Credit Crunch: Impact of Emerging Economies
Interviewer: Steve Macaulay
Interviewee: Professor Sunil Poshakwale
September, 2008
SM:
The credit crunch hasn’t just affected the developed world, although they
have certainly had most of the publicity. I am discussing today with
Professor Poshakwale exactly how the emerging economies have been
affected by the whole of this credit crunch. So let’s start off – China,
India, has the financial turmoil affected them?
SP
We can see the impact of the developments in the US on the Indian and
Chinese stock markets. Stock markets have reacted negatively, they have
been registering falls, not only in India and China, but also Russia where
the government had to suspend trading because of the continued price fall
for nearly three days. In fact on 16th September, the Russian stock market
recorded the highest fall in the stock prices for the last decade in the
market.
So, yes, there is a reaction in emerging markets. The main reason for this
reaction in my view is the large scale withdrawal that foreign institutional
investors, mainly from the US, have made in this market. They have been
withdrawing their investment, mainly because they need capital; they need
cash in the US because the US system at the moment is cash starved.
Nearly $26bn worth of outflows have occurred in the last three months,
compared to something like $100bn that happened in the last five years.
So that is telling you the scale at which foreign institutional investors have
become risk averse and therefore they are withdrawing funds and that is
having an impact on the stock markets – the stock markets are reacting
negatively in these markets.
SM
So if this continues what implications do you think it will have?
SP
It has made average investors in emerging markets panicky. Clearly
there has been a lot of interest in the emerging countries, the emerging
markets, where the banks and financial institutions, as well as the average
man on the street, had been putting their savings into the stock market.
Clearly it has shaken their confidence in these markets and the availability
of capital for big developments within those markets for companies to
release finance capital from the stock market is going to be quite tough,
quite challenging. Fund managers all around the world have also
become very risk averse. The latest data shows that fund managers now
have a much stronger position in bonds rather than emerging equity
markets.
Also, the fall in oil and commodity prices are partly to blame. Because
when commodity and oil prices are doing very well, the investors who are
playing the carry-over trade game, when they were borrowing at lower
interest in the US and UK and investing in currencies in some of the
commodity rich countries such as Russia and Brazil. Now the price of oil
and commodity prices have fallen, those currencies have become less
attractive and therefore there is a lot of unwinding of carry-over trades
going on, putting pressure on the currencies of those countries. So there
are some significant repercussions for emerging markets.
SM
It is always dangerous to predict ahead, but say in six months time, how
do you see this working out?
SP
In my view, within the emerging market block – again, we have been
talking especially about Brazil, Russia and then China, the so called BRIC
economies as famously named by Goldman Sachs in their survey – I see
that the fundamentals of economic growth in those countries are still quite
strong.
For example, the growth forecast for India for instance, has been slashed
– it is no longer at eight or nine per cent as it was thought because of the
credit crunch and the lesser availability of capital that people expect in
future, but the growth will still be within about seven, or seven and a half
per cent. Now seven or seven and a half per cent growth rate is still very,
very good – excellent in fact, if you compare it to some of the growth
forecasts that economists are making for US and UK economies. In fact
they are slashing the growth forecast in these economies.
So in my view, the fundamentals for economic growth and development
are still there in those economies. Yes, there are short term problems.
Some economies, like China, may feel the pressure more than India for
the simple reason that China, unlike India, has been much more
venturesome in going out and investing – they had to invest partly
because they wanted to keep their exchange rate at a competitive level,
particularly with reference to US dollars. They had been buying US
government bonds, treasury bills and they have also been investing in the
bonds issued by investment banks. In fact, three banks in China have
together pumped in about $10.5bn worth of bonds and some of those
bonds were issued by Lehman Brothers.
So you can see there is going to be a direct impact on China because
they have been more aggressively investing in US market, whereas in
India, for example, the maximum exposure that Indian banks have to the
US bonds for example is not more than $5mn and that is the kind of
difference we are talking about. But even within China I think the growth
prospects remain strong, China’s exports are suffering a bit because of
the fall of the US dollar, but I don’t think that will be a very long term trend
and that trend will reverse sooner or later.
SM
So, despite all the catastrophic news coming out of America, the UK, and
Europe what we are actually seeing is some not- too- bad news from the
emerging economies?
SP
Yes, the growth prospects of those economies has remained
fundamentally very strong. There is one fundamental difference between
the US, and for that matter the wider Western developed economies and
some of the emerging economies, is that the emerging economies still rely
heavily on savings. The rate of savings in those economies are very,
very good – very strong, very high, and therefore you will see that the
banks in those emerging economies are not likely to suffer as much as the
banks in the UK and US which have been less reliant on savings that
people put in, in terms of deposits. But they have been relying on the
money markets, the credit market, to raise capital for investment
purposes.
And so, given that very fundamental difference and the way the banks
work in emerging economies and the way banks work in the developed
economies, I don’t see a huge problem occurring in those banks. I am
not saying there are no problems in banks: for example, it has been well
known that some of the Chinese banks are carrying a large amount of bad
debts on their balance sheets, but I don’t think the US will have the moral
guts to say anything to China if the Chinese government decides
tomorrow to start to capitalising their banks and pumping money into their
banks.
China, India, Brazil-and Russia for that matter- and other emerging
economies generally have good levels of foreign exchange reserves, and
therefore they have quite a cushion to absorb these shocks. Ffor example,
in the last month alone the Indian government has spent nearly US$6.5bn
buying US dollars from the market because they didn’t want the US dollar
to weaken against the Indian currency. So you can see there are
cushions available, there is flexibility available within the systems because
of the excellent performance these economies have shown in the last ten
years or so.
SM
Thank you very much, I have found that you have shed light on some
areas that haven’t had a lot of publicity and what you have done is to give
some very useful information.