Do it yourself: EM

Showing posts with label EM. Show all posts

Thursday, September 5, 2024

Funding crisis deepening for emerging economies

The latest report of the United Nation Conference on Trade and Development (UNCTAD) highlights that the funding deficit for the developing economies to meet Sustainable Development Goals (SDGs) is rising. As per the report, the gap is now about US$4trn, up from US$2.5trn in 2015 when the SDGs were adopted.

The amount of global foreign direct investment (FDI) has been on decline since peaking at US$2.05trn in 2015. In fact, a percentage of world GDP, FDI peaked at 4% of global GDP in the year 2000 and has been on decline since then. In the year 2023, global FDI fell to US$1.3trn or 1.27% of global GDP.

As per a recent Moody’s report, “Global foreign direct investment flows have shrunk in recent years. The COVID-19 pandemic, supply-chain chaos, surging inflation, and tighter funding conditions have taken a toll on global FDI. Investment flows are also being reshaped by economic fragmentation, trade and geopolitical tensions, industrial policies, and supply-chain diversification. But many of the ups and downs in FDI in recent years are due to tighter regulations to thwart the usage of tax havens. These have curbed the flow of investment through conduit economies, especially in Europe. While retreating inflation and easing monetary policy settings might offer some relief, economic fragmentation will hinder the smooth flow of FDI. Climate change will increasingly shape FDI flows in longer term.”

UNCTAD report emphasizes that “Tight financing conditions in 2023 led to a 26% downturn in international project finance, which is crucial for infrastructure investment in areas such as power and renewable energy. As a result, investment in sectors linked to the Sustainable Development Goals (SDGs) fell by more than 10%. The report highlights that agrifood systems and water and sanitation registered fewer internationally financed projects in 2023 than in 2015, when the goals were adopted.”

FDI in China and India shrinking, despite India’s manufacturing push

The Moody’s report highlights that “The drop in FDI flows to developing economies was largely because of shrinking investment in China and India. The world’s second-largest recipient of FDI, China, saw a downturn in 2023. Inflows turned negative in the third quarter as withdrawals and downsizing outpaced new investments. More recent data showed a fresh decline in the second quarter of 2024. FDI into India has also seen better days, falling in recent years despite the country’s push into manufacturing and notable investments from tech giants such as Apple Inc. On the bright side, FDI into Southeast Asia has held at a high level.”

Most renewable energy funds allocated to the developed economies

Although renewable energy investments have nearly tripled since the adoption of the Paris Agreement in 2015, most of the money has gone to developed countries. While developing countries need about $1.7 trillion each year in renewable energy investments – including for power grids, transmission lines and storage – they only attracted about $544 billion in 2022.

The report shows that more than 30 developing countries still haven’t registered a large international investment project in renewables.

And in most of the 10 developing countries with the highest levels of international investment in renewable energy, investment in renewables represents between one tenth and one third of total FDI.

OECD rules impacted FDI

Changes in taxes and regulatory requirements appear to have materially impacted the FDI flows – amount as well as direction. Moody’s report mentions that OECD members “have strengthened regulations to make it harder for companies to locate profits in zero-tax jurisdictions. Also, a revised corporate tax rule in the U.S. in 2018reduced the incentive for U.S. multinationals to reinvest earnings and hold intangible assets abroad, leading to a significant drop in outward FDI that year. These efforts, later bolstered by laws to establish a global minimum tax, have dampened FDI flows to and from low-tax jurisdictions in Europe.

This appears to be macro trend. Nonetheless, it may have implications for the investment portfolios of several investors, especially those investors who are overweight in capital intensive businesses relying on foreign capital for growth. If the decline in FDI flows sustains the current trend, we may see downward revision in growth projections and hence valuation multiples. It is therefore advisable to watch this trend closely over the next couple of years.

Thursday, April 25, 2024

State of the economy

The recent RBI bulletin (April 2024) contains an interesting article on the current state of the economy. The article is written by officers of RBI and does not represent the official views of RBI.

The authors find most macroeconomic parameters positive and growth-supportive. The two areas of concern are climate and geopolitics. Overall, the global economy, and particularly the Indian economy, is stable and oriented towards resilient growth in 2024.

Some of the noteworthy points in the article could be listed as follows:

Global economy

Growth: Global growth remains resilient despite geopolitical challenges and extreme weather event risks. In its latest world economic outlook (WEO April 2024), the International Monetary Fund (IMF) raised the global growth forecast for 2024 to 3.2%, 10 bps higher than its January 2024 Update, and expected the global economy to grow at the same pace in 2025 in also. Advance Economies (AEs) are now expected to grow by 1.7% in 2024 against the forecast of 1.5% in January. Emerging Market and Developing Economies (EMDEs), the forecast has been revised up by 10 bps to 4.2%.

In March 2024 The global manufacturing PMI accelerated to its highest reading since July 2022 as new orders, output, and employment expanded. The manufacturing component reached a 20-month high; the services export orders index has remained in expansionary territory since January 2024.

Inflation: Headline inflation receded significantly from levels recorded a year ago in most economies, although it remained above targets. The global headline inflation is expected to fall from an annual average of 6.8% in 2023 to 5.9% in 2024 and further to 4.5% in 2025 (both revised up by 0.1 percentage points from previous projections), with AEs returning to their inflation targets sooner than EMDEs.

Consumer sentiment: Consumer sentiments continued to improve across geographies as inflationary pressures receded from year ago highs, supported by broadly stable employment prospects. Financial conditions remained accommodative on the back of strong equity market performance.

Trade: According to the UNCTAD Global Trade Update of March 2024, global trade is expected to gain momentum in 2024 after a decline of 3% in 2023. WTO in its Global Trade Outlook and Statistics – April 2024 projected world merchandise trade volume to grow by 2.6% in 2024 and 3.3% in 2025, following a larger-than-expected decline of -1.2% in 2023.

Monetary policy: Major central banks, especially in AEs, remained cautious, balancing the risks of cutting too soon against maintaining a restrictive stance for too long and hurting economic activity with financial stability risks. Most AE central banks held their policy rates constant in their latest meetings.

Treasury yields and mortgage rates are ticking up in major economies as expectations of interest rate cuts are being pared.

FDI Flows: A recent UNCTAD report estimated a modest rise in global FDI flows in 2023 over 2022, driven by two European countries (Luxembourg and Netherlands); however, excluding these countries, global FDI flows declined by about 18% in 2023. Amidst an uncertain global investment environment, India held its position as a favourable investment destination among peer Asian economies in 2023. India ranked fourth among EMEs in the 2024 FDI Confidence Index, reflecting continued optimism over its growth potential.

Domestic economy

The Indian economy continued to exhibit resilience amidst external headwinds which led to the build-up of supply chain pressures. Consumer confidence strengthened across parameters set out in the RBI’s latest survey of households. Enterprise surveys indicate that business assessment and expectations remain in positive terrain, with optimism on production, capacity utilisation (CU), order books, employment and overall business conditions. According to the economic activity index (EAI), economic activity remained resilient in Q4:2023-24, although available data indicate some moderation in March vis-à-vis the previous month on a seasonally adjusted basis.

Growth: The conditions are shaping up for an extension of the trend upshift that took the average real GDP growth above 8% during 2021-24. In order to achieve its developmental aspirations over the next three decades, the Indian economy must grow at a rate of 8-10 per annum over the next decade to reap the demographic dividend that started accruing from 2018 and, as calculations show, will last till 2055.

The domestic economic activity remains resilient, backed by strong investment demand and upbeat business and consumer sentiments. Headline inflation has come off the December peak; however, food price pressures have been interrupting the ongoing disinflation process even as shocks from adverse climate events and geopolitical tensions add uncertainties to the outlook. The Monetary Policy Committee of RBI, in its last meeting, projected real GDP growth for 2024-25 at a robust rate of 7%.

High-frequency indicators point to sustained momentum in domestic demand conditions in March 2024. As per the data from the Centre for Monitoring of Indian Economy (CMIE), the all-India unemployment rate (UR) fell to 7.6% in March, declining across both urban and rural regions. Agricultural prospects are expected to receive a boost amidst the IMD’s forecast of an above normal monsoon. Construction sector indicators reflected sustained growth in steel consumption and cement production. Available high frequency indicators for the services sector exhibited an optimistic picture in March 2024.

Inflation: Headline inflation moderated to 4.9% in March 2024 from 5.1% in February 2024. Core inflation eased further to 3.3% in March from 3.4% in February, the lowest in the current CPI (2012=100) series. The moderation was broad-based, with inflation softening across various sub-groups barring personal care and effects, and recreation and amusement. In terms of regional distribution, while CPI-rural inflation increased by around 10 bps to 5.4% in March, CPI-urban inflation moderated by 64 bps to 4.1%. Most of the states continued to record inflation in the range of 4-6%.

Food price uncertainties continue to weigh on the inflation outlook with the increasing incidence of climate shocks a key upside risk for food prices. Cost push pressures faced by firms are showing an upward bias and the recent firming up of international crude oil prices poses an upside risk to the path of inflation going forward. CPI inflation for 2024-25 is expected to be 4.5% with risks evenly balanced.

Financial Conditions: Liquidity conditions eased in March, with net liquidity adjustment facility (LAF) [including marginal standing facility (MSF)] injection narrowing to ₹0.29 lakh crore from ₹1.78 lakh crore in February 2024. Increased government spending and the RBI’s market operation smoothed system liquidity. While the buildup of government cash balances on account of GST collections and advance tax payments tightened liquidity intermittently, liquidity conditions turned into surplus towards March-end and early April in response to the increase in government spending. Overall, the Reserve Bank injected ₹4.16 lakh crore cumulatively into the banking system during March 16 - April 19, 2024.

Reflecting these liquidity developments, the weighted average call rate (WACR) – the operating target of monetary policy – has remained within the policy corridor since the February policy meeting, barring the usual year-end spike.

Across the term money market segment, yields on 3-month treasury bills (T-bills), certificates of deposit (CDs) and commercial papers (CPs) for non-banking financial companies (NBFCs) eased towards end March and early April. The average risk premia in the money market (3-month CP minus 91-day T-bill) reduced to 98 bps during March 16 – April 19, 2024 from 141 bps during February 16 - March 15, 2024. While short-term rates moved in tandem with the evolving liquidity developments, long-term rates remained largely stable. Corporate bond yields generally softened and risk premia narrowed during March 16 to April 19, 2024.

External conditions: India’s foreign exchange reserves reached an all-time high of US$ 648.6 billion on April 5, 2024. As on April 12, 2024, India’s foreign exchange reserves stood at US$ 643.2 billion, sufficient to cover for 99% of total external debt outstanding at end-December 2023.

India’s current account deficit (CAD) improved to 1.2% of GDP in Q3:2023-24 from 1.3% in Q2:2023-24 and 2.0% in Q3:2022-23. Robust services exports and strong remittance receipts eased merchandise import pressures on the current account in Q3:2023-24. Net capital inflows exceeded the CAD, supported by robust FPI and banking capital, leading to an accretion of foreign exchange reserves on a balance of payment (BoP) basis (excluding valuation effects) to the tune of 6.0 billion during the quarter.

At end-December 2023, India’s external debt stood at US$ 648.2 billion; the external debt to GDP ratio declined to 18.7% at end-December 2023 (at end-September 2023 it was 18.8%). India’s external sector exhibited resilience, indicated by sustainable levels of key vulnerability indicators at end-December 2023.

Currency: The Indian rupee (INR) depreciated marginally by 0.04% (m-o-m) vis-à-vis the US dollar in March 2024 while remaining one of the least volatile major currencies.

Climate challenge

Global weather agencies are in agreement that March 2024 was the warmest March since record-keeping began in 1850 – global surface temperature was at 1.6 degrees Celsius (3.01°F) above the 1880-1899 period.

The World Meteorological Organisation (WMO) sounded a red alert about global warming in its latest report “State of the Global Climate 2023”, stating that there is a high probability that 2024 will breach the threshold set in 2023 as the hottest year on record even as the world careens towards a freshwater shortage crisis. According to the WMO report, “data from the Indian Meteorological Department (IMD) reflects a worrying escalation in extreme weather events necessitating an urgent and collective response.”

Central bank conundrum

Central banks continue to speak in cautious tones about growth prospects in 2024 as they deal with the interest rate conundrum. Regime shifts are underway in the form of exits from negative interest rates and their unintended consequences. Expectations of interest rate cuts are being pared where they have not yet commenced in recognition of the risk of moving too fast and turning disruptive if inflation moves up again with the lift provided by buoyant economic activity. Switzerland became the first AE to cut interest rates, reflecting a wariness of currency appreciation and an eagerness to join the growth party, given that inflation is well within the tolerance band.

Wednesday, December 16, 2020

Pain of an investor

Before I say anything, I would like to make it clear that I use the terms “investor”, “trader” and “punter” in the context of equity investments, very judiciously.

To me an investor is a person who thoughtfully invests his money in a business to participate in the future growth of that business. A trader is person who is trying to optimize his return on capital by choosing from the best instruments available at any given point in time. It may be bond, fixed deposit, equity stock, gold, crypto currency, foreign exchange, other commodities etc. or a mix of these. Traders do not invest with the objective of “wealth creation”. Their focus is usually earning more than the risk free return while maintaining liquidity of his money. Punters buy financial assets or commodities just like lottery tickets. They get kicked by the prospects of hitting a jackpot someday and do not mind losing their entire capital in the process.

Here we are talking about investors only.

In summer of 2007, the global equity markets were doing great. Most global indices were close to their all-time levels. The global fund managers were exploring the world like Cristopher Columbus. Emerging Markets, BRICS, MENA, Frontier Markets etc were the hot themes. Everyone was deep in the money. Indian markets were no different. Then appeared first signs of sub-prime crisis and a sharp correction occurred in July 2007. However, the losses in correction were entirely recouped in no time and markets surged to their new highs by January 2008. The 14months after that were nothing less than a nightmare. The global equity indices saw cuts ranging from 35% to 75%.

The investors who had conviction in the strengths of the businesses they were invested in stayed the course and emerged winners. The punters lost their entire capital and much more. The traders also lost money.

In July 2007, at peak of the market, one investor invested in the stock of Mahindra and Mahindra Limited; the other investor invested in the stock of Reliance Industries; and a retired person invested in the Gilt Fund that invests in long duration government securities.

If they stayed invested in these instruments till today, the two investors in M&M and RIL stocks would be making about 9.25% CAGR (excluding dividends) on their investment; while the retired person would be making 9.5%.

A plain reading of previous two paragraphs may prompt the readers to jump to many conclusions. When I sent these two paragraphs to some of the readers for their comments, I got many responses. I find the following five responses as representative of the entire sample:

· “Are you suggesting over a longer time frame, investment in gilt and stocks yield similar returns, but risk adjusted return are far superior in gilt.”

· “If equities of front line companies have matched the return of Gilt, even after weathering two unprecedented crises (GFC, 2008-09 and Covid, 2020), then next decade perhaps equities will give phenomenal returns.”

· “RIL gives you excitement’ but M&M is a steady performer.”

· “If you are a long term investor, do not try to time the market. Over a longer period, returns would automatically get normalized.”

· “Investment in reliance is like making a fixed deposit in SBI. You can never lose money.”

However, the responses could be very different, if I show the following chart to the respondents. This chart shows the relative performance of the stocks of M&M and RIL from July 2007 till date. The stock of M&M gave the entire return during first seven years (2007-2014) period. The current price of stock is almost same as it was in August 2014. The stock of RIL did not give any return for 9years (2007-2016). The price of the stock in December 2016 was almost the same as it was in July 2007.

A trader would immediately think, “December 2016 was the best time to sell M&M and buy RIL. This way one could have made the 2x the return of an investor.”

But an investor who is convinced about the business prospects of either M&M or RIL or both, the long intervening periods of no return are quite painful. The one who learns to manage this pain ultimately comes winner. The ones who succumb to this pain of non-performance, would sell RIL in 2016 and buy M&M, and end up as total losers.

If you want to fully assimilate the point I am trying to make here, then please talk to someone who had sold ITC and bought RIL in September this year, after getting no return in ITC for 5yrs.