China crisis worsens EM rout, choppy times ahead
Though the fear of increased tapering by the Fed on January 29 is probably responsible for the selloff in all emerging markets including India where the Sensex closed 2% down and the rupee 0.66% on Monday, each of the affected countries have their own set of unique issues—Thailand is once again rocked with street protests and the possibility of next month’s elections getting delayed, Argentina looks like going into another of its decennial crises, Turkey’s corruption scandal has come dangerously close to its prime minister … But of all these, the biggest fear is that, with its factory sector continuing to shrink—at 49.6, manufacturing PMI is contracting and at a 6-month low—China's shadow banking crisis can erupt anytime soon. China’s National Accounts Office data confirmed, on December 30, that there was a massive 67% jump in the debt of provincial governments in the last three years—it has now reached 31% of local GDP—and around 60% of this matures in the next three years. In itself, that is not worrisome since, at the worst, the national government has the capacity to bail out the sector.
What spooked the market was news that one of the shadow-banking sector’s investment scheme—this was sold by the Industrial and Commercial Bank of China (ICBC)—was about to renege on its obligations. China Credit Company, the shadow-banking company loaned around $500 million of the funds it collected to an unlisted coal miner that is now not in a position to pay back its loan. While ICBC has now, according to a Reuters report, qualified its earlier position that it would not bear the main responsibility of paying off lenders—it has now said it “won’t ignore the issue of its reputation”—the investing community doesn’t know which shadow bank will go bust next given that much of the money raised has gone into real estate. Real estate investments are up to 15% of GDP, up from 10% in 2008—more worryingly, the market value of floor space under construction, a BNP Paribas analyst note points out, is up from around 65% of GDP in the five years to 2008 to around 155% of GDP, making it very susceptible to a slowdown in growth.
Though India looks a lot better than it did a few months ago with $34 billion more with RBI, the current account deficit in much better shape, and the government more proactive than it has been in a long time, investor resistance to EM stock will certainly affect India. So far, after the $3.7 billion FII outflows from equity in June to August when the Fed began talking of a taper—it was $12.9 billion for debt between June and November—another $9.2 billion has come into equity markets since and there is a stock of close to $175 billion already invested in the market. The only hope of escaping the EM contagion—and it does look like that right now— is keep reforming and hope that, post-elections, India has a stable government.