Dec 21, 2016, 10.35 PM | Source: CNBC-TV18
The momentum is with the developed markets and China still remains the biggest risk to the global economy, said Ruchir Sharma, Author & EM Investor.
Q: As an emerging market investor, what would the India call be today then?
A: As far as India is concerned we have pulled back in terms of the fact that it is a very difficult time to be in many countries because there are very few countries where the prospect looks any good and there is one statistic which captures for me - in the boom period of 2003 to 2007 - there were about 50-60 economies in the world which were registering growth rate of 7 percent or more every year. This year that number is down to 5-6 percent, so economic growth is lower everywhere and in particular across the emerging world.
Q: But relatively we are still doing better?
A: No but this is where I think we are missing the point - markets and investors respond to change, not to absolute levels. In the developed world economic momentum is coming back, like in USA the dramatic improvement in sentiment since Trump got elected on the market place is staggering, no one would have expected that.
Q: Record highs for the DOW.
A: Yes and apart from that you look at all the services, consumer confidence, business confidence, massive bump and the rally in the US stock market today, I think I saw this data and currently this is the best rally that the stock market enjoyed after the election of any President in American history. So this is really sort of huge surge in animal spirits going on in the United States. The other surprise is Europe; an economy that people written off, even their economic momentum is accelerating. Japan too is coming back from the brink. So in the developed world what we are seeing is economic momentum is coming back.
Q: So that is bad news then for emerging markets in terms of flows?
A: Yes in a way and that is what we are seeing currently which is that the dollar is supreme and the only giant sucking sound, we have heard so far, is of money going back to the United States and that is something which doesn't bode well for flows to emerging markets, but there is more fundamental problem out here which is the emerging market growth model is sort of under serious question and this is what is going back to my earlier point about Trump presidency with two changes that they are going to make or are very serious about making. One of them will pass for sure, the other one, I am not sure but this has major implications for India. Take the first thing that they are going to reduce the corporate tax rate, from 35 or something that they are talking about to 15 or 20 percent, this is huge because here is the largest market in the world which is reducing its corporate tax rate from 35; effective it is a bit lower but 35 is the top rate down to 15-20 or something, that is huge because why would anyone invest outside their domestic market and it is so large, when the corporate tax rate is being brought down so dramatically.
Q: So that is not an issue as far as the foreign institutional investors (FIIs) investment is concerned but even FDI investment for countries like India?
A: As far as India is concerned - that's what even I said two years ago - the first thing that India needs to do is to bring down its corporate tax rate.
Q: While the growth map is 25 percent that the finance minister laid out in his first Budget.
A: Yes but that was very incremental and now if you do not do something dramatic on corporate tax rates.
Q: What would dramatic be for you?
A: If the United States is going to reduce its corporate tax to 15-20 percent and if we do not bring it down to at least a similar level, I think that is going to be a big trouble. Why would you want to setup plant or factories here or at least a US person would want to do it, if the corporate tax rate in the United States is going to be 15-20 percent, so that is a major change which is taking place.
Q: You think that the government ought to bite this bullet even in this Budget?
A: Absolutely and this is where you have the long-term consequences of demonetisation because what is happening today is that the focus is now shifting to what sops to offer to try and make up for whatever hardship that the poor have gone through and the sentiment has been a bit more anti-rich.
Q: In that context to do a significant corporate tax rate you believe will be in question?
A: I think so but for me this is the economic necessity, this is the need of the hour that you need to match those corporate tax rate because the US used to have highest corporate tax rate in the world and now from 35 they are going to go to 15-20 percent - that is like a dramatic shift and if you do not match that that is going to have a serious implications - that's one. So the corporate tax rate cut of 15-20 percent is a very high probability that's going to happen in the US. The second is much more controversial but with even greater implications for India which is that they are discussing something called destination tax. The destination tax implication is that exports are going to be tax-free and imports are going to be taxed - that's a very crude way of putting it but that is what they are talking about. If that were to go through - that would mean the entire outsourcing model to emerging markets or even exporting your way to prosperity model which is how many emerging markets have grown rapidly, Korea, Taiwan, China - that model is going to be seriously impaired.
Q: But this impacts the US economy itself, doesn't it. Do you believe that this is going to be something that perhaps they will tempo?
A: Yes. So this is like something they are facing opposition for but what is very clear is that America from an economic standpoint is turning much more invert. It is about how we get investment back into our country because investment has been so weak out there for a long period of time and you have a very business friendly government that has come into place just now; a whole host of businessmen out there. So this is the business friendly government that America has had in a long time, some people possibly say ever and they are very focused on these kind of things as to how to get investment back in; lower corporate tax rates, possible border tax, repatriation of overseas earnings, profits, so that's the way they are moving. However, eventually you can argue that American cannot live in isolation if the rest of the world doesn't do well, the dollar surges too much - that is going to hurt them but for the next year or two that is the dynamic, that is what is going to happen and this is where we need to wake up which is to get out of our insular mindset and say that this is how the world is changing, how do we respond to this change.
Q: One response you said is that for India to be more aggressive when it comes to bringing down its corporate tax rates, you believe this 25 percent is not going to work, much more radical action needs to happen and it needs to happen perhaps as soon as Budget 2017.
Q: What else?
A: I think that our entire model of exporting our way to prosperity is something under serious threat because we are in the world of deglobalisation and in this to rely on external capital much to fund our growth that is something that the government spoke about, we just have to be mindful that yes, that is how it used to work but that model today is seriously impaired.
Q: So encourage domestic investments which haven’t picked up?
A: Exactly but to expect much more FDI or foreign investment to flow into India, I am not very hopeful of that because we are in a deglobalising world which means that the trade flows are going to remain weak for a long period of time across the world and also capital flows are going to remain weak across the world. In that environment, you have to focus much more on the domestic economy and exporting way to prosperity that model has been seriously impaired.
The developing ladder from just being like this has basically gone vertical. So it is going to be much harder to grow. Even in terms of bringing back black money and doing these kind of things, I think that once again I wish we had sort of learned from our own experience of the past and what other countries are doing like Indonesia -- Indonesia wanted to bring back black money so they decided to have a penalty rate of just 4 percent and they got USD 300 million including the former President Suharto -- one of the biggest crony capitalist leaders, his son brought in USD 30 billion. So it depends what we want to achieve.
We are a capital starved economy, if we need more capital, it is getting more and more difficult in the global market place. How do you attract capital flows in this? It is best if you attract your own money back, which is in terms of overseas money but today in terms of the message is -- if you speak to businessmen, they are still figuring out how to keep a lot of their wealth overseas rather than bringing it back.
Indonesia did the opposite, in fact, they have been criticised a lot, it is the other extreme, 4 percent penalty rate and you can bring back whatever money you want. They did that under the scheme and they got USD 300 billion dollars so that is like an abundance of riches but see how the mechanism works because they got that much capital in, now they are being able to cut interest rates, the currency has stabilised even though they have a much larger current account deficit as a share of gross domestic product (GDP) than India does.