Emerging markets – way to go

David Bloom, Global Head of FX Research, HSBC, was in Oman to deliver his annual address on currency movements and the outlook on the world economy in 2010, recently. Mayank Singh catches up with him on the sidelines of the event

What is the main thesis of your address on world economy?
The main thesis of what I am saying is that US interest rates at quarter points pose a challenge to many parts of the world. Once the carry trade comes over, then currencies like the Swiss franc and the Japanese yen will become popular with traders as the risk is low with fundamentally strong currencies with low interest rates. What we now have in the US and UK are low interest rates, but the risks are high in these markets. That makes the carry trade more alert. Also, the US and UK have double digit budget deficits; their debt-to-GDP ratios are high and moving to 100 per cent; they have net external liabilities and they are printing their own money. You cannot get a better combination to borrow the money of a country under such dire circumstances.

Now let us look elsewhere but the question is where is this elsewhere? You have Brazil that pays you around eight per cent interest; in some pegged exchange rates, they have much higher interest rates than these. We heard the Lebanese Central Bank Governor saying last year that they got $15bn in remittances. This is because they offer five per cent interest and have a fixed exchange rate. The interesting thing is that the dollar as a major anchor of stability is breaking down. People pegged into the dollar because in a rocky sea, you could lock your policies into the US which was traditionally a consumer of last resort and a global price setter of commodities. So it gave you an anchor of stability. The US is no longer any of these.

If people are looking at emerging markets with dynamic populations and not ageing populations as in the West, you draw a possibility of a high risk with a high return, that is the emerging world compared to high risk and guaranteed low returns given by the Anglo Saxon model. So people want to catch the crest of the emerging markets world in terms of population and growth, which add up to one thing in a resource-hungry world. So there is a move towards commodity currencies and resources. People want simple products and not complicated products that have caused so much misery and the thing is that you can borrow money at quarter per cent to put into these countries. My main concern is how pegged exchange rates will function six to nine months down the road.

Take the Gulf economies for example, at the moment, it totally suits the region that we have come from global crisis and zero rates. But imagine a scenario if oil prices remain at $100 per barrel and US rates remain at quarter per cent and the dollar keeps falling for the next nine months, then the Gulf economies will be in a recovery phase. In a normal recovery, you would expect rise in asset prices and a slight tightening of policies, but instead the region will be receiving a loosening of policy. This creates a dissonance or as they say a stone in the shoe. And how do you go forward in such a scenario – this is a challenge facing not just the Gulf region, but also South America and Asia. People have linked in to the US as an anchor and some of them are way ahead in the economic cycle and they have to answer the question. We have historically understood as to why we pegged into the US dollar, but the question is – Is it appropriate today? I am not surprised that talk of a single currency is on everyone’s lips and that is something that requires careful consideration. So what I am saying is that the world has moved on but policies have not and this is creating a contradiction and anomaly.

Can we expect interest rates in the US to go up in 2010?
The focus has shifted now. In the old days people were talking about the euro dollar cable, dollar yen. I no longer talk about the yen. I am not interested in the yen anymore. I am only interested in the lessons that yen has to teach us about Japan, which is if you tighten policies too soon, you will be in dire straits. In 1997, the consumption tax in Japan killed the economy, they tightened rates from a quarter to half a per cent and had to cut them again. So this whole idea that the US will raise rates is fanciful and I do not think that we will get a rate rise in the next 12 months. You have to understand that unemployment in the US is at 10.2 per cent and rising. So we have zero rates in the US for the next 12 months. You have to understand that there were independent central banks. This means that fiscal and monetary policy were in a sense divorced from each other, but now there needs to be a reunion of fiscal and monetary policy. Because if we have economies doing well, then we need tighter fiscal policy not tighter monetary policy because tighter fiscal policy does the job of a tighter monetary policy plus it repairs the balance sheets of governments. If that happens then rates could stay lower for even longer.

The global meltdown has changed a number of fundamentals that were taken as a given. What in your view is the big story of 2009?
Emerging markets. Everyone is long on dollars, we know that central banks have four and a half trillion in dollar deposits, private sector has a trillion. If I am wrong and the US does well then everyone with dollars will do well, because they cannot get rid of them wholesale. The advice for people is to have a diversification policy away from dollars and not to shift from dollars to sterling or euro but away from the dollar to the Brazils, Indias, Chinas, the South Americas of the world, branch out and diversify and look to the dynamic, emerging markets of the world in order to bring growth. If the emerging markets are going to grow at a fast clip then there is where the capital is going to go.

These countries are very commodity intensive, so people are getting into the commodity side and that is the big story. Whether it is genuine or not is an interesting question. One thing that I have learnt about the financial market is that pricing is much more aggressive and virulent than you thought possible and once it boils over, it goes everywhere. But you never know what that point of time is. In 1997, Alan Greenspan called it irrational exuberance, in 1999 he was calling it the new economy. In Dubai people talked about a bubble seven years ago, six years ago and five years ago and then three years ago, everything became genuine.

The Anglo-Saxon model of development has been a consumption driven model of growth. Will emerging models follow the same course or be different?
Rather than consumption growth, emerging markets are looking at investment growth within themselves and that is very resource intensive. No one will take on the slack of the US and so global growth will be slower. Emerging markets need a lot of infrastructure growth and when such projects and funding come they are resource intensive.

So if you want to buy in emerging markets, there are many ways of doing this – one way is to buy equities of multinational companies that offer governance and stakeholders’ involvement in emerging markets; the other way is to buy currencies in these markets or commodities themselves. If you are brave enough then you go to any of these countries and buy an asset in any method. So there are different methods and that is what the market is hungry for.

What is your take on China and India and can we expect a free floating renminbi anytime soon?
China will get appreciation starting only in the second half of next year. Chinese are not in a rush. A Chinese official once told me that the country will have a free floating currency soon, so when I asked him what is soon, he said in the next 500 years. The beauty of the renminbi is that unlike other currencies in which we do not have a sense of direction or timing, in the case of renminbi we only don’t know the timing, but we definitely know the direction, so it is a winning currency.

In the case of India, an economist said that he was bearish about his own country India because the budget deficit was going to be in double digits or 11 per cent and I said I would swap that any day. When the UK and US had a 2.3 per cent budget deficit and UK had under 40 per cent debt to GDP, they looked down upon any country with double digit deficit. But that has changed, the US and UK can no longer look down on anybody as they have the same problems.

The crisis started in the US and spread across. Do you expect the US to come out strongly in 2010?
The further you fall, the faster you rise, that is the natural phenomenon of economies but it does not mean anything. In a way the US will get back to three and three and a half per cent growth next year, but that is not the point, the point is where is long term trend growth. Because if you go back to Japan in the 1990s after the crisis, trend growth had not fallen from six per cent to four per cent but to one per cent; you would have never said that this is the year of Japan.

The question is what is the long term sustainable growth rate of the US? Is it three and a quarter? It’s probably two and that’s what comes as a shock. We reckon that the US will need three and a half per cent to four per cent growth over the next ten years to get back to the trajectory where we thought we would be a few years ago but that is not really possible. So the US has to accept a massive loss of output. The dollar will still be the reserve currency of the world but it will not be the anchor of stability and safety that people want it to be.

What have we learnt from crisis?
Nothing. During the Nasdaq bubble every one said bubble but just before the Nasdaq bubble burst in 1999, everyone thought this was a genuine productivity miracle or the oil price example. Everyone said bubble at $50, $60, $80, $90 per barrel. When it reached $140 everyone said $200; in Dubai as property prices went up everyone said bubble. But just before prices went bust everyone said you must buy it. People will repeat the same mistake all the time.


Quick Take
> Emerging markets are the big story of the year
> Investment growth to drive emerging markets
> US to grow at around 2% in the next ten years
> Interest rates in the US will remain at zero per cent for the next 12 months
> The world has learnt nothing from the crisis