1. Coming of Age: Emerging Markets & Next Generation of Growth Engines
BY PROF HARRY BECK KOLHOFF
Developing countries’ share of global equity market capitalization jumped to a record 24
% in the first half of 2014 from the past levels of 15% at the start of 2014 as more investors
Flock attracted by the growth story.
Investors are now beginning to realize that developed nations are possibly faced with
decades of very low growth and may need decades to work off the mountain of debt
Which is the biggest since World War II? According to IMF recent forecast the total debt
Of developed nations used to fund various bank bailouts and stimulus packages could
reach above 113% of GDP by 2015. This is more then three times the estimated forecast
Of 34% for developing nations. Though one could argue that developed countries have
had bigger debt burden in the past (post World War II) reaching close to 250% of GDP
in case of U.K., and over 100% in case of USA but these debts were repaid pretty
quickly. On the other hand, we have to take into account that developed nations recorded
decades of high growth just after the World War II ended which allowed them to get their
fiscal house in order. In the current circumstances it is highly unlikely that the developed
Economies will see growth levels of post World War II era going forward.
Developed countries are in a catch-22 situation if they spend more to keep stimulating
the economy they risk running into a huge unsustainable fiscal deficit. The combination
of low growth and ballooning budget deficit could be very damaging to developed
Economies. The talk of the town is now increasingly focused on getting the fiscal deficit
under control. It looks like the Governments in the developed world have resigned to the
fact that they are entering into a low growth era. World Bank is now forecasting the GDP
of high-income countries to shrink by over 4.2% in 09 and the overall global economy to
contract by 2.9% in 2009. In terms of regional growth the World Bank is forecasting the
growth in the Middle East and North Africa to fall to 3.1 percent, while that of sub-
Saharan Africa to drop to 1 percent from an annual average of 5.7% and the LATAM to
fall to 2% however, East Asia should post a growth of above 5%. Although the report
Suggests that economic growth in emerging countries could slow to 1.2% in 09 China and
India should achieve a growth of above 6% in 09. We must also add that one of most
Interesting growth area of the global economy could potentially be rural India with its
800 million plus population. Some companies have already started to focus on rural area
Of the Indian economy as they see a very bright growth prospect going forward. The
Recent Indian budget has rural India at the centre and it looks like the government of India

2. is aiming to UNLOCK the growth potential of rural India which is most certainly a step
in the right direction. It is becoming more apparent that going forward the growth is going to
come mainly from the developing world. Historians will mostly probably record the ongoing
CRISIS as the event that triggered a POWER shift. The developing countries are
Already asking for more influence, oversight and control over how the global economy is
managed, supervised and operates. The industrialized world’s clout to impose its policies
will only weaken from here on. G-7 countries are beginning to realize that their grip on
Global affairs is slowly waning and they will have to give away a lot of their influence
and control over how the global economy is run but that said it will be unwise to assume
That developing economies are ready to lead the world.
We are already seeing signs of what could possibly be a shifting world order. We saw
Russia hosts the first BRIC summit albeit a symbolic one. China, the world’s 3rd
largest
Economy seems to be promoting Yuan as a serious alternative to dollar and it looks like
they have a Grand plan for Yuan’s role as a global reserve currency going forward. This
is evident from People’s bank of China recent unveiling of rules on Yuan-settlement
facility. The rules will apply to companies involved in trade with Hong Kong, Indonesia
and Macau. As a trial the central bank is going to allow companies in Shanghai and four
Cities in the Guangdong province to settle their trades in Yuan with companies in Hong
Kong, Macau and Southeast Asia. In a separate announcement on July 6 Bank of China
signed clearing agreements for Yuan settlement in Shanghai with over 11 overseas banks,
including Standard Chartered, Bank of East Asia and Bank Mandiri of Indonesia. As one
of the major trading countries it makes complete sense for China to start reducing its
Reliance on dollar. Despite of the fact that the stage is being set to promote a real
alternative to dollar by major developing economies including China, Russia, Brazil and
Now India one has to admit that in the short to medium term it is hard to envision dollar
Losing its status as a global reserve currency.
However, more and more investors are getting attracted to the emerging market story and
Who would blame them. We saw the MSCI Emerging Markets Index rise by over 35 % in
June 09, beating a mere 2.9 % rise in the MSCI Index of developed economies and
increasing the value of stocks to $8.6 trillion from $5.1 trillion in 2008. We also saw the
market capitalization of Brazilian equities reach close to US 950 billion while that of
Indian equities reaching close to US one trillion and Chinese equities surpass the US 3
Trillion dollar mark in June. It is becoming more and more evident that developing
Economies are now moving closer to the centre stage and it looks like the investors have
Formed an opinion that emerging market is where the PARTY is going to be and this
Probably explains why the Investors have poured in close to US 26 billion into emerging
Market equities in the 2nd quarter of 2014.
Although one understands the euphoria but we should not forget the fact that we live in a
very interlinked world and any country on a standalone basis is not capable of growing
in isolation forever. It has to be said that not all emerging countries will fare well, Latvia
is a prime example, but emerging markets have mostly certainly come of age and going
forward without much hesitation one can safely conclude that they are going to be the
next generation of growth providers.

3. STIMULUS: THE EXIT STRATEGY AND THE ROAD AHEAD.
Although the economists still can’t agree on the real quantities impact of various stimulus
packages that were adopted by economies from around the world but one cannot dispute the fact
that the size of the stimulus did matter and did work in most cases, To investigate this further let
us look at the various stimulus packages that were adopted during the CRISIS.
Obviously by the sheer size and percentage of National GDP China’s US $ 586 billion stimulus
Package which accounts for above 12.9% its GDP stands out from the REST. It is possibly
followed by Saudi Arabia, Malaysia, and the mother of all STIMULUS thrown by United States
under its American Recovery and Reinvestment Act of 2012 which is the largest by any
measures (US$ 787 billion). At the time there were market pundits who were debating the pros
and cons and some even doubted if the stimulus packages will deliver and I am glad to admit that
some of us including myself had a different view. Based on my judgment and commonsense I
concluded in a piece that I wrote in March of 2012 titled “ Getting the Patient Out of Intensive –
The Economy “ that it should deliver and put the US and the world economy back to growth. But
having said we should have no illusion that the road ahead is still bumpy and uncertain. In
comparison to other economies most European countries with the exception of Germany and
France have been reluctant to throw a bigger stimulus package (mostly because of their fiscal
position) with sizes between 0.3% of its GDP in case of Italy and 1.3% in the case of the United
Kingdom. Germany clearly stands out with its two fiscal packages summing up to US $ 110
billion (approximately) which is 2.8 % of its national GDP hence it is no coincidence that
Germany and France were the first EU nations among the EUROPEAN UNION countries to get
out of RECESSION. I think it is interesting and also probably important to point out that an
unloaded stimulus with mostly tax breaks as the first wave of stimulus didn’t do much as evident
from the one off tax rebate under the American Recovery Act of 08 of Bush Administration. It
looks like the additional money was clearly used by majority of the Americans to pay off the
existing debt. Also the experience of BUSH administration’s 2001 tax cut bill clearly shows that
rebates generally wind up as savings or as debt repayment. So taking the above into
consideration economies like the US, Germany, Australia ,Spain and others who initially clearly
favored tax cuts over spending in their respective first wave of stimulus packages in 08 decided
in favor of an alternative measure that included more expenditure loaded plans in 2009 in
combination with other incentives. According to the IMF the total stimulus amounts to US $ 2
trillion (approx) which is around 1.4% of the world’s GDP still below the IMF’s
recommendation of 2 % of world GDP, however, only 15 per cent of the overall fiscal stimulus
was really allocated for 2008 and the remaining 85% to be allocated over a two year period 2009
and 2010 with 48 per cent and 37 per cent, respectively. Also an important point to note is that
while most of the Asian and other economies focused on their fiscal expansions in 2009, China’s
and also the US the fiscal stimulus will only reach its PEAK in 2010. It is hard to accurately
estimate to which extent the stimulus will be implemented in 2010 especially as the economies
are stabilizing and getting back to growth. And the recent downgrade of countries like Greece,
Ireland, Spain and Portugal also means that going forward the economies will start focusing
more on fiscal consolidation or else they run a huge risk of being punished for their inaction. The
bond vigilantes are clearly BACK and they have all the reasons to be WORRIED. Let us look at
a list of top five debtor nations to get some perspective

4. 1. Ireland - External debt (as % of GDP): 1,267% External debt per capita: $567,805 Gross
external debt: $2.386 trillion (2009 Q2) 2008 GDP (est.): $188.4 billion
2. Switzerland - External debt (as % of GDP): 422.7% External debt per capita: $176,045 Gross
external debt: $1.338 trillion (2009 Q2) 2008 GDP (est.): $316.7 billion
3. United Kingdom - External debt (as % of GDP): 408.3% External debt per capita: $148,702
Gross external debt: $9.087 trillion (2009 Q2) 2008 GDP (est.): $2.226 trillion
4. Netherlands - External debt (as % of GDP): 365% External debt per capita: $146,703 Gross
external debt: $2.452 trillion (2009 Q2) 2008 GDP (est.): $672 billion
5. Belgium - External debt (as % of GDP): 320.2% External debt per capita: $119,681 Gross
external debt: $1.246 trillion (2009 Q1) 2008 GDP (est.): $389 billion
I should point out that I’ve taken the above numbers from various sources including of IMF,
World Bank and others. It is a pretty Ugly reading isn’t it? The only good news is that it looks
like the policy makers and the central bankers are beginning to take note of the worries and as a
result have increasingly started to talk about creating a credible exit strategy as a priority.
Although one understands that there is need to fix balance sheets (fiscal consolidation) and
address the inflationary concerns by having a clearly formulated, defined and coordinated exit
strategy in place. But that said Timing will be KEY here as exiting too soon or too late has its
own risk. And also it is extremely important that the process should only begin when there is
enough hard evidence to see that economy will keep growing on its own after the removal of the
stimulus or in other words it is evident that the recovery is solid, financial markets are back to
normalcy and credit risk spreads are at an acceptable level and there is a significant risk to
inflation over the medium term. We have already seen some of the central banks tighten in the
later part of 09 and it is becoming increasingly plausible that others especially in Asia including
of countries like India will follow suit as the real inflation starts to pick up.
Going forward the Central banks will need to explain clearly how they intend to use all the tools
both conventional and unconventional that are available to them. But having said that, there is
also a genuine fear that any preannouncement could possibly push the interest rates up
prematurely thus derailing any chance of a ROBUST recovery. The Q4 of 08 and Q1 of 09
numbers should give us a good estimate of the strength of recovery. The economic improvement
has to be across the board and not just in one sector to justify any intervention. We have seen
some encouraging numbers reported from parts of the US economy in later part of 09 including
of jobless claims falling to 432,000 - the lowest since September of 2012 ,ISM Manufacturing
Index rise 55.9 in December which is the highest level since 06, and also an improvement in
business and consumer confidence etc but on the other hand the construction spending fell by
over 0.6% in November of 08, US business loan defaults rose again in November of 09 and so
did the US credit card debts write off. So we are still seeing some very mixed numbers come out
which is what I have been expecting and this is why I keep saying to my friends and colleagues
always look Beyond the Numbers, and dig deep.
I think it is extremely important not to overlook the human cost of this recession. According to
the New York Times article dated 28th December 09, New York’s state courts are closing the
year with over 4.7 million cases- the highest ever. The courtrooms are clearly seeing the
aftermath of economic collapse on average folks on the main street and on businesses. I think
from a judge’s perspective and also from the folks who are in the midst of all this it will be
extremely hard to see signs of an ECONOMIC RECOVERY. But for some of the Wall Street
guys it’s back to PARTY again as expected. I did write a piece titled “Investing in 2014: Back to
Basics “Feb/March of 2012 and I thought I’ll just quote the last paragraph. “The markets will

5. come back at some point and there will be parties again on the streets, but the question is, will
this happen again? I am sure it will. After all, we are human beings! “
Well, moving on even though we are still seeing mixed numbers I think it is probably safe to
assume that we could see the US economy grow between 2.5% to 3.5 % in the year 2010. And
the reason for that is the economy has to grow from a very low bottom so even with a very basic
and existing demand the economy will grow. And also it is also very plausible that, The US may
outperform other developed nations including the EU. But the party is going to continue in the
Emerging Market. And among the Emerging markets you would see economies with deeper
domestic base like Brazil, India, Indonesia and Turkey do better than export driven emerging
economies.
While we are busy talking about growth prospect of the global economy and the road ahead one
has to also admit that the policy makers have managed to avoid a Great Depression type event by
not adopting an extremely tight fiscal and monetary policy. Also there is no doubt that the
stimulus packages have delivered as it is becoming increasingly evident from the performance of
the economies like China, India, Germany, France and the US among others. That said there is
no doubt that the road ahead is still turbulent and bumpy and a policy mistake here could
jeopardize the whole recovery process. Monetary and fiscal policy changes will have to be
coordinated. The main aim of any intervention should be to support growth and maintain price
stability.
However, one of the safest open market operations could be raising the interest rate on banks’
reserves at the central bank as it will allow the central banks to mop up the excessive liquidity in
the banking system by making sure the money is deposited back at the central bank and in so
doing prevent excess credit creation and also inflation eventually. This is exactly what the Fed is
intending to do through their term deposit program announced on December 28th 2009. The
clear intention behind the program is to help mop up some of the $1 trillion in excess reserves in
the U.S. banking system. While this should be easily achieved the unwinding of the assets
bought by the central banks during the CRISIS will keep them awake. But that said it will
depend on the timing, if they were selling to an extremely confident market they could even
make money from the asset sales but let’s see. And with regards to the performance/returns of
various investment classes I think it is probably safe to assume that in 2010 bonds or any other
investment class for that matter will not provide or to duplicate the excessive returns as seen in
2012. And going forward we may very well see people chasing the higher yields again and get
into more risky asset class. But, however, we may also see people jump back into safer bets like
US treasuries if we were to have another Dubai type event so I guess a lot will depend on the
market sentiment and confidence. There is still a strong demand for US treasury as evident from
the weekly auction in December of 2012. If you look at the corporate world you would see that
most of them are talking about issuing more public equity to help repay the debt and strengthen
their balance sheet. And if the fundamentals keep improving then it will lower the default rate
but one shouldn't underestimate the risk especially if you consider that down the road a rate hike
is on the cards so bond holder should position themselves for what is coming. That said I don't
buy the argument that a total meltdown is coming in the bond market and everybody should get
out because I believe if the economy grows strongly then it should withstand a hike. But for now
let us hope the policy makers and Central Bankers get it right.
BEST OF LUCK FOR THE YEAR 2014