Global recession to last 2 years: Morgan Stanley

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Chetan Ahya, Managing Director of Morgan Stanley, feels economies will take more time to come out of the global recession. The recession, he said, will take long to get over, and can last for as much as two years. As real economy comes under pressure, we will see rise in non-performing loans, he said, adding that credit markets will recover only once the recession is closer to an end. Ahya added the current account deficit and strong credit growth compounds problems.

 

Ahya also said the issue of exchange rates remains a key challenge to emerging markets, adding that he sees rupee depreciating to lows of Rs 54-55 per dollar in five or six months.

  

Here is a verbatim transcript of the exclusive interview with Chetan Ahya on CNBC-TV18. Also watch the accompanying video.

 

Q: The first signs of recession are coming out from the West--it is there in United Kingdom, Singapore, etc. How much more painful do you expect the global economic data to be over the next few quarters?

 

A: We are now stuck in a vicious loop where the credit markets are weighing on the real economy. As the real economy goes through stress, one will probably see further rise in the NPLs (non-performing loans) making the lending standards even tighter for the banking system. So unfortunately, we are in a cycle which as IMF (International Monetary Fund) has highlighted, in one of its papers, that whenever there is recession in the global economy driven by either the credit problems or the property market, it tends to be longer. Thus, we have to keep in mind that this global recession is going to take longer to come out and the credit markets will settle only once a recession is closer to the end.

 

Q: The other problem is that many of these problems are hitting homes, that is in Asia now as well many other countries are at the IMF's door asking for loans. There is an Asian economy that is also on the brink of, if not already in, recession. What is your view of the whole Asian picture?

 

A: Financial markets are integrated and they had made a one-way bet towards emerging market and the biggest problem we are facing now is towards the currencies. Even some of the longer-term oriented funds like pension funds and large institution funds are facing challenge in appreciating the fact that while the long-term story is intact they are suffering such a huge loss on exchange rate. So, the big problem now for emerging market is that exchange rate issue, which is blowing up a lot of balance sheet in corporate in the emerging market economies and also what we are facing is the countries with current account deficit and having had a credit cycle are going through much severe challenges particularly in the region--we have Korea and Australia right in the front. We are seeing that now it is spreading to India and Indonesia as well.

 

What is common in these four countries is that they have had a strong credit growth, which can be measured by the fact that the credit growth was significantly higher than the nominal GDP (gross domestic product) growth and at the same time they are suffering from current account deficit. That only compounds the problem for some of the emerging markets in Asia as well.

 

Q: How many quarters of global recession or US recession are you looking at now because some people have started extending the duration of this painful period from a couple of quarters to even as many as 5-7 quarters?

 

A: Whether you call it recession or not--technically qualified--it seems very clear that we are in at least a two-year global slowdown and we are just in the beginning of the first year. So, we have a lot more to go in the global economy and I do not think that emerging markets will be left out and be kept away from this pain. They will be sharing the pain equally pretty much in the cycle.

 

Q: How much more damage do you think currencies like ours will have to take?

 

A: We are looking at rupee to go to 54-55 a dollar in over five-six months time. When the rupee is depreciating, it is not as if it is depreciating on a trade-weighted basis. It is depreciating against the dollar much more because the dollar is appreciating against all the other currencies. So, one has to take it in that context. It is unavoidable for us to not to depreciate because the dollar is coming back in a big way globally.

 

 

Q: What about India? Do you think that these expectations of 7-6.5% kind of growth will hold out even as we are far more domestic consumer focused at a situation where most global markets are going into a recession?

 

A: The way India story panned out is that everybody appreciated the fact that the trade linkages are low but the most important linkage factor was capital inflows. If one looks at the state of capital inflows, we were getting roughly about USD 10-12 billion in 2002 which rose to about USD 110 billion in twelve months ended March 2008. I think that was a big driver to India's domestic demand.

 

So, the virtuous cycle was capital inflows come in, keep the real interest rates low and then we have a very strong credit cycle. The credit growth or a credit stock in India has gone from close to USD 150 million in March 2003 to about USD 575 billion right now. That is a massive increase in credit stocks, which we have been able to do because of the support of capital inflows.

 

Thus, India story has been linked to the capital inflows and to the extent to which we have seen a disruptive fall in the capital inflows over the last four months by our math, the capital inflows into India have literally come down to close to USD 5 billion or so. This is an extremely low number from USD 110 billion number that we had seen in March 2008.

 

Hence, this is the single-most factor which is causing a lot of impact on the economy. Firstly, the currency is depreciating because we were running current account deficit and certainly capital inflows have stopped. Secondly, we have seen a side effect of this on domestic liquidity in terms of the tightening of cost of capital. While the RBI is cutting the policy rate what we should watch is the cost of borrowing and also that the banks are tightening their lending standards, the cost of borrowing is going up. This will have an impact on that domestic demand, which seemed to be insulated in the face of global trade slowdown but it is not insulated in the face of a global capital market disruption that we have seen in the last three-four months.

 

Q: Just to drill this down to one facet of earnings or growth, there is big fear of companies that are highly leveraged, of course, the quantum is much lower than companies aboard but what is your sense of how much damaged to the companies that are several times overleveraged?

A: I think leverage is only one aspect of it. In today's market we are not just leveraged in rupee but we are leveraged in external dollar debt form as well. If company is not adequately hedged the external liability, it has seen a straight 25% rise in its liability over the last nine months and that is a dramatic rise in liability.

 

The leverage is showing up not because of just rupee-debt but also because of dollar-debt. The other aspect is, I don't know whether or not one calls it leverage but people are exposed to different contracts whether in commodities or in exchange rate for exports or for hedging of external liabilities. There has been a massive change in currencies in the global markets and that has also meant that a lot of the assumptions that one would have had in his calculation would have gone awry.

 

So, leverage is a very simple barometer of what's going on in the global markets. It is a complex set of factors which are now affecting the balance sheet. Hence, corporate balance sheets are going through massive disruption globally, particularly, the SME sector. Firstly, the leverage aspect on the external debt, and secondly, they are going through problems on trade credit. In many cases we have heard that counterparties are not honouring letters of credit and at the same time we are seeing commodity prices falling dramatically. So, if one is an exporter of commodity then he must have also seen his P&L affected big time.

 

So, I think the disruption in the corporate balance sheet is just massive beyond that small rupee-debt leverage which we have been looking at traditionally.

 

Q: Do you think it is a matter of time before all this starts affecting the Indian consumer in a major way because if that were to happen then one can see far deeper ramifications for growth out here? Are you seeing the first signs of that happening?

 

A: We have seen some bit of slowdown in the mortgage sector as well as in the consumer durables and cars. We really haven't seen much dramatic slowdown. But my sense is that with the way the cost of capital has spiked up in the last two months in India and the way the banks are tightening the lending standards, one will see a major correction in the consumer spending particularly the leverage consumer spending.

 

Hopefully, the non-durable segment and the fast moving consumer good segment should be doing okay. However, the leverage segment will be going through a major correction over the next three-four months itself; we should have the data proving that point.

 

Hence, the consumer sector will be definitely taking the pain. It is going to be unavoidable for the consumer to walk out of this without taking the pain.