Podcast 28th August 2015
Hi I am Arjun Parthasarathy speaking and this podcast is on “China is Exporting Deflation or Disinflation not Inflation and that is positive and negative for Your Investments ”
China is now exporting deflation or disinflation not inflation. China was once exporting inflation when it drove up commodity prices from oil to coal with seemingly insatiable appetite for investment led growth. Post the 2008 global financial crisis, China has struggled with weak global demand hurting exports, over investments, asset price bubbles and pollution. The last two months that saw the country’s equity market plummet by over 40% and the currency being devalued has brought to fore China’s problems.
China’s growth model is coming under scrutiny. Export led growth with a currency that was pegged to the USD has led to a large scale accumulation of foreign exchange reserves leading to liquidity flooding the system. China till recently had administered interest rates in the economy and that led to a property bubble as investors shunned artificially low savings rates and bought into speculative property. Banks too doled out loans to trusts that in turn funded property and infrastructure investments leading to what is known as “Shadow Banking Crisis” in China.
China is struggling with reforms as by nature the economy is not transparent. The “Black Monday” on the 24th of August 2015 underlined China’s woes.
The global market reaction to China was a free fall in equities, emerging market currencies and commodities. Commodity prices are off by over 50% from peaks seen in 2007 and given China’s economic issues, the outlook is extremely weak. Weak commodity prices are hurting countries from Australia to Brazil including all oil exporting countries such as Russia, Saudi Arabia and Norway. All these countries face the prospect of recession or almost zero growth.
The fact that the second largest economy in the world, China, is going through a slowdown driving a broad economic weakness in many parts of the world, the prospects of prices falling or rising at a very slow pace is extremely high. The lack of inflation is both a positive and negative. Countries running high government debt will have issues in servicing the debt if their economies do not grow and that can lead to a sovereign debt crisis such as the one seen in Eurozone.
On the positive side, lack of inflation will prompt central banks from the Fed to the ECB to keep rates at extremely low levels for long periods of time and pump in high amounts of liquidity to try and increase aggregate demand. The purchasing power of consumers too will increase as they can buy more with the same level of income.
India largely benefits from lower commodity prices as it lowers inflation expectations. Government benefits from lower subsidy bills for fuel and fertilizers and from a falling current account deficit. Interest rates can fall in the economy and with lower interest rates and stable to falling prices of goods and services, consumption can increase. However on the negative side, cheap goods from China can flood the country hurting corporates across all industries.
Investing in a deflationary or a disinflationary world can be tricky but with the right amount of analysis to identify the gainers in this environment, rewards can be big.
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