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Rediff.com  » Business » US crisis unlikely to affect India much

US crisis unlikely to affect India much

By Akash Prakash
August 23, 2007 08:48 IST
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As was to be expected, as soon as investors had become complacent about risk, it came out of nowhere to bite us. Having gone through a couple of wrenching weeks, in which volatility was all-pervasive and all sorts of doomsday scenarios began to gain credence, the important issue to focus on now is how the investment scenario will change going forward.

What will be the longer-term impact of this sub-prime crisis? Once this de-leveraging and repricing of the risk cycle gets completed, what investment assumptions will investors need to rejig as they look forward?

There are two to three clear takeaways from this investment crisis, which will drive investment returns and the investment environment going forward.

First, one clear message and outcome of this crisis is that US growth will be impacted and the US will grow slower than one would have thought even two weeks ago. Whether the US slips into a recession or not is still a moot point, and one will have to track that very closely, but a significant slowing of the US in the second half of this year is now baked into the cake, so to speak.

One just has to read any research of the type of loans being originated, the large-scale prevalence of fraud, and the quantum of loans still to be repriced, to understand the full magnitude of the impact this crisis will have on the US economy and its growth trajectory.

The impact of this coming US slowdown will also stress-test the global decoupling thesis. Can the global economy really continue to grow at nearly 5 per cent, even with the US clearly faltering badly?

Can global markets also decouple from the US? This is after all, from an economic perspective, largely a US problem; no other geographical area has really participated in this sub-prime frenzy. Financial institutions in other countries may have to take a hit because of the sub-prime exposure and over-active treasuries, but their economies should not.

If, however, global growth does get impacted, what will be the implications for commodities and other more cyclical assets? This is an issue all investors will have to ponder on. Could this mark a turning point in the global growth cycle, and are we about to see sector rotation away from cyclicals and commodities?

Secondly, interest rates in the US definitely and most probably globally will come down by more and faster than one would have budgeted for earlier. This will have its own impact in terms of increasing the attractiveness of equities and other growth assets, boosting liquidity and should eventually cushion any fall in these asset classes.

The third impact that comes to mind straight away is a further weakening of the dollar. With the US economy being hit the hardest, and seeing probably the greatest adjustment in interest rates, this will put pressure on the currency.

On top of this, with so much damage being inflicted on the US debt markets, their liquidity and credibility, one should expect many investors to reduce their exposure and commitments to certain parts of these markets.

Given the huge financing requirement of the US current account deficit, any reduction of capital inflows into the US can have a significant impact on the currency.

The fourth impact will be on the whole gamut of structured products, as investors were clearly buying assets of which they understood very little, and were blindly relying on credit rating agencies and the originating investment banks to guide them.

The risk appetite of all these investors has taken a severe beating, and they are unlikely to touch more exotic instruments for some time.

The inevitable outcome of this will be reduced access to capital for smaller less-established companies as the high-yield markets become more constrained.

Given the above context, I would argue that after the next couple of months, when all the forced selling and redemptions are done with and markets once again settle down, the above changes in the global investment environment may actually favour markets like India.

Investors will be looking for strong growth stories that are independent of the US economy, and India fits the bill perfectly. We are in the midst of a huge domestic capex cycle, driven by infrastructure, and this is complemented by a strong domestic consumption story driven by demographics, income distribution and retail finance.

The visibility of 8 per cent plus GDP growth is very strong, and I do not expect any significant change in India's growth trajectory because of the problems in the US. Exports as a percentage of GDP are the lowest in India among all Asian countries and we as an economy are much less exposed to the US consumer than most in Asia.

The larger Indian companies have very limited leverage on their balance sheets and we are not overly reliant on foreign capital for our growth. When investors look for growth visibility and sustainability, India should stack up very strongly.

Also, if the global interest rate cycle has turned, then one would also expect the RBI to be more cautious about tightening domestic monetary policy. The biggest concern on the domestic growth story has been the possibility of the RBI being too zealous in tightening, and slowing down the economy too much.

Many of those concerns will recede if, as looks likely, the global growth and interest rate cycle has turned. A possible correction in commodities will also dampen inflation concerns.

India is also a more expensive but higher-quality growth story compared with most of the other markets in Asia. We are more expensive on PE multiples but have better return ratios in terms of RoE (return on equity) and free cash generation.

Indian companies also tend to have much better-articulated growth strategies. In an environment where interest rates are dropping and sustainable, visible growth is hard to find, those few economies, which can demonstrate a high visibility of earnings and economic growth should see a valuation expansion. There is a possibility this can happen in India as well.

The whole emerging markets asset class will have a few choppy months as the full extent of deleveraging and quest for liquidity plays out. India will be as badly affected as any of the other large emerging markets, in this indiscriminate bout of risk reduction.

We also of course have the possibility of shooting ourselves in the foot by overlaying political risk on top of all the other global factors. However, at the end of this in the new market environment, which will emerge, India should actually be a beneficiary.

It is already probably too late to sell now, instead focus on building positions in high quality companies trading at reasonable valuations. This bull market is not over.
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Akash Prakash
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