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“The essence of this-time-is-different syndrome is simple.
It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now.
We are doing things better, we are smarter, we have learnt from our past mistakes.
The rules of valuation no longer apply.
Unfortunately, a highly leveraged economy can unwittingly be sitting with its back at the edge of a financial cliff for many years before chance and circumstance provoke a crisis of confidence that pushes it off.
”— Carmen Reinhart Kenneth Rogoff (This Time Is Different: Eight Centuries of Financial Folly)When Morgan Stanley wrote a note titled “Five Cs” to clients last December on how to prepare for 2018, it mentioned things from China to capex.
What it missed was a T — Turkey.
The Wall Street investment bank was not alone.
Almost every top strategist listed events to watch out for that included geopolitical risks from North Korea to US interest rate increases.
But come August, the talk is all about Turkish lira and the contagion.
Suddenly emerging markets — the oasis to make money in an era of slow growth in the developed world — have suddenly become untouchable.
The Turkish lira is down 31 per cent, Indian rupee has declined 4.6 per cent to its lowest level, Indonesian rupiah has collapsed 6.9 per cent and Argentine peso is down 25 per cent.
The MSCI Emerging Market stock index is into a bear territory falling 20 per cent from its recent peak.
Emerging markets have seen a fund outflow of $39 billion this year, compared with an inflow of $23 billion in 2017.
The US dollar index has climbed 4.33 per cent.
One phrase that is yet to rear its head is whether it’s a Black Swan event — a phrase coined by Nassim Nicholas Taleb, the Lebanese-American scholar, to express the rarest of rate events.
But the talks about past crises, from 1997 to 2013, are back.
Geopolitical tensions may be the reason for Turkey’s sudden slide this year, but it was just a trigger.
It has been feeding on high dollar debt and was running an average current account deficit of 5.2 per cent of the GDP for 12 years.
“Memories of 1997 spring comes to mind, when Thailand’s unexpected forex devaluation led to broad fund withdrawals from the region, leading the SP 500 to rally 8 per cent in July,” says Hans Redeker, a strategist at Morgan Stanley.
“As then, EM is under pressure while US markets remain strong.”
Thailand devalued its baht due to macro-economic imbalances that developed after years of fast growth.
That spread to other East Asian economies, then known as Asian Tigers, and subsequently resulted in capital controls and International Monetary Fund-designed bailouts.
This time the tune is different.
From experience, these countries have built up foreign exchange reserves, the banking system is efficient, and their economies are in a better shape.
“Unlike in 2013, the sense of panic is not across the board, with the reaction in bond yields and equities still rather contained,” says Radhika Rao, economist at DBS Bank, Singapore.
“This gives them a sense that there is no reason to push the panic button as yet.”
Defend the rupeeNo doubt that the Indian economy is in a much better shape than it was in 2013, when fiscal deficit and current account deficit were at multi-year highs.
But is that good enough for the rupee’s stability Or should the currency remain stable for all times
Political points are being scored now that the rupee has breached the Rs 70 level to the US dollar under PM Narendra Modi’s watch.
The absolute number reflects the weakness, but in a trade-dominated world, it needs to be looked at in relative terms.
“I think the RBI should let the currency depreciate mainly because there are larger global forces at work, and there is no point in fighting those dynamics,” says Su Sian Lim of BNP Paribas.
“The valuation argument is secondary.
In any case our model — which does not use REER — suggests that USD/ INR should be around 72, or about 3 per cent weaker from current levels.”
The Indian rupee has been overvalued in the last few years due to large inflows of the US dollar, which also led to the Reserve Bank of India piling up $400 billion in foreign exchange reserves.
When currencies of countries such as China, Indonesia, Thailand and Vietnam are depreciating — making their goods cheaper for those who are paying for them in the US dollar — a strong Indian rupee only makes Indian products expensive.
So, any depreciation in line with other trading peers is a welcome relief.
So long as the currency slide is due to global factors, it may be beneficial.
But is it only the global factors
Vulnerabilities returnFinancial markets tend to ignore the fault lines for years before they wake up to the fundamentals of an economy and begin to punish them.
Just like an individual or a corporate balance sheet, the nation’s deficits determine its fate.
Since the high current account deficit — the excess of imports over exports — of 4.8 per centof gross domestic product in 2012 that led to the rupee rout, the numbers improved due to curbs on gold imports and focus on containing inflation and narrowing fiscal deficit.
But that’s changing.
Trade deficit for July at $18.02 billion was the highest in over five years.
CAD is projected to rise to 2.5 per cent of the GDP this year.
And fiscal deficit is beginning to climb with the government shifting the goal posts for two years in a row.
Some of the weakening of the rupee and pulling out of international investors may also be due to that.
“I think the market is reassessing EM risk after Turkey and Argentina,” says Jahangir Aziz, chief economist, emerging markets, JPMorgan.
“This is not a good sign for any CAD economy even though many have already adjusted their currency significantly and some have raised interest rates, albeit modestly.
The reassessment poses a risk for all CAD economies.”
History is repeating itself and this time may be no different in the outcomes, though what is driving the direction of trade and the broader economy is different.
Gold and crude oil have been India’s nemesis.
This time around, it is the electronics import.
Electronics comprised 11.69 per cent of imports in July, up from 6.7 per cent in 2013.
Crude is down to 28.2 per cent and gold is down to 6.7 per cent.
Policy optionsUS dollar reserves in EMs may be close to record highs, but all these have not been built on solid ground like in China, which is among the few nations that run a current account surplus.
Quantitative easing (QE) by the US Federal Reserve, European Central Bank and the Bank of Japan in the last decade since the blow up of Lehman Brothers flooded the markets like India.
This led to higher consumption and record lending by banks in domestic markets.
The party may be coming to an end now with the US raising rates.
The binge during those times, when overseas borrowing was cheap, led to many EMs building up debt.
When rates rise, these come back to bite.
“The reasons are high dollar borrowing and a habit of running large current account deficits,” says Chris Wood, strategist at CLSA.
“Fed chairman Jerome Powell has made it clear that he believes emerging markets are better positioned to handle monetary tightening than in the past.”
Indonesia and Turkey have raised interest rates sharply so far to defend their currencies.
But India has been relatively calm with just a 50-basis points increase in 2018.
A basis point is 0.01 percentage point.
With short-term debt of $222 billion coming for repayment in the next eight months and inflows slowing, India is exposed to a selloff.
The Monetary Policy Committee, in a conventional way, may have to hasten interest rate increases if the contagion worsens and the rupee nosedives.
“It is always imprudent to rely only on a handful of instruments because then those pressure valves have to adjust a lot,’’ says JPMorgan’s Aziz.
“The prudent strategy is to spread the adjustment around and this requires more rate hikes.”
Another alternative is to come up with a special deposit scheme like in 1998 and 2013.
“Raising rates tends to hurt the rupee.
Unlike most emerging markets, portfolio investment in India is dominated by equities that is six times of debt,” says Indranil Sengupta, economist at Bank of America Merrill Lynch.
“We think that the government should be able to raise $30-35 billion by launching NRI bonds.
Every NRI bond issuance — 1998, 2000, 2013 — has succeeded in containing INR volatility.”
But India may not be there yet and it could send wrong signals with little panic as yet.
“At still over $400 billion in reserves, if India is to go hunting for more reserves then the signal to the market will be that things are much worse than the authorities are letting them know,” says Aziz.
As financial markets grapple with a plethora of troubles from Turkey to China slowdown, to the US interest rate increases and the looming debt repayments, just one thing is clear — there are few in financial markets with a crystal ball.
Morgan Stanley’s Jonathan Garner sums it up the best: We are in Alice in Wonderland’s down the rabbit hole.
Thefreedictionary.com defines it as “to enter into a situation or begin a process or journey that is particularly strange, problematic, difficult, complex, or chaotic, especially one that becomes increasingly so as it develops or unfolds.”
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