Over the last few days as we have seen a selloff in several EM currencies there has been renewed talk of an acronym “Fragile 5” coined by Morgan Stanley. India being part of this group of countries which includes Turkey, Brazil, South Africa and Indonesia is one of the most absurd things that I have seen over the last several months. India is much better off than each of these countries as I will elaborate going ahead. This is despite the follies of the current UPA GOVERNMENT.
Turkey- Turkey has been one of the leaders of the current Emerging Markets sell off. Its currency plummeted over 15% since the beginning of the year before their central bank acted a couple of days back by taking overnight rates up from 7.75% to 12%. This has created some stability in their currency, which in all probability will be short-lived as increasing interest rates to control your currency is one of the worst ways to improve the value of the currency. Turkey has a big political crisis which includes a corruption scandal going on. In India we have already gone through these scandals 2 years back. They have a widening Trade Deficit as compared to a contracting one for India at this stage. Trade deficit for last year was $ 100 billion up nearly 20%.Turkey has forex reserves of $ 150 billion, GDP of $ 790 bn and a CAD which is touching 6% of GDP.
Brazil – Brazil has been facing problems related to increasing inflation, slowing growth as well as the contagion impact of the crisis facing its biggest trading partner Argentina. Brazil ended 2013 with the highest CAD over the last 12 years at $ 81 billion which is 3.66% of GDP. Brazil does have Forex reserves of $ 360 billion which the Central Bank has conserved without too much of direct intervention. However Brazilian Companies have nearly $ 500 billion of external debt with another $ 400 bn as investment by foreign investors into that company. Brazil also has extremely anaemic GDP growth which has largely averaged between 0-2% over the last 10 years. The major exports out of Brazil are that of industrial and agricultural commodities which have seen price pressure and might see more price pressures going forward due to slowing growth in China.
South Africa – South Africa has also seen a huge increase in its Current Account Deficit due to the commodity nature of its exports as well as a series of strikes which has impacted production of various products. In the last quarter the CAD shot up to 6.8% of GDP which on an annual GDP of $ 400 billion amounts to around $ 26 bn. South Africa has Foreign Exchange reserves of just $ 50 billion. Falling commodity prices and a slowing China directly impacts South Africa due to large exports to that country. Due to lower Forex Reserves the vulnerability of South Africa to an EM crisis is quite high.
Indonesia – Indonesia has seen its CAD move up to around 4% of GDP last year. A ban on unprocessed mineral exports combined with falling prices of its key exports has put further pressure on the CAD. The Rupiah was the worst performing EM currency in the year 2013 and fell by 21%. Lot of exports of Indonesia are related to agricultural and industrial commodities where the prices are under pressure. Indonesia saw its forex reserves fall by 13% last year to $ 100 billion and they are enough to cover just 1.6 times its short term debt which is the lowest in South East Asia. Its exports are venerable to a Chinese slowdown. The central bank in Indonesia has been slow to increase interest rates, which is likely to put greater pressure on inflation and has led to the sharp Rupiah fall.
India is clearly in a very different position from the above mentioned countries. India is a beneficiary of a fall in commodity prices and does not get hurt by the same like in the case of South Africa, Indonesia and Brazil. It’s Current Account Deficit has moderated significantly over the last two quarters and not expanded as is the case with the other countries.
We in India have borne the worst impact of the corruption scandals as well as lack of decision making under UPA over the last three years and things are likely to improve and not deteriorate going forward. RBI has successfully built reserves over the last three months anticipating a crisis scenario unlike the central bankers of most of the other affected countries. Infact the CAD for the 2nd and 3rd quarters has been extremely low and seasonally the fourth quarter is always better for the CAD. This has also reflected in the way the INR has behaved where we have seen extremely low volatility in the INR vis a vis other EM currencies. With CAD likely to decline below 2.5% of GDP this year and the probability of a pro growth Central Government increasing in the elections whose results will be out over the next 100 days this is actually the time to be optimistic rather than pessimistic on India. I have argued for a weak INR policy earlier and the actions of the RBI lead me to believe that they are in agreement with this strategy. The economy can take a 4-5% INR decline without it adversely impacting inflation in any big way. As it is we have got a tremendous Term of Trade benefit built up over China due to the relative currency movements. This should be supportive of the CAD going forward.
A lot of the increase in the Trade Deficit over the years 2011-13 has also been due to the poor policy environment in India which has increased Coal imports to over $ 10 billion and reduced mineral exports by over $ 10 billion. Lack of increase in import substitutes across the board has led to greater imports. Modern consumption basket products like Smartphone’s, Televisions, Laptops & other electronic products are being directly imported without there being any domestic manufacturing. A proper manufacturing policy can take care of this issue over the medium term. As the new government focuses on growth we will see domestic manufacturing and productivity pick up and help the external trade further. Retrospective tax amendments, poor policy framework and lack of growth have slowed down FDI flows which will also pick up as domestic growth picks up.
In conclusion this entire Fragile 5 thing is total humbug and best given a miss.
As expected the markets in January were difficult to call as are most Januaries. As I write this article we are 35 days to election notification, 70 days to the start of the elections and 100 days to a new government. The leads in the elections are quite clear at this stage and the wave that has built up should only get stronger in my view. This will lead to the start of a pre election rally. The risk is more from the Western Markets which rallied sharply in 2013 and a correction in those markets always impacts EM’s in the short run. With the impact of Tapering by the US FED now clearly getting built into all models there is unlikely to be great volatility due to this factor going forward.
The longer term outlook remains the same as what I wrote at the beginning of the year. Markets look good for a 20% plus gain this year and sometime from now to the next two months might be the best time to buy into Indian Equities.