Akash Prakash: Slaves to policy

Last Updated: Thu, Nov 22, 2012 19:40 hrs

Morgan Stanley has just come out with its economic outlook for 2013. The firm has an excellent global economics team, and its forecasts have always been worth paying attention to. Morgan Stanley has in recent years also been quite realistic in its growth forecasts; it understands that an economic downturn that follows a financial crisis has very different characteristics from the standard post-war recession. It has generally been of the view that any recovery will be subdued, slow and uneven.

Morgan Stanley has likened the growth outlook for 2013 to being in a twilight zone, with the global economy stuck in a kind of no-man’s-land between recession and expansion. The company believes global economic growth in 2013 will be only 3.1 per cent, the same as 2012. This rate is exactly midway between the 2.7 per cent global growth threshold for a recession and the long-term trend rate of growth for the global economy of 3.7 per cent. While the growth forecast for 2013 is identical to that for 2012, the headline numbers hide some of the underlying changes.

First of all, in the Morgan Stanley forecast, GDP growth in the developed world slows appreciably in 2013; it drops from 1.2 per cent in 2012 to 0.7 per cent in 2013. The US shows a drop from 2.2 per cent to 1.4 per cent; the euro zone remains in recession with negative growth of 0.5 per cent in both years; and Japan shows a drop from 1.7 per cent GDP growth in 2012 to 0.4 per cent in 2013. These subdued outcomes, weak as they are, mostly depend on significant policy action, without which growth could slip much further. The expected growth outcome of 0.7 per cent in 2013 is dependent on the US not falling off the fiscal cliff, progress in Europe towards fiscal and banking union and the European Central Bank (ECB) embarking on outright monetary transactions (OMTs). In the absence of policy action (god forbid), Morgan Stanley expects developed-world growth to fall to -0.5 per cent in 2013, with the US, Europe and Japan all in recession. If, on the other hand, policy makers deliver on all counts (no fiscal cliff drag in the US; the ECB cutting rates and implementing OMT quickly; structural reform in major emerging markets), then Morgan Stanley has a more bullish scenario, in which global growth accelerates to nearly four per cent in 2013 itself.

Next year is quite unique in that the final outcome on growth depends almost entirely on policy action. Morgan Stanley itself has global growth in 2013 varying from two per cent (bear case) to four per cent (bull case), with the underlying difference in each scenario being the efficacy of policy intervention from the authorities. The firm also makes the point that since most policy measures – such as a resolution to the fiscal cliff and a green signal for commencement of OMT – remain a work in progress, the first half of 2013 may look quite grim, before growth expectations stabilise even as policy action kicks in towards the second half of the year. One should also be prepared for significant market volatility, as market expectations for growth outcomes may fluctuate depending on how the markets handicap policy action and efficacy.

In the Morgan Stanley base case of 3.1 per cent global growth in 2013, emerging-world growth accelerates from 4.9 per cent in 2012 to 5.4 per cent in 2013. Growth in China accelerates from 7.7 per cent to 8.2 per cent, with India’s growth moving from five per cent to 6.1 per cent. Brazil also shows faster growth at 2.8 per cent in 2013. Only Russia faces declining growth.

Thus, while Morgan Stanley expects no acceleration in global growth in 2013, the acceleration and improvement in emerging-market growth rates are disguised by another leg-down in the growth rates of the developed economies. Morgan Stanley also expects monetary policy to remain hyper-easy and interest rates still stuck near zero throughout 2013. Central banks have no scope to raise rates, as any rate hike will raise real interest rates and further weaken the debt sustainability profile of the sovereign. In fact, Joachim Fels, Morgan Stanley’s chief global economist, talks of a “type two” stagflation for the global economy, in which growth is very slow but we see an inflation in asset prices (as opposed to generalised inflation in goods and services).

If the Morgan Stanley scenario were to come to pass, it should be a good year for emerging-market assets. In a growth-starved world, with developed-market growth dipping, significant policy support from the major central banks and growth in emerging markets accelerating, money should continue to move into emerging markets. This trend will only get accentuated as most of the larger emerging markets still have the scope and willingness to cut rates further.

This is also a huge opportunity for India. If we can move ahead on some of the policy measures outlined by the finance minister (cutting the fiscal deficit, the goods and services tax, improving the investment environment and boosting foreign inflows), investors will want to ratchet up their exposure to the country. In a growth-starved world, where many still doubt China’s sustainability, India remains a structural growth story with significant low-hanging fruit. Investors want to believe and invest, if we can deliver rational economic policy making. Many investors have still not given up hope on the country, but want to see the lurch towards populism being arrested. One would think the government has no choice but to meet investor expectations, given the size of the current account deficit and the need for inflows to fund it. If you cannot convince investors (both FDI and FII) that you are open for business, how will we fund a gap of $60 billion?

Growth, earnings expectations and perceptions about India have all bottomed out and are turning. Valuations, while not dirt cheap, are not hugely expensive either. If only we can hold our political nerve and do what is necessary to stabilise the economy. Then the markets can do very well and surprise positively. Domestic investors are significantly under-invested in equities and have adopted a backward-looking asset allocation focused on real estate and gold. The markets are giving us the time to correct this.

If we fail to seize the policy initiative once again and continue shooting ourselves in the foot, we risk triggering a negative spiral on both the currency and financial markets. A spiral that, once it starts, will be very difficult to control or escape.


The writer is fund manager and CEO of Amansa Capital

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