Back in mid-2013, America’s Federal Reserve signalled that its massive money-printing programme – so-called quantitative easing – would be coming to an end. Just the hint of “tapering” was enough to destabilise the US government bond market. The yield on 10-year Treasuries spiked above 3pc, from 1.7pc at the start of last year. The Fed, after all, since QE began in late 2008, had bought hundreds of billions of dollars of US sovereign IOUs.
For now, America’s Treasury market seems relatively stable, even though the taper eventually happened and QE officially ended this autumn. The US government currently pays a relatively benign 2.15pc to borrow 10-year money, despite its vast debt mountain just hitting $18,000bn – a mind-boggling 78pc up since President Obama took office in early 2009.
One reason Treasury yields remain low is that the money-printing baton has been conspicuously passed to Japan and possibly the Eurozone, dousing liquidity concerns. Global investors anyway assume that at the first sign of market turmoil the US central bank will start its virtual printing press anew. Back in mid-2013, the Fed-induced “taper tantrum” sparked higher borrowing costs that spread from America and rippled across the Western world. Today, though, all appears calm.
For many of the emerging markets of the East, in contrast, the impact of the West’s “taper tantrum” lives on. Since the end of American QE was mooted 18 months ago, a slew of Western capital, previously “searching for yield” in exotic locations and sensing that ultra-low domestic interest rates could soon start rising, has begun to return home.
More generally, the wind-down of the biggest monetary stimulus in history has focused minds on dangers of a systemic backlash, switching prevailing investor sentiment from “risk on” to “risk off”. This has hit emerging markets disproportionately, despite their far superior fundamentals – leading to breathless claims that such upstart economies are “finished” and perhaps the centre of global economic gravity isn’t shifting east after all.
As far as equities are concerned, the emerging markets have certainly had a tough year. Since the start of 2014, the MSCI index of all emerging markets is down around 5pc in dollar-terms. With Brazil mired in corruption scandals and Russia embroiled in sanctions, the main stock indices of these two high-profile markets have plunged around 13pc and 40pc respectively in dollars. These heavy falls reflect the combination of specific local difficulties and the broader retreat of mainstream Western capital related to the Fed’s QE taper.
Having said that, many Western markets have also been lacklustre. Eurozone stocks are down around 8pc in dollars this year and the FTSE-100 has dropped almost 9pc. Even America’s mighty Dow Jones Industrial Average, despite massive pump priming and strong US GDP growth, has managed just a 5pc rise so far during 2014. At the same time, despite dollar appreciation and the general impression that “alternative investments” have floundered, stock in some of the big emerging markets have actually done pretty well.
China’s main dollar-denominated equity index, for instance, is up over 12pc since the start of 2014. But the real portfolio investment success story, the shining star, is India. For the Bombay Sensex is up no less than 31pc in dollar-terms this year – which means India now boasts the world’s top-performing major stock market.
When QE tapering was first mooted in mid-2013, India looked vulnerable – with rising inflation, stagnating growth and an external deficit approaching 7pc of GDP. Since then, the country’s headline performance has been transformed. Last week, a United Nations report forecast that Indian growth will rise from 5.4pc in 2014 to 5.9pc next year and 6.3pc in 2016 – rates of economic expansion over twice those predicted for the US and three-times those of the EU.
The catalyst for India’s turnaround has been the election of Prime Minister Narendra Modi. In May, Modi’s BJP broke the rule of India’s Congress party for the first time since independence in 1947, forming the first majority government in three decades. This victory came after Modi campaigned as a pro-business candidate, vowing to tackle rampant corruption and India’s stultifying civil service. Given that he turned his home state of Gujurat into a flourishing investment destination during a thirteen-year stint as Chief Minister, Modi’s election has generated a wave of hope he can pull off meaningful reforms at the national level too.
Along with “Modimania”, India is enjoying the benefit of oil prices that have fallen to a five-year low. The world’s third-biggest crude importer behind the US and China, India experiences reduced price pressures and a narrower current account deficit when crude is relatively cheap.
Annual inflation dropped to 5.5pc in October, well below the Reserve Bank of India’s current 8pc target, allowing the highly-respected central banker, former International Monetary Fund Chief Economist Raghuram Rajan, to raise the prospect last week of an interest rate cut. India’s external deficit is meanwhile set to fall from almost 5pc of GDP just a couple of years ago to under 2pc in 2014.
Cheaper oil is also helping tame India’s budget deficit. Heaving government spending on fuel subsidies means that $10-a-barrel fall in crude prices improves the fiscal imbalance by around 0.1pc of GDP – if subsidy rates stay constant. The Modi government, though, has taken the opportunity of cutting diesel subsidies in half and increasing taxes on both diesel and petrol, while raising passenger and freight fares across India’s extensive train network.
These reforms weren’t popular, but the state-run Indian Oil Corporation, the nation’s biggest fuel distributor, has softened the blow by cutting petrol prices seven times since August and slashing non-subsidized cooking gas prices by 15pc. The budget deficit has meanwhile fallen, set to possibly fall below 4pc of national income in 2014/15 for the first time in six years.
Back in 1770, as the Western world’s industrial revolution began, India accounted for no less than 15pc of global output. Pretty soon, the sub-continent, with its burgeoning population, tech-savvy business elite and ubiquitous shopping malls will be an economic superpower once more.
With it’s 1.2bn people, and already the world’s tenth-largest economy, India is on course to rank second by 2040 – behind China, with America by then coming in third. On a purchasing power parity basis, in fact, adjusting for the cost of living, India is already the third-largest economy on earth.
Under Modi, the sub-Continent is now becoming increasingly audacious – and far more willing to defy the West. Last week Vladimir Putin travelled to New Delhi, the “isolated” Russian President striking deals to help India tackle its burgeoning energy needs. Russia is to provide 10 nuclear reactors over the next two decades, while the two Cold War allies also signed a chunky 10-year oil and gas agreement, following Moscow’s similar recent deals with China. “Times have changed, but our friendship has not,” Modi tweeted in Russian as Putin flew from New Delhi. “We stick together through thick and thin”.
Over any medium-term investment horizon, the rising eastern economies will grow faster than their western counterparts, their companies displaying fatter margins. QE has done nothing to change that.
Much has been written over the last year to suggest that the flight of Western capital from the East signals that the emerging markets story is over. This is nonsense. Our fiscal weakness and bank fragility – a plight highlighted by on-going money-printing – means that we’re in the more vulnerable position. The bigger and more pertinent risk than Western money quitting the East, in fact, is that Eastern money pulls out of the West.