behind the efforts to keep the most of the countries, if not all, onboard in the Euro zone. For a currency union to work, you need to have both – the weak and the strong members.
In Greece, two opinion polls were recently conducted. One asked the population whether they would support further austerity measures. Predictably, the answer by the majority was no. Another poll asked whether Greece should remain in the Euro zone. The answer to that was a resounding yes. Clearly, there is a conflict here, as continued Euro zone membership will come at the cost of significant additional austerity.
But will Germany stay?
Lambregts: We think Germany will indeed stay in the Euro zone. There is a strong economic and political rationale that supports this view. Economically, Germany is the strongest Euro zone country, but much of its strength depends on exports to the rest of the Euro zone and Eastern European economies. Hence, a strong and surviving Eurob zone is in Germany's best interest, as the country is a key beneficiary thereof.
Politically, Germany clearly recalls the origins of the Euro zone, which were always political and meant to avoid another war between the large European countries. Interestingly, there is no mainstream opposition party in Germany that supports walking away from the Euro zone. In fact, the opposition Socialist Party in Germany supports closer fiscal union, on a time track faster than the current coalition government is willing to consider.
Is the Euro zone truly viable in the long term?
Lambregts: If you look at the debt statistics, I feel that all isn’t lost. The Euro zone has a debt-to-GDP (gross domestic product) ratio and a deficit which is lower than most major blocks in the world if not all the blocks in the world, except for Asia. The US, Japan and the UK all have worse figures. But still, most investors focus on the debt crisis in Europe rather than the other blocks.
So, what needs to be fixed?
Lambregts: While on one hand, we have a monetary union that has been built without a matching political and fiscal union and then you have a central bank that until very recently was reluctant to position itself as a lender of last resorts or buyer of government bonds.
We are not exactly at the end of the crisis yet. Yes, the end of the road is fiscal union; we need a European Central Bank (ECB) that is more aggressive. It is a systemic crisis and the next six to 12 months will be important. The structural reforms that are underway in Europe will have repercussions for several years to come.
What about the macros in the Indian context? Do you see them getting worse from here on?
Foster: When you look at the development level and the demographic profile, these are all underlying positives. We are all more pessimistic now compared to two years ago. You’ll need to have really good policy measures to boost the economic growth from the current levels to the eight-nine per cent range. To be honest, I don’t see those types of policies will come through. One must also remember that the global backdrop is also unimpressive. It is unlikely we’ll see eight-nine per cent growth rates again. It will remain in the five-six per cent range in this year and the next. However, given the rains, the prognosis for the rural sector is a bit better from what it was a few months ago. For the full year, I expect the growth to be at 5.6 per cent.
China reported falling imports and lacklustre growth in exports for August. Moreover, it has been buying bonds from debt-laden countries in the Euro. Is this a cause for concern?
Foster: China is a much bigger part of the global economy now that it has ever been. Risks in China are now a global affair as compared to, say, 10 years ago. Some of the risks that one can point to were the housing market.
How does India appear amidst all these economic growth projections and the risks associated with it? Do the valuations and prospects of other emerging markets appear more attractive?
Foster: At a global level, as we see, no economy is doing particularly well. We still have some reasonable growth rates in the Asia – Pacific region. I don’t see a significant pick-up in growth in the next year also and this more subdued growth trend is here to stay.
So, which economies are contributing more to the regional growth momentum?
Foster: There are three according to my analysis that stand out – China (despite losing momentum), has contributed relatively more in the first half of this year as compared to what it did between 2004 – 07, Indonesia is the second one that came up into investors radar in 2008 – 09 amidst the global financial crisis and is again doing relatively well. The third one is India, where the prognosis is not quite as positive.
What is your assessment of the quantum of portfolio flows that India can attract in the second half of 2012 among its BRIC and emerging market (EM) peers?
Foster: When I see India, I see one particular characteristic and that of course is that it stands out in the Asia-Pacific region because of the current account deficit. It is a consumer of foreign capital as opposed to other regions in Asia that are net exporters of capital.
The FDI landscape is not easy for the foreigners to get involved and then there is heavy reliance on portfolio capital, as I mentioned earlier, which comes through the global banking system. So, when the banking system is incumbent, the portfolio capital is harder to come by. And this has been one of the primary reasons for the fall in the rupee since the past one year. Portfolio capital was harder to come by given this and thus finance the external deficit.
Foreign direct investors (FDI) have a lot of appetite for India. However, it is hard for the FDI to overtake the portfolio flows, which were strong this year because the European financial institutions were much stressed late last year and the LTROs really lifted the sentiment, and India certainly received a share of that. Long term though, the escalation of the tension in the euro-zone will be a challenge for India. I don’t want to call the rupee weaker, but the 25 – 30 per cent fall, I think it will remain range-bound between 53 – 56 levels in FY13.
