See double digit inflation with oil price hike: Jim Walker

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Jim Walker , MD, Asianomics expects Indian inflation to be in double digits if oil prices are hiked. He said that the inflation scenario has been worsening and the monetary policy has been loose across emerging markets and Asia. He feels that we are currently in an era of credit contraction. The Central and State government deficit is seen at 10% of GDP this year, Walker said.

 

Walker expects more bad news from US and Europe. The state of the US housing market is worrying and the worst will not be over till the US house prices stabilise, he said. Walker expects many more writedowns of securities.

 

Excerpts from CNBC-TV18's exclusive interview with Jim Walker:

 

Q: It looked for a bit the last quarter that the things were on the mend, but are you convinced that the things are not yet?

 

A: I am still convinced that I have a long way to go on this whole process. It is a very interesting comment you made earlier that the market is softening on the back of bad news, which is not a good sign. It's been a strange last month or so where the markets have been reacting positively to bad news. That to my mind is never a good sign because really they are just fooling themselves. Bad is bad news and I am afraid there are lot more bad news to come especially from US and the Europe.

Q: The contrarian view on that from some of your peers has been that maybe the economic data has not been so bad in the US. We didn't see a negative tick on the GDP date and maybe we will avert a recession this year, what are you takes with the kind of data that you have been seeing from the US?

A: Clearly they are not looking at the US housing market, which is worrying because that is where the main problems are and the main problems for the future are. I think this is the thing that the people really need to understand that the housing market has been soft for two years in the US, but last year the house prices have started to fall and as those house prices start to fall they affect everything else. They affect consumer attitude to spending, they affect business attitudes to investing and much more worrying for the financial system and this is where it is really going to kick in over the next 12-18 months as they affect the worth of the securities of these financial institutions still have in our books.

People have been saying in the Q1 of this year, the write downs in financial companies maybe the worst was over. The worst can't be over until US house prices stabilize and all of the signals over the last two to three months are that the US house prices are accelerating on the downside. House prices are falling faster and faster and that means there is lot more write downs of these securities to come, which means there is much more recapitalization of the financial system and basically that means there is much less in way of credit growth going forward. While we haven't seen too weak numbers so far in things like GDP, I am not worried about the last quarter or the last year, I am much more worried about the next year and I think that is what people are missing, they don't understand relationship between credit and economic growth.

Q: The really bad word for us of emerging markets economies this year has been inflation; what is your sense of where we are at, is it going to get a lot worse before it gets better? Or are we peaking off?

A: I think the problem is that the focus of attention is coming through to inflation. What we have known for the best part of this year and probably the latter part of last year, the global markets, the money flows have only started to pick up in the last couple of months and have began to realize that the natural flight to inflation is much worse then the Consumer Price Index (CPI) is telling us and particularly in places like India, China, Indonesia, Malaysia. These are four good examples of countries that have not allowed oil prices to rise and if they did, inflation would be well into double-digits already. Indonesia obviously made a move a week or so ago and that is going to over a next couple of months push inflation up into that 14-15% range and then interest rates are going to rise.

Many people are beginning to realize that even if inflation and food prices peaks out and if oils stabilizes or even comes down a bit, there is much more inflation in the pipeline and what it is going to take to get rid of that is tighter economic policy, tighter monetary policy and with exchange rates not appreciating so much in the recent weeks that means higher interest rates and markets don't like that.

Q: Some analysis seem to throw up the fact that for the non-energy commodity indices they have actually come off the levels of mid-March while the energy Index is up almost 26%, how have you read this big burst across commodity classes and are you in the camp that feels any pocket of it is towards cooling off?

A: I think some commodity prices went too far too fast especially in some of the food stuffs, but it takes a long time for those price rises to actually feed through into consumer prices and although we have seen a sharp correction in things like wheat, rice prices are off considerably. The fact is that pipeline inflation is probably still coming through. So even with these retracements, I think we have still got elevated price levels, elevated cost levels. For people looking at their wages, they are beginning to ask more money and that is very natural especially in places where food and energy take up a huge part of the average persons spending basket and as they ask for more money then cost rise generally and inflation becomes much more embedded in the system.

The fact is that the general inflation picture of anything is actually worsening today and part of the reason for that, I think India has still managed things reasonably well, but generally across the markets in emerging Asia, monetary policy has been far too loose for the last number of years and they are now paying the penalty. There will be lot more inflation going in the system going forward.

Q: Equity markets globally have been remarkably resilient; some markets have gone to new highs, the US has not done too badly this year at all. Do you think we are setting ourselves up for a nasty crack this summer or do you think equity markets might actually continue to amble along well despite the picture that you are painting?

A: Problem for me is that equity markets tend to do well when credit growth is strong that is when there is a lot of expansion in money supply and a lot of expansion in credit, we have seen that over mostly over the last decade especially from the big countries like the US and Europe. We are now in a year of credit contraction that is all you can see. The banking systems have gone completely off hand especially the investment banks and the non-bank financial institutions, they are now paying the penalty and you saw more of that overnight with the downgrades and the way share prices have reacted in some of the big American investment banks.

Some people think that the earnings for those banks are coming back in the second half of this year. Maybe in the second half of 2010, if you are lucky those banks will begin to make money again in any reasonable way.

But some of them would have lost business by that time; they have certainly shrunk down their work forces and have shrunk their whole business models because these models are inherently flawed on the kind of securities they were issuing over the course of the last five years. They can no longer make that business; they are going to contract that whole credit base and when credit contracts in the global system, asset prices fall. Equity markets have fooled themselves so far, but I don't think they will be fooling themselves for much longer. 

Q: What about the Indian macro situation? How would you rate our macros, our fiscal situation, what oil prices have done to us, our current account situation, has it worsened since we last spoke?

A: Yes, it has worsened. Obviously the government has taken a decision not to allow energy prices to rise and even when it does talk about rises they are so miniscule, that they are hardly worth thinking about. Then there are obviously subsidies on food prices as well. That has blown off fiscal position and is probably going to be the case; I would think India is going to end up with general government plus state government deficits in a region of 10% of GDP this year. They have blown away all the good work of the last few years.

Of course, international investors look at that and they get very nervous and local investors look out at that and they probably become nervous as well. That's been the main part of retracement in the rupee over the course of the last month or so.

Domestically my view is that I have always been very positive about the Indian economy especially the Indian companies and their ability to read price signals and their ability to respond to them, for economic growth to continue, for corporate earnings to be good and also the Reserve Bank of India continues to do a fantastic job. It is just a pity that the government doesn't join in and try and make the signals clear.

Everything the government seems to be doing at the moment from interfering with foreign debt to interfering with the price of cement, interfering with the price of oil; it makes things worse because it creates more in the way of distortions. It has got to be said that politics are playing a part in that because they are close to their elections and that's always a dangerous thing for a country, it is just a pity that Mr P Chidambaram and the rest of them don't step back and get out of the way and let Dr Y V Reddy actually sort things out because he is perfectly capable of it.

Q: When we spoke about a year and a half back, I think for the spaces that you wanted to buy, it included gold, water harvesting projects and food. From where we stand right now what would you put your money in as an asset class globally?

A: It is a hard question. I am very long on gold, it's obviously come off a lot from its high. But I still think Central Banks are going to be printing money over the course of the next two years and gold is going to go up in price.

Within the equity universe, it is much more difficult at the moment to be positive in anything. Defensives, and anything with a yield I would be much more keen on, utilities tend to be in that boat and also telecoms which have much more steady business, it's not just India but across Asia. In currencies I am still long on yen, on Swiss Franc because these are under owned currencies and they very nervous of just about everything else. So it's gold, defensives and the yen and the Swiss Franc, two countries that everybody love to hate for over the last five years.