'Emerging markets an obvious destination once QE3 comes in'

The economies of the Untied States and the euro zone continue to teeter on the brink of an in-again-out-again recession. As borrowing costs get closer to the danger area that forced Ireland, Greece and Portugal to seek a bailout, investors are concerned that Spain is next in line to dial for help.

In an interview to CNBC-TV18, Jerome Paul Booth, head of research, Ashmore Investment says that a third round of quantitative easing (QE3) is close at hand but that is hardly great news for global markets. “It puts further downward pressure on expectations for the dollar as well over time,” he adds.
For Booth, once QE3 comes in, there will be a continuing search for places for this money to go and emerging markets are an obvious destination, particularly, in the fixed income market. Below is an edited transcript of his interview. Q: What have you made of the recent data from the US which seems to have shown some sluggishness?
A: We have had a change of mood over the last week in the US. The data remains poor and the expectation now is that QE3 is increasingly likely. That has the effect of pushing markets up. The expectation is more liquidity is going to be forthcoming. Hardly good news though. It does of course put further downward pressure on expectations for the dollar as well over time. Q: How are emerging market assets now positioning for this QE3 possibility? How should they be positioning in your eyes?
A: There will be a continuing search for places for this money to go and emerging markets are an obvious destination, particularly, in the fixed income market where yields on the government bonds, by that I mean the heavily indebted developed countries (HIDC), the average public plus private sector debt to GDP in the HIDCs is 250%, compared to 25% in the EMs.
It is in those north Atlantic countries, where the real problems are and the risk of major deleveraging causing huge contagion and risk. The likelihood also there is for a period maybe as in the 70s of heightened inflation after the deflationary pressures today ease. As this new sense of global geographies seeps into investors’ minds, there will be more people looking to invest in EMs and QE3, simply prompts that. It makes it more obvious that people should be going to EMs.
A lot of investors in HIDC countries themselves are massively invested in their own countries. There is a huge home bias. In India, bizarrely a lot of people invest in Europe or in the US and I am not quite sure why. It seems to be even more obvious that they shouldn’t do that and if they want to invest abroad, they should do so elsewhere in Asia or EMs; countries that are likely to grow and not as likely to lose you your money. Q: Where does all of this leave the US dollar which has been quite strong relative to the euro over the last few weeks?
A: The dollar is suspended on hope and belief that somehow it is solid and of course it isn’t at all. People talk about moves up in the dollar as a flight to quality or safety. It may be perceived that way but from a macro economic point of view, I don’t see it that way at all.
I see a country with huge fiscal problems, enormous debts and a history - very recently in 1971, of not paying back as much in real terms. Remember that the last time there were big global imbalances in the 60s, this ended in 1971 with Nixon taking the dollar off gold. At the time it was convertible to gold at USD 35 per ounce. By the end of 1974 it got to almost USD 195 per ounce. That is a major devaluation.
The idea that the dollar can remain strong is pure nonsense and it will fall. Surplus countries with these huge reserves are going to be the driving force behind that. It is EM central banks themselves which will determine how the dollar moves or the trajectory by which it gets to a much weaker level in a very similar way to the then if you like EMs of Europe in 1971, did the same to the dollar then. Q: How are you positioned on India or asking your clients to be positioned here, in a week where expectations from government policy are much heightened?
A: I think there is a lot of hope that there should be more reforms and with the PM now taking on the brief of the FM, there is anticipation there will be some action and a better sense of determination from the government which is necessary. The central bank of course has been giving the right signals. We have had concerns over inflation and the RBI is quite right to not do anything for the moment, wait until those expectations turn around.
When we have expectations of growth and I think reforms from the government will help enormously in that, then we can start to see investment take off, then we will start to see a change in the interest rate cycle as well. So the government is really in pole position here. Everybody is looking for the finance ministry to come out with some ideas on fiscal reform.
One of the basic problems in India is not profligacy per se, it is the fact that a lot of people don’t pay tax and a lot of companies don’t pay enough tax and I think just extending the tax system as well as some reforms on the expenditure side is really what is needed.