Of all the ‘Bric’ economies (Brazil, Russia, India and China), I’ve always had a sneaking preference for India.
There’s the fact that it’s a democracy. Call me old-fashioned, but I still find that a desirable trait in a country. Democracy isn’t everything – Lord knows, India proves that – but it does indicate a grasp of property rights that is lacking in both Russia and China.
Brazil of course is a democracy too. But I always liked the fact that India is one of the few emerging-market nations that isn’t – unlike Brazil – heavily commodities-dependent.
In any case, right now, the Brics don’t have many fans at all. But India looks to be in the biggest trouble. The rupee keeps hitting fresh lows. We aren’t seeing full-blown panic yet, but it could be a matter of time.
So is this a buying opportunity?
India’s classic emerging-market dilemma
Federal Reserve chief Ben Bernanke’s threat to reduce the amount of money being pumped into the US economy has hit markets around the world. But few have been hit harder than emerging markets. And India’s currency – the rupee – has been one of the biggest casualties.
The rupee, reports the FT, started to “slide in earnest in May”, triggered by Bernanke’s warning. But the slide has turned into a rout. The currency has hit a series of new lows against the dollar, setting a fresh record this morning. It is down around 16% since the start of May.
Yet as James Mackintosh points out in his Short View column, that’s still quite tame by currency crisis standards: “In 1997 the Thai baht more than halved in six months.” So things could still get worse.
India has a classic emerging-market problem. The country runs a large current account deficit, at 4.8% of GDP. In short, that means it relies on foreign money to fund itself. This is fine when the foreign money wants to be there. It’s not so good if this foreign money belongs to flighty investors, chasing the next big story. This so-called ‘hot’ money has a tendency to pack up and leave the instant things start to look tough.
One side effect of quantitative easing (QE) (in the early days certainly) was to push up the value of assets in emerging markets, as investors chased better returns. So there’s a logic to the idea that the threat of QE tapering off, has driven money out of emerging markets.
And of course, there’s a self-fulfilling aspect to all this. If investors fear that others will pull their money out of a country, then it’s in their best interests to pull their money out first. A good rule of thumb in markets has always been: “if you’re going to panic, panic quickly”.
Competent governance can go a long way to soothing the fears of investors. If they think that the government has everything under control, and can fix a country’s problems, then investors will be more inclined to stick around.
Unfortunately, India’s governance doesn’t encourage confidence. The government has introduced a range of measures to try to stabilise the currency. It has imposed capital controls – not on foreign investors, but to prevent Indian companies and individuals from investing outside the country. It’s also raised the import duty on gold – Indians buy a lot of gold, and when they do, currency leaves the country.
But of course, these sorts of restrictive measures merely flag up how desperate a situation is. They also make foreign investors all the more keen to get their money out of the country in case the Indian government tries to trap it there, despite constant reassurances to the contrary.
The Indian stock market hasn’t fallen far enough
So, what’s next?
So far, while the rupee has been hit hard, the Indian stock market has held up pretty well. Sure it’s down about 10% this year so far, but it’s hardly collapsed – this is not yet a market in capitulation territory.
As the FT notes, foreign investors “own roughly half of freely traded Indian shares, but are yet to withdraw large quantities of capital.” The danger is, these investors will be hurting quite badly just now. The market may be down 10% in local currency terms, but in US dollar terms, it’s down about 20%.
So they’ll be feeling jittery. They’ll be hoping that things get better. But if it looks as though a big exodus from the stock market is on the horizon, they’ll not want to wait in the queue to be the last to leave.
The Reserve Bank of India is getting a new central governor, Raghuram Rajan. Rajan is a smart guy with a good track record. He’s one of the few economists in the mainstream who genuinely saw the financial crisis coming. And most of his peers still seem to think his ideas are a bit ‘out there’, which is a good sign, given how wrong they tend to be about everything.
The problem is, he has no good choices. India’s problems are structural. As a central banker, he can only plaster over the cracks. If he wants to make the rupee stronger, the main tool he has is to tighten monetary policy. But that could make India’s already frail economy slow down even further.
Perhaps more to the point, the real difficulty is that the one thing that affects Rajan’s job most is completely out of his control. This panic was kicked off by fear of the ‘taper’ in the US. Chances are, if Bernanke changes his mind, or doesn’t taper as early as markets expect, or by as much, then India and the other emerging market stocks will bounce back. But if the taper looks worse than expected, the sell-off will continue.
So while I like India and I’ll be looking for an opportunity to buy in, I don’t think we’re there yet. I’d like to see a harder crash in the market, or a clearer sign that the rupee is out of the woods before I bought in. This is one to be patient on.
We’ll be looking at emerging markets in more detail in the next issue of MoneyWeek, out on Friday. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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