How Chindia will impact the world economy !!

Among the large emerging economies such as Brazil, Russia, Nigeria and Indonesia, it is the rise of China and India (Ch-india) which will have (and already has) enormous business implications during the first half of this Century mostly beneficial to the world.

First, both nations will require enormous natural resources because not only are they manufacturing and service centers of the world, but because of their own rapidly expanding domestic consumer markets. And this demand for natural and industrial resources such as oil, gas, coal, copper, bauxite, aluminum, iron and steel will be for many years.

While China today is roughly nine times as big as India, it is expected that China will very soon become an aged and affluent nation, similar to what happened to Japan, Singapore, Taiwan and others and will begin to plateau its economic growth. Also, it will outsource manufacturing to other nations, especially in Africa and other resource rich nations.

The rapid aging of Chinese population attributed to its one child policy implemented over two generations will impact its domestic economic growth. On the other hand, while India is at present one tenth in size of China, it will experience accelerated growth in less than ten years with better infrastructure, political reforms and financial transparency.

Also, India will refocus on manufacturing both for global supply as well as for its domestic demand. Unlike China, however, India's manufacturing will be selective and largely concentrated on high-end aerospace, military, space and consumer durables including automobiles and appliances. It will begin to catch up with China and some experts even believe that its growth rate will surpass that of China. In any case, both nations with more than a billion people each, will have enormous need for industrial, agricultural and other natural resources and raw materials.

Since a vast majority of these untapped resources are in other dormant or emerging economies in Africa, Caribbean, Latin America, Central Asia and Russia, the rise of Chindia will create economic boom for them which otherwise did not happen for nearly 200 years of colonial rule.

Second, the global integration of China and India will be radically different. India's economy and enterprises will be globally integrated especially with other advanced countries (Europe, US, Canada, UK, Australia, Singapore, Japan, South Korea) through large scale acquisitions of well established and well respected foreign companies with technology, branding and manufacturing assets.

The journey has already begun with Mittal Steel's acquisition of Arcelor, Tata Steel's acquisition of Corus Steel, and Hindalo's acquisition of Novelis (largest North American sheet aluminum company). And it will not be limited to industrial raw materials and to private enterprises of India. For example, several large public sector units (PSUs) of India such as ONGC (Oil and Natural Gas Corporation), Indian oil and SBI (State Bank of India), who have the domestic scale and capital reserve, are starting to fl ex their acquisition muscles. Similarly,

Wipro, an information technology (IT), engineering services, as well as consumer products company, has recently made several worldwide acquisitions (including Infocrossing, a data center company in the US, and Unza, a personal care consumer products company in Singapore).

Finally, Ranbaxy and Dr. Reddy's have become significant players in the global pharma industry largely through acquisitions. So have Mafatlal and Raymonds in fashion and garments. In other words, India will contribute to global growth as much, if not more, through revitalizing and investing in Western assets as it would through growth of its domestic consumer markets.

On the other hand, China's growth will be proportionately more domestic and only on a selective basis through global acquisitions. This is due to several reasons. First, China has begun to focus on domestic demand especially in consumer markets such as consumer electronics, appliances, automobiles and financial services. It has the physical infrastructure as well as large scale domestic state-owned enterprises such as Haier, Lenovo, China Mobil, Petro China and China Development Bank to capitalize on domestic demand.

Second, the advanced world seems less willing to sell their assets to China (especially technology assets) due to what I believe are myopic misperceptions about the peaceful rise of China (in contrast to rise of India).

For example, Chinese oil company, CNOOC's attempt to buy Unocal as well as Haier's (the largest Chinese appliance company) attempt to buy Maytag Company in the US, met with political resistance. The obvious exception is IBM's sale of its personal computer (PC) business to Lenovo. But it is more an exception.

Consequently, Chinese enterprises that have the scale and incumbency advantage to dominate the domestic Chinese markets will end up expanding globally by first going to other emerging economies such as countries in Africa, Caribbean, Latin American and the ASEAN as well as in Central Asia and India, both through trade as well as foreign direct investment (FDI). In addition, despite history and current uneasiness of rise of China, it is inevitable that both Japan and South Korea will quickly integrate their economies with China, just as what Taiwan has already done.

This will result in rapid growth in bilateral trade as well as reciprocal foreign direct investment between China and Japan and China and South Korea. Consequently, the largest trading bloc will be Asia especially with free trade with India. This will require formation of a new currency comparable to the Euro; and it will become the dominant currency of the world similar to the rise of the dollar as a global currency after World War I.

While the global integration paths taken by China and India will be different, their impact on businesses worldwide either as suppliers, customers, partners or competitors will be benefi cial and enormous. In fact, it is no exaggeration to state that the future survival of most admired enterprises from all advanced economies including the United States, Canada, Europe, Australia, Japan, and South Korea will depend on how quickly they participate in ensuing rise of China and India even if they have to distance from their own government's politics and public opinion.

This includes companies such as General Electric, HSBC, Mercedes Benz, Siemens, Alcatel and many others.

Is a US slowdown good for Indian markets?

January has turned out to be the cruellest month for the Indian stock markets. A news report I came across claimed that it was the markets' worst start to a year in the last 28 years.

From its peak of 21,207 on January 10, the Sensex has lost about 16 per cent as I write. Foreign institutional investors have pulled out about $3.2 billion over the month.

This sudden bearishness is underpinned by a number of changes in the market dynamic. The most critical, in my opinion, is the de-linking of the local market from US interest rates.

Until recently, declines in US rates invariably saw an uptick in Asian markets (including India) as fund-managers borrowed at cheaper rates and bought high-yielding Asian stocks.

However, this time the unprecedented a one-and-a-quarter percentage point cut in the US central bank's policy rate has failed to bring succour.

This reflects two things. First, there has been a rapid escalation in risk aversion, which has reduced the appetite for all risky asset classes, including emerging market stocks.

The best index of the reduction in risk-preference has been the yen-dollar rate, which has moved down from levels of over 120 in mid-2007 to current levels of about 106. I suggest that local stock market investors watch this rate very closely to get a sense of what the FIIs are likely to do.

Let me just elaborate on this a bit. The Japanese money market, with its exceptionally low interest rates, has been the principal funding currency ("carry currency") for higher-yielding assets across the world. With rising risk, investors sold risky assets and bought back the yen to pay off their yen loans. This led to a rapid appreciation of the Japanese currency. Only a significant depreciation of the yen would signal a change in risk appetite and the possible return of FIIs to our shores.

Second, investors are slowly pricing in dimmer growth and profit prospects for India as the US heads towards recession. Elevated valuations (at its peak the Sensex was trading at a price earning multiple of 22, using projected earnings for a year ahead) have not helped India's case.

The result has been fairly sharp and sustained sell-off by foreign funds. Domestic investors have been more optimistic about India's prospects. If they hadn't been around to support the market, the plunge would have been sharper.

I suspect that the negative sentiment towards Indian and other emerging equity markets will continue for a while. While the jury is still out on whether the US is already in a recession or not, the US Fed's somewhat panicky policy gestures seem to suggest that it is preparing for the worst.

That might, ironically, bring global funds back to America. Past recessions have shown that investors don't flee American shores in times of crisis. Instead, they start buying the safest of the safe assets, US treasury bonds, with a passion. The fact that the dollar has tended to appreciate against major currencies over most recessions reflects this flight to safety.

Indian stocks are likely to remain in the dumps for a while but I don't think it is the beginning of a prolonged bear market. While I have argued against the notion of decoupling -- the theory that business could go on as usual in Asia even if the US economy were to slide -- it is unlikely that economies like India or China will see a severe slowdown.

Thus company earnings growth could disappoint if the effects of the US slowdown spill over but it is unlikely that they will plummet. Stock prices may fall more but this will make stock valuations look increasingly attractive relative to growth prospects.

The US Fed's response to the apprehension of recession is to cut interest rates relentlessly. Other central banks might not match the Fed, cut for cut, but it's likely that they will pare rates to a degree.

Thus by the middle of the year or perhaps another quarter ahead, investors would be looking at significantly lower cost of borrowing leverage in most markets.

When investors get the first signal that the US economy is bottoming out (a couple of months of falling unemployment rates, for instance), their risk appetite will rise sharply.

Rising risk appetite and low borrowing costs can turn out to be a heady mix for markets like India where valuations have corrected and growth has, as I anticipate, sustained at fairly healthy levels.

In short, the Indian market might thus be one of the first to gain in the advent of resurgence in preference for risky assets.

When could this happen? The US Fed has taken a bit of flak for pandering to the whims of the financial markets. However, its strategy of cutting rates relentlessly is likely to buoy not just the financial markets but the real economy as well somewhat soon.

There are various channels through which lower rates could work. Adjustable rate mortgages, the bane of cash-strapped US households, could reset at significantly lower rates and set off benign income effects.

As risk-free treasury bond yields plummet, banks might just start to jettison their government bond holdings and start lending to the real sector instead. I will thus not be surprised if the US economy finds a bottom by the third quarter of 2008.

I am not suggesting that America's problems will disappear overnight in the third quarter. Problems could linger both in the financial markets and the real sector but one could just see the mix of data and news emerging from the US turning favourable. This could be the turning point for Indian equity markets.