Dollar weakness will boost EMs, commodities ahead: HSBC

In the past month, we have seen fairly decent economic data coming from the United States whether it was GDP, retail sales, factory orders, manufacturing, home sales. We have also seen a falling dollar fire up commodities and equities, all of which, in their own way, have changes the global growth dynamics. To put all the recent economic data into perspective, CNBC-TV18 talks to HSBC Chief Economist Stephen King.

Here is a verbatim transcript of Stephen King’s exclusive interview on CNBC-TV18. Also watch the accompanying video.

Q: Let me get your view on how the dollar is shaping up? Are you getting the impression that the continued dollar weakness has led to a round of asset inflation across the board will suddenly end and you could see risk aversion returning in all its fury?

King: It certainly a risk. The dollar has been extremely weak over the last couple of years but also the US has got an incentive to go in for more dollar depreciation. The economy in the US is recovering but only very slowly.

There’s a tremendous amount of debt, which the US has taken out, which is debt to foreign investors. So, one easy way to deal with that excessive debt is to depreciate the currency, which effectively leaves foreign investors empty handed. So from that perspective, yes, the risk is that the dollar could fall further over the months ahead and particularly I would suggest fall further against the currencies of emerging nations because what we are seeing around the world is a big shift away from investing in the West where there is still hangover associated with the credit crunch, the subprime crisis, with all the household and government debts and instead investors are looking at the faster growing nations in the emerging world.

So people are borrowing in dollars, they are investing in emerging nations and putting downward pressure on the dollar and upward pressure on other currencies

Q: Before I come to the emerging economies, what kind of a growth are you seeing in the US itself? There are fewer and fewer supporters for the double dip revisiting of a recession. Which camp do you fall in? Will there be low but steady growth or will there be one more dip towards recession?

King: I think the issue is not so much double-dip, Vs, Ws, Ls, whatever letter you want to look at. It seems to me that the issue for the US is that the structural rate of growth has come down and will fall further over the years ahead. You have got to bear in mind that this is an economy that has been building up growth rate based on increases in debt, household and government debt in particular, based on the housing boom, which is not going to be repeated.

Few years back the trend growth in the US was about 3.5%, they revised it down to two-three quarter of a percent but my guess is that over the next couple of years people will be revising down their assumptions by the long-term growth rate of the US. So maybe not more than 2% and that really matters because even if you get the recovery, it will be weak. You will see a lot of talk about stagnation and with stagnation mean much more difficult for the US investors to get decent returns from his US assets.

Q: I read your recent report and you are pretty bullish on emerging market economies. A combination of weak dollar and developing strength in the emerging market recovery story could mean bad news for inflation. What’s your own prognosis on how Inflation globally might pan out? Do you think commodity prices could see a fairly decent surge in the first half of 2010?

King: On commodity prices, yes. The key thing here is first of all dollar is weaken, commodities are priced in dollars. So if dollar weakens, commodity prices tend to go up. The other key thing is that if you are seeing a world, which is shifting away from Western growth towards Eastern growth — if I can call it that then in those circumstances you get tremendous upward pressure on commodity prices because growth in the emerging markets is much more dependent on commodities than is the case in the West because of all infrastructure projects for the fact that per capita income is still low which puts tremendous pressure on commodities for all sorts of buildings of subways and roads and airports so and so forth.

So the consequence is you end up with a situation whereby commodity prices are likely to come on the upward pressure for two reasons, (1) weakness in the dollar and (2) because of the structural strong growth rate coming through in the emerging world.

Q: In that case what would be your comment on the way the Reserve Bank of India (RBI) has handled monetary policy? We have seen the Reserve Bank of Australia already go up and do not just one but two rate hikes. The Indian growth story looks strong. What’s your forecast of the Indian growth story and do you think the EBI is in this case falling behind the curve with a 3.5% policy rate and a 6.5% inflation forecast?

King: I think at this stage the world is still very uncertain and central banks around the world want to make sure that there is a recovery in the bag before you do anything else. As far as Australia is concerned, one of the reasons why they have raised rates is precisely because Australia is directly connected in many ways to China and China of course is doing extremely well at the moment and so in that sense Australia is a play on the strength of the Chinese economy.

As far as India is concerned, we are pretty optimistic for the next couple of years — we have had a difficult year this year — but next year we can see growth up to 8.5%.

If that’s the case then of course there will be pressure on the RBI to put interest rates up in the first half of next year and that I think comes as a surprise to anybody. Are they behind the curve? That really depends on how much of the pick-up inflation we likely to see, will be sustainable and I suspect that we are going to see some effort and trying to make sure that the central bank is ahead of the curve during the course of the next year.