Not Turkey, China devaluing will be worse for India: Russell Napier

Everybody who runs an emerging market is going to have to answer that big question; do I follow the dollar or the Renminbi, Russell Napier, Co-founder, 65433225 65418936 65436667 ERIC, tells Tanvir Gill of ET Now.Edited excerpts: You have been calling for a big risk in Turkey. Over the last two years, since the coup in Turkey, you have been talking about how there is a big default risk, a big overhang for the region. How bad can the situation get? The currency has moved so much and interest rates have moved so much that the answer to that must be yes. Unlike India, Turkey has borrowed a huge amount of money in foreign currency. In fact, the foreign currency borrowings of Turkey are certainly above 75% of GDP and close to 100% of GDP. You may say how can I be that accurate? Well, I know exactly how much the foreign currency debt is. It is $430 billion. It is just that the exchange rate moved so quickly, it is hard to assess the size for Turkey’s economy in dollar terms but these are numbers from which it is very, very rare indeed for they are not to be at default. Now the double problem for Turkey is that three months’ money is available at the bank rates of 22%. I am sure everybody listening to this will realise just how punitive interest rate at that level is. So, anybody going to a bank will have to pay a significant premium to that rate. So, yes default and the important thing for global investors is that the total amount of that that Turkey owes to the foreigners in both foreign currency and lira is $467 billion. That is a big number. To put it in context, Lehman Brothers had $618 billion worth of liabilities on its bankruptcy and Turkey on credit alone -- there are the exposures people have to Turkey – has $467 billion in foreign debt. I know that is a big number but is there a clear and present danger and everybody is debating a big default on foreign debt in Turkey. The interesting thing about this that is, of that $467 billion, the foreigners have lent only $95 billion to the Turkish government. The vast majority of this money has been lent to Turkish corporations and a big chunk to Turkish banks. The government would not default on its domestic lira-denominated debt. Countries that own the printing press very rarely do that. It happened in Russia 1998 but it is quite rare. What we are talking about default is the foreign currency debt owned by corporations and buying of Turkey and that is highly likely. The restructuring of domestic currency debt has been being underway since last November, some of Turkey’s biggest corporations. So, restructuring default call it what you will but it began last November. It has been underway for some time and even before the currency collapse and even before interest rates got to these astronomical levels. But what would be the ramifications of this financial crisis in Turkey? The finance minister in Turkey has already addressed concerns. Qatar has infused liquidity to aid their economy. How much of all of this can really help resurrect the situation? That is an interesting point. For several years now. Turkey has been able to access capital not really from the pure private sector but we may call that Qatari public sector money, controlled by de facto by the Government of Qatar and Turkey has got a long way into this mess by relying on that money. But it is worth pointing out that this is a trap that has been sprung this high foreign currency debt. It is very hard to get out of it and one thing that might happen as $15 billion dollar worth of Qatari money comes in is that $15 billion dollars of Turkish private sector money may well go out.I am surprised that the Qataris are ready to put their money in without some sort of move to capital controls or restrictions on capital outflows. Just to stress, I believe that is what will happen. So, there are two ways in which Turkey can default. The normal way which is its corporations are simply not able to meet their obligations to foreign banks or secondly their capital control makes it illegal for those to meet those obligations. So, the implications fall very squarely on the European banking system and the emerging markets but we are not focussing enough on the impacts on Europe of this. The banks that are really involved in this are all European banks. There is also a large level of bond investment which is different this time. It was not an issue in 1997 and Asia was not an issue in 1982 and Mexico. We are going to have bond investors caught up in this and a significant amount of bonds are also held in Europe and then the unthinkable issue for Europe is what happens if the President of Turkey releases the 3.5 million refugees that he currently looks after with payment from the European Union. We cannot know if that is part of what is going to happen but it is clearly a bargaining chip which he keeps alluding to. And so it could happen and for the unity of the European Union, a large influx of immigrations will be important. It is negative for Europe in the sense the dollar is much higher because American banks really are not exposed to this at all and that is very positive for the dollar. We all know that a strong dollar is not good for emerging markets. Finally the implication for emerging markets. Capital control, in particular, would be dire for emerging markets. Those providing capital would be worrying what else is going to happen and they would see strong men as risk. The strong men that one could obviously point to would be in the Philippines, China, Romania, Hungary, Poland and Mexico and in terms of India obviously the Prime Minister Modi is in a very strong position, but he has over the last few years, built up incredible credentials as a man prepared to work with foreign capital. I do not really see any risk that certainly that foreign capital would see him as an Erdogan -like risk. But the countries that I mentioned, there are strong men already overruling the rule of law and taking actions which will increasingly make investors nervous. So, all of this is very bullish for the dollar, negative for European equities and I think also negative for selected emerging markets.Taking the last point forward, do you think that contagion fears are real or would you say they are overdone? Can this impact the emerging markets in a meaningful manner?It definitely spreads from Turkey. Turkey’s fundamental are not the worst either. There is no doubt that Turkey has done some very silly things that other emerging markets have not done. I think people but emerging markets would be penalised because one of them has misbehaved. But remember. what we are really talking about is the strong dollar. So, the ancillary impact of Turkey is a strong dollar and a strong dollar is never good for emerging market equities.People tend to follow the dollar and that tends to tighten monetary policy as the dollar goes up, number one. Number two, it is unfortunate that the emerging markets are grouped together. A lot of emerging markets exposure is held in open ended funds and if people begin to pull money from those funds, it will simply find it incredibly difficult to liquidate the Turkish bit of the portfolio to meet those redemptions.Part of the portfolio was already quite illiquid, given what is happening in Turkey could become entirely illiquid if capital controls were implemented. Therefore, Turkey instigates the move away from emerging markets in general. This was exactly what happened in 1997 and in 1982.To some extent, it has always been unfair to call them emerging markets and group them together. There really is no comparison between India and Turkey, but unfortunately in the world of international capital flows -- a business which is not always the world’s most rational -- there is a spill over. There is also lower commodity prices which we saw pretty dramatically yesterday.That is a positive for India and not a negative but there are some emerging markets for which those lower commodity prices are very negative. We will all focus on the direct impact of Turkey. The indirect one lies in dollar fall in commodity prices. Actually that is why we find ourselves with negatives for emerging markets. One final thing on that is there is one emerging market which has never devalued in the last 20 years in any significant way. But it is now devaluing and that is China. Although Turkey is grabbing all the headlines today, what may ultimately be the most important thing is that China does seem to be moving to a much, much more flexible exchange rate.As we discovered in 1994, when China did its last major devaluation, that had punitive impacts on anybody who was competing with China.I believe that Chinese devaluation would be the worst among all these issues for the emerging markets.Where does India stand amidst the news flow that risks emerging market inflows or investments? The rupee has gone past 70; Indian macros are being tested too, especially with what is happening on oil prices. Also, elections are coming very soon. That is the backdrop in which you need to evaluate the macro headwinds. Can India hold its own if the EM trade is turning negative?I do not think it can but this is not terribly bad news for Indian equities and Indian markets. I do not think it can hold up and it is not holding up. I note today that in dollar terms, the MSCI India dollar index is very close to what it was in 2015 in dollar terms and has not really made much progress over that period. There was a big dip in 2016, a huge rally but not too far away and it has been kind of trading like the other emerging markets. It seems unacceptable that it should trade like other emerging markets because it is so different but it does definitely get caught up. Over many years that we have spoken, we have discussed optimism for the Indian economy which is not matched by my optimism for the Indian equity market because it appears to be so expensive.Once again, we should not confuse the two things. The Indian economy may have some issues with what is going on in emerging markets, but it will certainly have some issues if China devalues. But it seems to me that among all the emerging markets, India from an economic perspective, remains one of the most flexible. But remember the first rule of basic financial history over the long run is that there is no relationship between economic growth and the return from equities. As Mr Buffett says. price is what you pay, the value is what you get. At various times in history, equities can be so expensive that it can take many years for the economic growth to have a positive impact. I do not think the Indian economy will find itself as troubled as most emerging market economies, but I still find myself in a situation believing that the equity market is too expensive and is reflecting a lot of good news at a time when it is not just India but the world which is facing more bad news in Europe than in emerging markets.The weakness in the rupee is being seen as a positive for Indian exports but if the yuan weakens simultaneously, does not that increase the prospects of higher exports from China? Does it not put China in a more advantageous position versus other emerging markets? This whole trade of all expectation of a trade bias coming in, export competitiveness would get diluted then?Very much and the crucial difference this time is the yuan is part of this devaluation story which was not the case in 1997. It stayed very steady against the dollar then. It is the second biggest economy in the world. It is one of the world’s biggest exporters. It is not just that the stability of the yuan relative to the dollar has forced over many years the Chinese to have very high levels of nominal GDP. It has also forced them to hold far too many treasuries. The global monetary system and global growth for two decades is changing and that is really making me nervous. Obviously when something that has not changed in 20 years, starts changing and it is the world’s second biggest economy, that is big news.For emerging markets they are ambiguous and that is fundamentally bad news. It is not good news that they have a lot of dollar debt. India is not one of those but the others have dollar debt and really we are reaching an incredibly important point in world history. Historically, if you are an emerging market and you follow the dollar, you were following Renminbi because the two are linked.Now if China is moving to the flexible exchange which it appears to be doing, then every emerging market has got this huge question to answer. Do I link my currency to the world’s biggest economy, a protectionist economy and American first economy or do I link it to the Chinese economy? This is very important because if China is about to reflate as it seems to be trying to do, that is the country which would move to current account deficit. But it is the country that you might want to be linked with. If you believe that a current account deficit is coming in China and you want to sell things, you want to be linked to China and not the US dollar.But in the intervening period, we are talking about emerging market currencies falling against the dollar. That has always been problematic because of the legacy US dollar debt issues. This is one of the seminal moments in world history. Everybody who runs an emerging market is going to have answer that big question; do I follow the dollar or do I follow the Renminbi?

from The Economic Times https://ift.tt/2L0JyuX