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Rahul Jacob: Emerging market contagion - again

Rahul Jacob 

Rahul Jacob

A photograph published recently showed what might have been a massive prop for a work of installation art by Row upon row of tyres were piled high to the roof as far as the eye could see. In reality, it was the warehouse of a US tyre distributor in Memphis, driven out of business by a tsunami caused by a glut of tires produced in China. The distributor, profiled in the Wall Street Journal, had been sitting on inventory from earlier purchases from Chinese suppliers when the US was flooded by even cheaper tyres.

From tyres to steel, an industrial disaster in slow motion is unfolding across the globe. Despite almost every private economist predicting the Chinese economy was slowing from 2013, Chinese companies continued to ramp up production; they only know how to operate at full throttle. With the stock market taking the place of property as the country's nationwide casino, steel production in China now far outstrips demand. Analysts from UBS calculated that the world has excess steel production capacity of more than half a billion tonnes a year, most of it in China, which exported 94 million tonnes last year - or more than the production of the US, India and South Korea combined, according to the Journal. In what must surely be an underestimate by now, the Chinese government identified 19 industries awash in overcapacity in 2013.

This glut has implications for every company competing against the Chinese and for those supplying to them. From Australia to Indonesia to Brazil, suppliers of commodities to the Chinese manufacturing machine are struggling. In a prescient piece written in July 2014, UBS strategist looked at 10 emerging markets with trade and current account imbalances. Mr Baweja noted that these emerging markets were "healing" and imbalances had improved by about 1-2 per cent of GDP. "As investment clocks go, the period after slowdown (enforced by higher rates) should be followed …by a period of expansion where export growth and industrial growth improve substantially without pushing inflation higher," wrote Mr Baweja. "We've seen the first half of the movie (but)…given a loosening relationship between growth and trade, even the modest developed market recovery isn't leading to the standard export and production (and therefore earnings) response." Sound familiar?

The broad drop in India's exports in May - ranging from engineering and gems to jewellery and electronic goods to mica, coal and minerals - makes sense against this canvas. Sure, the plunge of 20 per cent is exaggerated by a drop in oil prices that affected the price of petroleum products exports and also by the rupee's depreciation. But, India is clearly sailing into the headwinds of weak global demand. Emerging markets are already limping. Leave out China and the "average gross domestic product growth of emerging markets in US dollar terms "maybe close to 0 per cent in 2015," Mr Baweja told the FT recently. He says a tectonic shift is taking place in which emerging markets that long boosted growth are now slowing down the global economy. Writing in the FT, Jonathan Wheatley and James Kynge warned that this slowdown was comparable to the one that unfolded in 1999 in the aftermath of the Asian financial crisis. If this were not alarming enough, emerging markets' share of in nominal terms is now more than a third, compared to less than a quarter at the time of the crisis.

While all eyes remain on the Federal Reserve, this steady deceleration in global growth across the world is mostly being overlooked. downward revisions to reflect the new abnormal, but these are usually footnotes in our business press amid breathless headlines that India is at last growing faster than China. Never mind that that our recent freight (up 1.2 per cent in April-May) and cement production numbers are dire. Far from there being rainbows on the global horizon, there are many looming clouds. The manner in which the Greek drama unfolds is one, even if we get a temporary reprieve from a full-blown tragedy. A drop in the US stock market with an attendant collapse in silly money for e-commerce ventures like Flipkart and Uber is surely another.

In this game of economic make-believe, the tallest tales are being told on the Chinese stock market, which is up some 125 per cent in the past year. Leave out the banks and price-earnings multiples in Shanghai are at laugh-out-loud levels - the median P/E is close to 60. Companies are closing down factories and investing in the stock market instead. Profits earned by Chinese manufacturers increased by 2.6 per cent in April, but were nearly all the result of profits made playing the market, usually with margin financing.

Neither the government nor our companies can control the way any of this plays out. Even if the world manages a soft landing, we are still stuck with low growth for the foreseeable future. The government must focus on fixing things at home. A new bankruptcy code, sorting out exactly how much in non-performing loans is sitting on the books of state-owned banks and creating a vehicle to restructure them are now an urgent necessity. A new book, The Public Wealth of Nations, suggests that if government-owned assets worldwide were managed professionally and freed from the suffocating control of politicians it could yield $2.7 trillion. There are efficiency gains to be made in the billions if our public sector was managed at an arm's length from our politicians. We cannot be masters of the world's economic fortunes, but we can at least be better managers of our own.

First Published: Wed, June 24 2015. 21:46 IST
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