What China and India's knife-edge ride means for investors

What China and India's knife-edge ride means for investors

This article first appeared in Livewire markets on the 15th June 2022

China and India are the world's two largest emerging market economies, yet both face an uphill battle as they reckon with COVID and inflation respectively. 

Amit Goel, Lead-Portfolio Manager of both the Fidelity Global Emerging Markets Fund and the India Fund, gives us his take on the headwinds facing these emerging market heavyweights.   

"We have seen a huge impact of COVID lockdowns on Chinese consumption, which was the strongest part of the economy last year," he said.

In India, the problem is inflation, which India's central bank has responded to by lifting the cash rate by 50 basis points (sound familiar).

But there is one specific sector that he believes has found clear air above the headwinds. 

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What is the outlook for Chinese companies post-COVID lockdowns?

COVID lockdowns in China are a big event for a lot of industries within China. Obviously, we have seen two months of lockdown in large cities like Shanghai, Beijing had a small lockdown and they've been able to manage it better. 

So if you see the last four months of Omicron, what we have seen is that different cities have behaved differently. We had lockdowns in Shenzhen at the start of the year, which was managed very well, so they were out of the lockdown in two weeks' time. 

But then we had Shanghai which went on for two months. And some of these cities like Shanghai, Beijing, Shenzhen are a big part of the Chinese consumer market, and Chinese GDP, so they had a devastating impact on a lot of industries.

If I start with the most impacted industry, which is consumption and hospitality, so you saw a big decline in restaurant sales. 

A lot of these restaurants were closed in a large part of the cities. We saw consumer discretionary demand, whether you're talking about home appliances, whether you're talking about sportswear goods, they were all very strong in the first quarter but they started declining very strong double digits in the months of April and May. 

You saw the last of the property market, which was down 50% in sales year on year, which was again hugely impacted by both lockdowns as well as weak consumer sentiments. We have seen the huge impact of these COVID lockdowns on Chinese consumption, which was the strongest point of the economy last year when the property was already slowing down.

I think the way out from here is also very uncertain. Everybody has their own views on China zero COVID policy, but my view is that China will continue with its zero COVID policy unless they have a clear scientific exit strategy. 

China is continuing with a zero COVID policy because I think every country in the world has gone through a mortality curve and a lot of scientific models suggest that with the kind of vaccine acceptance and booster rate China has, with the comorbidity of the elder population China has, China will have few million deaths if they have to open up now to this Omicron virus. 

How the next six months could be an uncertain time for China's path out of COVID

China is looking at increasing its booster rate in the elderly population, especially in the 60 to 80 year old, which are mostly vulnerable. And then China will probably hope for a milder variant at the end of the year or early next year.

So, to me, the next six months are going to be very uncertain. We might continue to see some of these lockdowns back and forth, but the exit strategy is a combination of better acceptance of vaccine and booster rate and probably a milder variant of the virus.

How the Reserve Bank of India's rate hikes affect valuations 

If you come to India, I think India has been slightly behind on the inflation and interest-rate curve. 

The Reserve Bank of India has a kind of comfort zone of 4 to 6% inflation. We saw inflation being managed in that range till last year and then inflation started to creep up largely driven by energy prices and India has a large import of energy, which is almost 5 to 6% of a GDP. 

And these higher energy prices coupled by food inflation, as well as labour inflation has resulted in inflation going to 7, to 8% now, which is clearly [00:03:30] outside the Reserve Bank of India's comfort zone.

We saw a steep decline in interest rates in 2019, and 2020. We have seen a stabilisation of rate at 4% throughout 2021. And now we have started to see rates increasing, which I believe are still behind the curve. 

The Reserve Bank of India has increased the rate from 4% to 4.9. So they've done a 40 basis point hike and the 50 basis point hike yesterday. And now what we expect is maybe another 100 to 150 basis point going forward over next six months.

When it comes to interest rates, I always believe that interest rates are a symptom of something happening in the economy. Either the economy is heating up, we have very high growth and the central bank needs to moderate it. 

Or we are going through a very high inflationary period and the central bank needs to moderate it through their monetary policy. 

Now with India, the case is the latter, where they need to tame this inflation, clearly taking it back. They're still worried about high energy prices, and high food prices. India self-sustains on food, but we are seeing in some parts of food grains as well as oil prices are increasing. 

So, they're very conscious of inflation. They will do whatever they want to do to get this inflation back into mid-single digit range. And obviously, this will have some impact.

As I said, higher rates and higher inflation will impact consumer sentiments, consumer discretionary power. 

You can see further increases in energy prices from here because the government is actually now subsidising a bit of fuel and oil prices, which can change going forward as government look to pass some of those increases. 

So the next six months, again, are, are going to be slightly difficult for consumption, especially discretionary consumption.

Why Indian financials will remain strong in the face of rising inflation

But overall I think the financial stability in India is very good. I don't see big impact on markets like housing or financials. Where I think affordability is still very good in terms of financial system, banks' balance sheet is very strong, they've always capital, they've all gone through asset cycle. The bigger impact of inflation and interest rate is to be felt on consumers.

I think the joker in the pack is energy prices. 

If energy prices continues to remain this high, we can continue to see inflation moving up and interest rates moving up. But if energy prices moderate from here, I think India will have enough room to balance its monetary and fiscal situation.

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