May 07, 2012 02:00 PM IST | Source: CNBC-TV18

EMs less risky for investment than Europe, US: Jerome Booth

Most investors are going negative on India more so after rating agency S&P expressed concerns about fiscal deficit and growing economic problems. However, Jerome Booth of Ashmore Investment holds a very different opinion and thinks India shouldn‘t be paying too much attention to rating agencies.

Most investors are going negative on India more so after rating agency S&P expressed concerns about fiscal deficit and growing economic problems. However, Jerome Booth of Ashmore Investment holds a very different opinion and thinks India shouldn't be paying too much attention to rating agencies.

"India shouldn't be paying too much attention to rating agencies but should probably follow China's lead and have it's own rating agencies," he said in an interview to CNBC-TV18.

According to him, investment in emerging markets is clearly less risky than the countries in crisis in Europe and United States.

In the special show London Eye, Udayan Mukherjee speaks to one of the largest European investors, Booth, about how the best way of approaching the world and particularly if it is good idea to invest in emerging markets like India.

Ashmore is one of the largest money managers of the world with USD 66 billion in EMs, out of which USD 10 million is invested in equities.

Here is an edited transcript of his interview. Also watching the accompanying video.

Q: Let me start by asking you about Europe. Do you think we have seen the worst of the prices or do you think another storm is blowing this year?

A: The introduction of the LTROs, the issuance of paper by central bank is enormously helpful in reducing the extreme risks. But we still have the pressure on fiscal budgets. We still have the need to have supply side measures to boost the growth.

It’s actually crucial but we have structural reforms to reduce rigidity in the labour market to get rid of inefficiencies. That actually, I think, is the key to European growth. Clearly, there is also a lot of vulnerability. We still got more deleveraging ahead. The amount of deleveraging in Europe is at least known and we are sort of getting there.

Of course in United States we have a huge fiscal adjustment yet to come and there is a lot more denial about the scale of the problem there. So I don't think we can just talk about Europe. There are obviously problems in the United States of very similar nature, in fact more leverage in the starting position.

Q: What worries you more about Europe? The way the kind of rumblings about Spain? Do you think France and Germany could be headed to some kind of a face off from this austerity package?

A: The structural problems are everywhere in continent of Europe but Germany is not in itself important at all and very different to French economy where there are big structural problems. There has been very little change in France and yes, there could politically of course be a rupture and that is the core relationship in the European Union.

My main scenario is still very much that we move towards a fiscal consolidation with supply side measures to boost growth. This will result in further deleveraging, big bailout package but actually catharsis and low growth for a little while but not for as long as in the United States.

The second scenario is that we have further issuance of money by the central bank which is unfunded and is not replaced by private sector buyers coming and buying the bonds of them in near future, because confidence isn’t restored and that scenario clearly is inflationary.

The third scenario of an actual breakup of the eurozone is still the least likely but it has been talked about a bit more. I still know that it’s politically the least desirable by far and there are still plenty of tools that the European policymakers have to prevent it frankly. So, it is unlikely.

Q: How are investors positioned right now? Do they see another wave of risk off coming during the year because in January and February we saw quite a bit of risk on and surprised a lot of people. How do you see your investors positioned now?

A: I am a macro economist not just an investor. As a macro economist I have to say, the risks are very real and haven't really gone away. What's changing is just the perception of risk and the perception of risk is fickle.

Fundamentals are actually bit more stable not as bad as they were before. But people believe what they want to believe and people will grasp any straws of hope. So I think that's some of it.


Clearly the election in France has created a lot of attention, but on balance it is probably fine. We will see what Hollande comes out with in terms of growth pact. I still think that the big shock to the system is likely to come from more events in Greece.

I think Spain really has the political will to stay the course and it is politics. We have to remember the Spanish history - it wasn't very long ago that General Franco was there and I think the ability to stomach tough measures is very much there. So, I am less worried about Spain than some other countries and I think the real pressure point is still the banks and Greece specifically.

I actually think we are past the worst. The question for me is, not can we avoid massive spread of contagion anymore? That's a major question, but it is not as major. The issue really is what is the likelihood that the policy solution will basically involved inflating the problem away. That's my worry, together with further financial repression.

Financial repression is any measure which catches institutional savings for funding the government and for doing so cheaper than it would otherwise be possible. So a lot of the regulatory measures in Europe like Basel III Solvency II are forcing institutional investors to buy what I call highly risky paper that is sovereign debt in European countries.

The fact that they are being herded into this on math actually creates more systemic risk, artificially reduces the yields on these bonds. It creates a more unorganised market as other not so compelled investors decide they don’t want to buy these things.

So it actually creates more homogenous investor base and that in turn is a signal for blow-up in systemic risks - potentially. So, I am worried about financial repression. I am worried about the inflationary course, because if we don't have a return of real private sector confidence in buying the sovereign bonds, we are going to drift more and more towards the inflationary route.

Q: What does this mean for emerging markets when you talk to your large investors? How do they feel about emerging markets in the kind of context that you just described, are they still risk averse or they want to put money over there?

A: What we are starting to see is that people in the emerging world, in Asia being a little bit more confident. We are probably likely to lose a lot on the currency because the euro, dollar and sterling are all going down. We are discussing at what rate it is going down and to what extent we will lose money because of just the evaluation or its inflation as well or maybe out and out change in contracts.

A lot of our investors are from emerging world and they have I think a misconception about the world just as people in the West do but they have got less excuse for it. I think there is still a sort of double thing going; like I have go to be conservative on investing in US Treasuries etc. You need to shake people up a bit for them to realise that is not very intelligent that is actually the way to loose money.

In 1971 the last time the global monetary system collapsed and President Nixon took the dollar off gold. You have to remember that the price of the dollar fell from USD 35 an ounce all the way down to USD 195 an ounce. By the end of 1994, that was an overshoot, came back a bit but that is a huge loss and the idea of investing in Europe and United States being safe is just bunk, its absolute nonsense.

Q: Why are markets in the emerging world doing so badly? If you look at the Chinese equity market, they still have 7-8% growth but you wouldn’t guess that looking at how the stock market has done there?

A: Wait a moment, patience is a virtue and I think we have to distinguish between very short-term movements. I think we have to understand that a lot of volatility in foreign exchange in Asia is not actually Asian currencies; maybe it is the dollar that is volatile. If we look at the pattern of emerging currencies against the dollar that pattern is almost identical to the pattern of G-10 currencies against the dollar that is the dollar that is volatile.

We have this money illusion problem; we reference everything towards the dollar and so we don’t see when it is the dollar that is moving rather than us. Also of course it is the potential to intervene that matters for emerging markets, Central Banks. It is the potential of how you at in a really bad crisis because volatility is not risk.

Volatility is indicator of course, but the thing that really care about is large permanent loss and that is big structural move, big catastrophes. In those kind of scenarios, EMs are clearly less risky than the countries in crisis in Europe and United States.

Another way to express that is if you have USD 350 billion in reserves that means that you can actually change your exchange rate at will, anytime. So the question is not why has the currency come off, is this risky or am I losing money? - It is why it hasn’t it happened yet? What is the motivation for possible moves in the future? And how do I understand when a Central Bank actually starts intervening and using its reserves as a buffer that it should be against more sudden moves in exchange rate.

India is a very good example, India is a country with as huge reserves, which should be importing capital because it needs to spend not one trillion or half a trillion although as half a trillion is in the five year plan for infrastructure in next five years, it needs to be more like 5 trillion on infrastructure.

That requires actually welcoming foreign capital in, stop trying to control it and realising that current account deficit is fine, India should have current account deficit. There is so much talk in India about current account deficit seems some horrible thing that for me is a hang up. It is coming from the past where that meant vulnerability it doesn’t mean vulnerability.

Q: You are saying something quite controversial, particularly after what’s happened last week with an S&P outlook change everybody in India seems obsessed with the current account deficit, you are saying it doesn't really matter?

A: I am saying that the supply side matters much more and by the way India shouldn’t be paying too much attention to rating agencies. But India should probably follow China’s lead and have it's own rating agencies, particularly if institutional investors are investing abroad, the last thing you want to do is be guide it to invest in Belgium or French government bonds, which are highly risky, you should stick to emerging markets.


But policymakers are wrong with this sort of mentality, this short-term myopic view of the Balance of Payments. That is appropriate for countries with huge debt and no reserves and that's obviously the way that a lot of rating agencies just view emerging countries. They just have that methodology. What I am saying is very different to that.

I am saying if you have big reserves you can think longer term, you can think of your investment potential. India's goal should be to have a sustainable non-inflationary growth of at least 8% and to achieve that it’s got to spend some trillion actually dollars on infrastructure.

It has to think much more aggressively, much more ambitiously about how to use foreign savings in an intelligent way.

If we let too much money in, it might flow out again is dealt with through active use of reserves to stem the extremes in that movement.

Historically there was this sort of laissez-faire belief that we just let the market adjust when we have exchange rate movements which are too extreme and of course that kind of came a cropper, not particularly for India, but a lot of the rest of Asia just over a decade ago. The result of that was, we are self insured by building these huge reserves. Now that you have got the reserves you can go back to more free open, free market on exchange rates, but you got the buffers, you got the ability to stop the extremes.

Q: Are you a bit disappointed then that the Reserve Bank has not actively intervened and kept a stronger currency in place?

A: Yes, particularly as half of the inflation in India is caused by oil import prices, it’s completely obvious to use the reserves to help boost, push the exchange rates up because I think that will help inflation. This is the only thing critical over that RBI by the way.

They have done a fantastic job on the whole and I see that the main economic problems from a policy point of view in India, not resting with the central bank, but really with the fiscal side.

Q: Do you have a view on commodities and how they might pan out in 2012 because in India we keep worrying about inflation getting re-stroked once again, crude of course is a big worry for us. How do you think that will pan out this year?

A: I think unfortunately it's likely to go up a bit and it's mainly driven by ones view of global growth both in emerging markets and in the developed world or the western countries which are heavily indebted poor countries.

The commodity demand coming from United States hopefully would be reasonably stable simply because we are not going to see a depression or massive negative growth. So, that will be stable, but low. Whereas emerging growth is going to be still very robust and that should actually push prices up a little if anything, in some markets like the oil market.

The main risk of course is a sustained supply side disruption and that could of course be quite a worse scenario. Other commodities metals may also see some further movement up though we have seen quite a lot of movement. Agricultural products have more elastic supply. So, I do think there is a possibility of volatility there, but I am less worried in the longer term.

Q: So what are you telling your investors to do now in terms of positioning for the rest of the year?

A: We are asset managers rather than advisors on individual stocks. So, what we basically tell them is to trust us and we will invest it for you. An active management of course is allowing investors to relax a bit more. The first role of an active manager is to reduce risk by being awake and paying attention and having the resources. I think I do like equities so I am very bullish on equities.


The other thing I am very bullish on, at the moment, is corporate debt which has tremendously high yields and very attractive both in local currency and in hard currencies. I think for insurance purposes I very much like the currency story as well. Currencies in Asia have got to go up by another 8% at least just to get back to where they were last year. The idea that the dollar is on some strengthening trend is utter non-sense in my view.

Q: Do you have a view on gold?

A: Gold is a highly speculative, non-yielding commodity with no fundamental economic reasons holding its price up. It's dangerous. It's also got a very highly homogenous investor base, a lot of retail investors obviously including in India but also central banks and we know central banks are liable to panic. In fact just over dozen years ago they did panic and they all sold gold and then gold price collapsed until central banks agreed not to sell anymore.

I can see scenarios where central banks get into a pickle in the developed world and they decided they want to sell some gold. I can see all sorts of problems for the market, but it is not for me. It's a gamble and that doesn't mean its not a good gamble, but it is as an asset class or something to invest in, I have always seen it as a gamble, its not for seriously conservative, prudent investors. It's for someone who wants to punt.

Q: Do you see a situation anytime soon where some of the liquidity which is being generated in the world starts fanning some bubbles in asset prices across the world or  are we too far away from that kind of scenario?

A: We definitely are. There are three things to watch out for in terms of bubbles. One, do you have a homogenous investor base because that's a sure sign of danger. So, I am worried about the treasury market for example because they have got a very homogenous investor base - emerging markets and central banks.

Secondly, a misperception of risk that might change in the near future so the term risk free rates comes to mind because that’s a complete fiction. But generally emerging markets risks are better priced and better understood than the developed world. So again its in the developed world where most of the bubbles are likely to occur and thirdly leverage. So, the treasuries don't suffer from that, that’s good, but a lot of other assets classes do have still lot leverage in the developed world.

Most of the bubbles are in the developed world. In the emerging world you have basically elastic supply in all of these markets particularly corporate debt, local currency debt but also equities of course as companies can come to market and creating more paper if there is demand. And it is very much the case that the size of emerging asset classes are driven by demand and everything with it is very short term.

Demand has been suppressed artificially for years by prejudice which is now gradually shedding and that is leading to a very gradual structural one way movement towards more allocation. Little bit of momentum on the equity side but basically the other asset classes, what I am describing is the very opposite of bubble dynamics. So, yes I am worried about bubbles, but basically I am worried about bubbles in the developed world not in emerging markets.

Q: In the first couple of months of the year when we started off with a big rally fueled by liquidity, everybody was asking the question whether we could be at the cusp of another bull market in global equities. Do you see the prospect of a bull market in equities over the next 12-18 months?

A: I think there is a lot of value in emerging markets. But I think the developed markets are going to hold things back. On one hand yes, I can but it is because we have got excessive amounts of liquidity coming out of quantitative easing.

The emerging markets really need to wean themselves off this sort of, constantly looking over their shoulder to the west because the value is greater in emerging markets. Unfortunately they are going to remain probably subject to the volatility that we see in developed world. Having said that, my main scenario is the S&P should go up.

Why? Because Fed would to ensure that they go up. We want them go up because he needs extra liquidity in the banks and we have still got big restructuring coming up. I think the real problem comes at the turn of the year when we have the need for a huge adjustment fiscally in the United States. So that could be a problem for the dollar.

It could be also taking the wind out of the sail in equity market at that point. But I think up until that, certain up until the US elections, yes we could see pretty strong rally.

Follow us on
Available On