EMs won't be supported by liquidity; only fundamentals: El-Erian

Emerging markets will no longer be supported by the immense amount of liquidity it has received due to FII inflows. Rather they would have to rely only on fundamentals, says Mohamed El-Erian of Allianz.India has been isolated from the global disruption led by negative rates in advanced economies, he says. EMs would look forward to a Federal Reserve rate hike in December.  The global markets saw deep cuts yesterday as they tried to price in Donald Trump's victory of the US elections. However, the tone and content of his acceptance speech reassured investors of relaxing corporate taxes and ramping up expenditure on infrastructure, says El-Erian. He also avoided any anti-trade talk in the speech.Below is the verbatim transcript of Mohamed El-Erian’s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18. Sonia: It is a start of a new era, we have a new US President Donald Trump, how does life change for global markets and equities? A: It is either a start of a new era or it is a continuation of something that we have seen in Europe which is the politics of anger and the growth of anti-establishment movements that can change political outcomes. We saw that with Brexit, we are now seeing it in the United States and we could well see it in Italy in next month’s referendum. I think of it more as a continuation of a theme that is playing out simply because the advanced countries have grown too little and the benefits of that growth has accrued to very small segment of the population. Latha: The way in which the markets have responded over the last 12-15 hours appears to be that Trump’s acceptance speech was fairly soothing. He did project himself as the President of all sections of the United States and more importantly the economic pundits look at him as someone who will cut taxes as well increase fiscal deficit to improve growth. Is that a theory that will work? A: You are absolutely right that there are two things in play here. One is the tone and the second is the content. So, on the tone, you are absolutely right, his acceptance speech was soothing, it was reconciliatory, it was unifying and it was amplified by what Secretary Clinton said and what President Obama said. So, you got a very clear message that the leaders from both sides were coming together with the notion that it is time to work together; that was the tone. However, then the content was interesting. What Trump did is he emphasised what the markets like to hear, in particular he emphasised corporate tax reform, he emphasised infrastructure spending, he emphasised the regulation. He did not mention what the market is afraid of which is the anti-trade policies and the potential dismantling of trade arrangements. So, you had both the tone and the content playing to a market that had reacted quite negatively as you know initially and you got a remarkable turnaround. Anuj: In that case, do you think there is still a risk of a second round of sell-off as we move forward and from emerging market point of view, now the next event to watch would be Fed rate hike, do you think emerging markets could see a bit of underperformance? A: We are certainly living in what I call an unusually uncertain, not just uncertain, but an unusually uncertain world and you see this not just from the politics, but from the notion that there negative interest rates in certain advanced economies. You see it in so many elements, so, we are living in an uncertain world. Now, so far, central banks have been able to shield markets long enough for markets to become conditioned by this notion that there is someone looking out for their back. Now why is that important? Because of what you mentioned; if the Fed were to hike rates next month, that would be interpreted as less willingness from the part of the Federal Reserve to support the markets. If the Bank of Japan continues being ineffective, that would be less ability. So, you are absolutely right, we have to keep an eye on central banks because they are the ones that have been able to disconnect advanced country markets from this unusual uncertainty.Latha: The point I wanted to ask you about the impact on emerging markets is, every time bond yields in the US rise, it has usually been negative for emerging markets. However, if it is accompanied by very good US growth like we saw between 2003 and 2007, then emerging markets have normally benefitted. What kind of a scenario you think will play out? A: You are absolutely right in differentiating a sort of cause of the higher yields. You have three things operating right now. One is the hope for higher growth and that is positive for emerging markets. Two, the expectation that inflation will be going up in the United States and that is net-net neutral but there is a third element which is the withdrawal of monetary stimulus which would be a negative for the emerging world. I view it as a simply proposition that the destiny of the emerging countries are in the hands of the emerging countries themselves. This is not a big enough shock to the emerging economy unless it is own economic management is lacking. Sonia: In that sense, we have seen an outperformance of emerging markets throughout the year especially markets like India. Do you think that outperformance versus developed markets could continue even in the early part of 2017? A: The outperformance came after a period of severe underperformance. So, what you are getting is a catch-up if you like it. If you recall, paper tantrum of May-June 2013 started a period of underperformance in the emerging world that wasn’t warranted by the fundamentals. However, it was due to, is a reallocation of capital among those who come into the emerging world not because they are attracted by the attributes but rather they are pushed there by disappointing returns at home. So, I think what you are getting is re-pricing. Where we go from here though will depend in great part on the fundamentals. Emerging markets will no longer have to support of the type of liquidity that they have had so far. Anuj: From Indian investor point of view, there have been two sectors where we have seen big selling, the IT sector and the pharmaceutical sector because of all the noises that were coming out of US. Do you think those could abate now or do you see fresh round of selling in any of these pockets? A: To the extent that the pressure on the pharmaceuticals has been coming from the US, you should expect that to abate. There is a lot less concern now about pricing issues, there is a lot less concern about regulation with the change in administration and you saw that today, yesterday in your case, in terms of what happened among the sectors in the stock market. The IT issue, ultimately is a question of where is the disruption coming from and it is very important for India to keep up with the disruption forces that are moving very quickly. There is a whole new angle that is being opened up because of a combination of artificial intelligence and data that makes the sector itself subject to disruption. I think what generally when people look at India, the question they ask is about the structural reforms, can India continue to unleash its massive potential or will the recent slowdown in growth prove to be something more durable and that really comes down to the question of structural reforms and unleashing what is a significant potential. Latha: Two questions from me. One, do you think Trump will go down the path of restricting international trade, restricting Chinese goods, questioning the NAFTA, tweaking it, will he be isolationist? A: We don’t know. The hope is that once you are in power, you realise that there are costs and risks to these approaches and that at the end of the day the US will be worse off; that is the hope. However, we really don’t know, we don’t not have any history of Trump as a policymaker; so, it is very hard to answer your question. My gut tells me he won’t but I don’t have any analytical foundation for that. Latha: An analytical foundation on the other issue of infrastructure spending, yesterday we saw stocks like Caterpillar going up, the entire rhetoric of economists about the central banks taking the world towards negative interest rates has been central banks you stop trying to set the economy right, the fisc should do the spending. So, if Donald Trump stands for higher fiscal deficit and higher fiscal spending, that seems to be what the doctors ordered, will that work? A: If fiscal policy is unleashed, and remember we have not had an active Budget in the United States for almost seven years because Congress simply could not come together. So, with the exception of one mid-term Budget, we have simply rolled over the Budget. So, we haven’t had responsive fiscal policy for a while. Second, there is a lot more support for infrastructure spending now especially at relatively lower rate. So, I suspect you will see a bit more fiscal and therefore it will relieve some of the pressure on monetary policy which has been overstretched. However, it is equally to important to move on corporate tax reform, to move on labour market re-tooling, to move on other elements that can reintegrate the growth model. Latha: So the death ceiling could be raise, you think that would be one way out? A: Yes, I think what you see is now that the Republicans have swept both the executive branch and Congress, and we haven’t had that since the beginning of Obama’s first term, so, we have had divided government since 2010. Now, that the Republicans have both branches of government, I suspect you will see a lot more activism than what you have seen before.