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Last Updated : Jul 01, 2016 04:42 PM IST | Source: CNBC-TV18

EMs in a sweet spot amid global volatility: Deutsche Bank AG

Considering the slowing growth momentum in US, expectations of no hike are legitimate, says Taimur Baig of Deutsche Bank AG.

The market is in a global deflationary environment currently, says Taimur Baig of Deutsche Bank AG. Emerging markets (EMs) are in a sweet spot in this volatility.

While the volatility continues in the global markets, EMs have strong growth potential.

Baig does not expect the US Federal Reserve to hike rates anytime soon. Considering the slowing growth momentum in the US, expectations of no hike are legitimate, he says.

China, which continues to slowdown, had got sidetracked due to the UK referendum. Debt realization by China will be closely watched.

Below is the verbatim transcript of Taimur Baig’s interview with CNBC-TV18's Nigel D'Souza and Reema Tendulkar.

Nigel: Brexit was on everyone's minds. Everyone was talking about it last Friday. The equity markets at least they have shunned it away. I was just going through your report and you believe that it is not really the right time to shun away emerging markets (EM), maybe there is more from the EM. Tell us what is your analysis? Brexit not such a bad event for EM?

A: Right, there is a blessing in disguise if you will. Of course the immediate aftermath was an unambiguous negative and it is hard to believe it has only been a week. But the world markets have gone to hell and come back during that period. In our report we made three points.

First of which is of course this whole negative yield phenomenon which has in fact become even more compounded since last Friday another USD 1.5 trillion worth of bonds have joined already, ballooned USD 10 trillion dollar worth of bonds with yielding negative yields.

So, in the G3 space right now we have basically bonds worth six times India's gross domestic product (GDP) yielding negative. So, all of a sudden high yield economies like India, Indonesia, Turkey, Brazil by definition look attractive and the view two years ago was that with the US Fed normalising we would see a rate compression between the differential between the EM and DM.

But I don't think we are going to see it any time soon because even if the short end of the curve is held back by central bank the long end is where the action is and EM will offer far more attractive yields. So, that is issue number one.

The second issue related to the issue of negative yield is that we are in a global deflationary or disinflationary environment where nominal and real GDP growth rates have become compressed particularly again in the G3-G7 markets. For better or for worse even if growth is a little lower than it used to be in EM normal GDP growth rates are much higher.

So, yes, countries like India, Indonesia would give close to 10 percent if not higher nominal GDP growth rate which would mean double digit earnings potential for various equity companies. So, it is not just a question of negative yield being attractive or the differential from negative to positive yield in EM being attractive but it is also the earnings potential on the equity side being attractive.

Finally it is issue of commodities. Commodities in my view are in a sweet spot. They are not so low that some EM economies that are dependent on commodity exports remain highly vulnerable but they are also not so high that commodity importing economies like India are facing any trouble. So, we are in this USD 40-50 horizon, it works out very nicely for EM countries.

Exporters bottom out, importers still enjoy low inflation, improved current account surpluses. So, this is why I think EM is no longer the basket case it was last year or so in expectation of Fed rate hikes. Those rate hikes are going to be delayed and EM yield and growth potential look pretty attractive.

Reema: Clearly EM seems to be in a better place, but that said you still see downside risk to the growth estimates for many of the EM countries. You have lowered the gross domestic product (GDP) estimate for Hong Kong, for China as well as a couple of the other Asian markets. What is the reason for that and will that hurt India in anyway, this external slowdown?

A: The adverse developments out of Europe cannot be helpful. We can take some solace that on a relative basis EM has some upside and therefore flows will still remain EM oriented but as far as growth outlook is concerned on absolute basis it is impossible to be optimistic on margin. Of course we will have to recognise that what has happened in the UK will be having negative implications for consumption, investment and perhaps even on trade both in the UK and the EU.

The Euro area is a very large component of Asia's demand with respect to exports. If we are going to see 2017 growth for Euro area revised down by 0.4 or 0.5 percent point that is our view then there has to be some knock on impact, particularly on the export dependent economies of Asia. So, that is the channel that has convinced us to revised down growth forecast for a series of countries in Asia. India is not entirely immune. India has a fairly strong domestic dynamics which should offset some of the external headwinds but nobody is immune, it is just a question of the degree.

Nigel: Brexit we have shoved aside, at least for the time being. How concerned are you about the Chinese markets, particularly the property market that is the first part of the question and also in terms of the US Fed what are you factoring in? How many rate hikes this year and is there a distinct possibility of some quantitative easing (QE) coming out of the US Fed?

A: I am going to address the US part first and then China. So, one set of argument for the US in the past particularly coming from the BIS used to be that US should expedite rate hike in 2015-16 so that when the inevitable downturn comes, let us say in 2017 it would have room to cut rate otherwise it would just have to cut once or twice and then have to go into QE.

Many of us have been somewhat dismissive of that argument pointing out that the act of rate hike itself could undermine US recovery in a very big way. So, create a self fulfilling dynamic if you will but at the same time it would have been nicer if the Fed had gone ahead and hiked late last year more than once and had hiked maybe once this year. It would have had more room to counter some of the headwinds that we see beginning to percolate in the US horizon.

Investment is not what it used to be, profitability is not what it used to be. Jobs growth is not what it used to be. This has been a fairly long recovery. It is a bit long on the tooth. So, I wouldn't go straight into the issue of QE but the fact that everybody is scaling back their expectations or rate hike not just this year but also in the coming years is a very legitimate thing to do. So, that is one issue.

China in my view should have been the focus for EM this summer. Unfortunately with the whole Brexit related issue it got a bit sidetracked but as we graduate pass the UK which itself should not have a very big impact on Asia. It is really the linkage of the EU that matter but once we go past all this for the months of July and August I am sure that China will come back to the radar screen. There has been fairly a sharp drop off in growth momentum in China in the last few months.

So, we liked what was happening in Q1 although we were not happy over the quality of the growth quantity wise growth was picking up but in Q2 onwards it has begun to slow. The property market is no longer upside driver of the upside momentum and the authorities themselves are not very comfortable with sustained strength in the property market given that it has bubble like tendencies.

So, China is slowing, how the authorities react to would be something to watch for and also with respect to liberalisation, specially debt market liberalisation, where they go and how they go about doing their business is another thing we will have to keep an eye on the coming months.

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First Published on Jul 1, 2016 12:55 pm
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