India Unraveling: Stay Short Emerging Markets

In mid-2007, as the population of Pimpri-Chinchwad (commonly known as the Detroit of the East) exceeded the one-million mark, property prices skyrocketed and the country’s top real estate developers rushed to start building luxury residences for what was then anticipated to be a steady inflow of IT professionals. And given the overly optimistic statistics governing middle class consumer demand, automobile manufacturers (including Daimler Chrysler) began to fast-track capacity expansion plans. Today, Pimpri-Chinchwad, a mere 150 km away from India’s commercial hub of Mumbai and 15 km from the IT-metropolis of Pune, is in a state of total disarray.

General Motors (GM), which has a manufacturing facility near Pimpri-Chinchwad, shut down production for the second half of December. Leading Indian companies like Tata Motors (TTM) and Bajaj Auto have closed their plants twice for 3-day stretches in recent weeks. The fate of a proposed Volkswagen project is now in doubt. But it is the 4,500 small-scale ancillary factories which are telling the story of the impact of the global recession on India. “If matters don’t improve quickly, the nexus of our industry will be destroyed,” a senior city official said Tuesday. “Any recovery then will be years away.”

More than 35,000 people have lost their jobs in the second half of 2008; if the overwhelming numbers of small-scale outfits continue to operate well below maximum capacity, another 75,000-plus jobs will be at risk in the first half of 2009. To make matters worse, 25% of unemployed workers have left Pimpri-Chinchwad. About 200 factories have closed altogether, thus far; the city official estimated that owners of more than 1,000 small-scale manufacturing units could declare bankruptcy in forthcoming months and move out of Pimpri-Chinchwad for good. Construction projects have come to a grinding halt; like their counterparts in the industrial sector, thousands of casual laborers (in the “unorganized labor” category) employed by builders have returned to their villages where they will further pressure poverty levels.

As the city official explained, there is a more than fine distinction between a temporary lull in production activity and a scenario which threatens to erode the very foundations which turned a pilgrim center and trading (agricultural produce) township into a classic example of the India Rising story in the space of a few short years: “We are advising the 7,000-odd industrial plants in our municipality to simply lower output targets and production capacity in a structured manner; the alternate is a chaotic disintegration of the civic and industrial infrastructure.”

Speaking of infrastructure, plans to spend on highways, high-tech parks, civic services, storage facilities and rail transportation systems have been shelved. The development of a series of “green zones” has been postponed. A well-known local religious priest is offering perhaps the best advice to anyone who cares to listen: tighten your belts, revert to the old days of austerity and simplicity and spend money only on living essentials.”

In brief, Pimpri-Chinchwad today is a useful example of how the economies of the developing world are contracting. There are hundreds, even thousands, of Pimpri-Chinchwad’s in China, Russia, Brazil, Turkey, Indonesia and Ukraine, to cite just a few examples. What Pimpri-Chinchwad is undergoing is not a temporary pullback, not a short-term downturn, but a comprehensive downsizing in production, in consumer demand, in the size of the workforce and in urban wealth.

Equity analysts in the West, who continue to use words like “turnaround” and “recovery” when forecasting emerging market equity prices through to 2010, are well-advised to grasp the fact (for the first time in modern history) that these markets are in the process of a broad-based economic transformation, an actual reversal (or retreat) which cannot be countered by monetary shocks and stimulus packages.

Arguably, emerging market exchange-traded funds (e.g. ADRE, BIK, EEM, PMNA and PXR) have declined sharply in 2008. But that, by itself, is no reason to go bottom-picking today. Another 25% collapse in asset valuations within 6 months is a safe bet. Stay short.

Disclosure: Author holds a short position in EEM

Comments

[Short Trade...:]

I had a beer the other day in New York with a guy who worked of a hedge fund investing in India, they had just closed their doors, and no good bye check. But at some point the value must be there, I just wonder when...

Jan 01 06:56 AM

[andyn:]

India is actually better than China and Russia since its such a domestic oriented economy, unlike the others.

Yes, sectors which depend on exports will suffer along with the rest due to the global slowdown.

But I think companies such as the banks (HDB, IBN) and construction firms will benefit hugely due to the lowered inflation and resultant interest rates.

Good time to buy into the Indian market now and ride the other side of the hill.

Jan 01 08:48 AM

[investor88:]

I salute Rakesk for not only giving logical well researched view but acting on it [short EEM]. There is now a flood of bullish calls for a turn around in 2009 [in SA, everywhere you look] -- on balance I place more weight on Rakesh's opinions unless the markets show otherwise.

Jan 01 09:24 AM

[Rakesh Saxena:]

Thanks Investor88. There is little doubt that the current behaviour of the equity and bond marketplace is contradicting extremely strong bearish fundamentals. And then there are the Obama bounces which are more than likely this month. It is indeed a difficult environment to trade short on leverage; but the bearish bias must remain intact. - Rakesh


On Jan 01 09:24 AM investor88 wrote:

> I salute Rakesk for not only giving logical well researched view
> but acting on it [short EEM]. There is now a flood of bullish calls
> for a turn around in 2009 [in SA, everywhere you look] -- on balance
> I place more weight on Rakesh's opinions unless the markets show
> otherwise.

Jan 01 09:46 AM

[PROXIMO:]

I concur with author's analysis (as usual). Regarding the Author's Reply, I am not convinced that any Obama bounces are more than likely this month. His election may have given infrastructure plays a little gas, but beyond that, I don't see him providing any relief.

Jan 01 01:50 PM

[Urbane Gori...:]

Rakesh.... Thanks for the article. As posted above, I have been concerned at the bullish calls on India. In particular, I've noticed that Indian banks seem to be on everyone's minds (ICICI, etc...). I believe that deleveraging is invalid and your comments support my belief. Thaks for the local flavor.

As ana side, I think it was Jeff Makie of 'Fast Money' that said "It no longer is the 'BRIC' countries. Now it's only 'IC'" .... In fact, I don't see any upside to foreign markets right now. However, as they have been beaten down so much, It's hard to believe that there is that much more upside in the EEV or FXP....

jegan

Jan 01 02:10 PM

[Firat Ünlü:]

There's a huge difference between South East Asia and East Asia, whilst I don't see much potential for SEA now, EA has all the tools to buck the trend in 2009. I'm still not sold on India.

Jan 01 02:15 PM

[notsosmart:]

very good article re a local situation that can be applied elsewhere.

Jan 01 02:35 PM

[HaavBline:]

Thanks for a good report on a local situation. It is true the case in India could be happening in many emerging markets, however, different countries have different strengths and weakness, and will have different policy response and different capabilities to adapt to the sea change in global economoic environment. China, India, Mexico are producing countries that should benefit from sharply lowered commodity prices, Russia, Brazill, Middle Ease may suffer more.

The Indian response about infrastructure spending reported by Rakesh puzzles me. Why are projects shelved when India needs to stimulate domestic spending? Why did India announce a paltry $8B stimulus package? (Why bother to announce it?) This seems to be very different policy responses from most other countries. India's balance sheet may not be golden, but as far as I know it is not in dire strait either. So I wonder what the Indian central & state goverments are doing?

I agree about the Obama factor, market seems to WANT TO warm UP to the expectations of the big stimulus package. It probably will be announced soon after he takes office in late January, then we will see what happen. Market willl probably be dogged by questions about the financing and viability of that package afterwards.

Another reader made a good observation responding to another article:
From the standpoint of purchasing power parity (or considering PP differences in China & US), even a $1T Obama stimulus package will have somewhat less impact to the US than the $580B Chinese stimulus package will have to China.

Jan 01 10:49 PM

[Rakesh Saxena:]

Dear HaavBline: In response to your question about infrastructure projects being shelved (rather delayed and delayed), part of the problem is that the machinery to implement many of them is simply not there; then there are those regular activist protests against dams and factories on rural land, rampant corruption, and vested political interests. When you put all that together, you can grasp the point: there are so many incomplete projects, that new announcements are meaningless, regardless of size. Many thanks - Rakesh


On Jan 01 10:49 PM HaavBline wrote:

> Thanks for a good report on a local situation. It is true the case
> in India could be happening in many emerging markets, however, different
> countries have different strengths and weakness, and will have different
> policy response and different capabilities to adapt to the sea change
> in global economoic environment. China, India, Mexico are producing
> countries that should benefit from sharply lowered commodity prices,
> Russia, Brazill, Middle Ease may suffer more.
>
> The Indian response about infrastructure spending reported by Rakesh
> puzzles me. Why are projects shelved when India needs to stimulate
> domestic spending? Why did India announce a paltry $8B stimulus package?
> (Why bother to announce it?) This seems to be very different policy
> responses from most other countries. India's balance sheet may not
> be golden, but as far as I know it is not in dire strait either.
> So I wonder what the Indian central & state goverments are doing?
>
>
> I agree about the Obama factor, market seems to WANT TO warm UP to
> the expectations of the big stimulus package. It probably will be
> announced soon after he takes office in late January, then we will
> see what happen. Market willl probably be dogged by questions about
> the financing and viability of that package afterwards.
>
> Another reader made a good observation responding to another article:
>
> From the standpoint of purchasing power parity (or considering PP
> differences in China & US), even a $1T Obama stimulus package
> will have somewhat less impact to the US than the $580B Chinese stimulus
> package will have to China.

Jan 02 03:34 AM

[mrjain:]

Rakesh,

What a downer...but very true. My relatives have land in that area and a year ago they were getting top dollar (actually in this case rupees) for it but now that is not the case.

Some of the top auto contract manufactures talked about their big order flows to US companies but now they are mute on those orders.

Jan 02 06:10 AM

[Delojozafado:]

In 20/20 hindsight of course! What a prescient call on PXR as it outperformed with a plus 5% one day move in trading a day after this article ran. While it is probably correct to write off Russia the major emerging market players of Chindia, Brasil, Korea and Singapore still have plenty of unspent ammunition. Whereas the Fed & Treasury are now out of ammunition & have eschewed the printing presses in favor of the electronic creation of money. The Treasury now has T bill auctions scheduled for nearly every day of the year in 2009. They are hoping for an implosion in the treasury market and it will come eventually and rival the market down turn of the last 14 months. Not that that down turn is over as of yet with the bankruptcy of the autos and their suppliers only postponed. Once the bond market reverses the major near term clear and present danger of DEFLATION will have been slain. While last year pundits were predicting China's GDP growth to slow to 3%, now with massive stimulus there and now in other emergent economies India most prominently, we see predictions rising to the 7-8% range. China has tons of cash to invest in itself and India need only ease it's foreign investment restrictions. This is bad news for the US debt market particularly low yielding LT treasuries. Global infrasrutucture companies and their bonds are likely to fare quite well going forward into this year. The US has resorted to desperate measures to prop things up. The issuance of TRCAs, which are not really temporary at all just rolled over on expiration is just one example of how bad it is for the US and it's currency. The idea that the US was responsible to prop up and bail out foreign banks and governments shows how desperate the situation is. There is likely not going to be any whole sale liquidation of short and Med term US Govt debt, just a gradual degradation in it's value. The long +10 year paper is just heading for the junk bond scrap heap or yield model. Probably both! China and India are just going to accelerate their consumption of stuff as they build more power plants, power grids, roads, bridges, public transport and the rest. They will continue to use lots of steel, coal, oil, Nat Gas (N/A sourced LNG?), copper, lead zinc and the rest. They may not have been decoupled going into the global recession/depression but they certainly look poised to "emerge" quicker and leaner than the rest of the world.

Jan 03 09:01 AM

[freefall51:]

Rakesh,

keep going. I like your articles.

BTW, I think the latest mini-bull is just based on a temporary lack of sellers after the recent tax loss sell-off and due to the fact that the indices hit a major uptrending support line. The market tries to sneak in an upswing on low volume. This is not logical to me given the overall conditions but the market proves me typically wrong.

Jan 03 10:41 PM

[Rakesh Saxena:]

Thanks freefall51. As far as the market is concerned, it will be interesting to see how long this mini-bull run can go on in the face of clear and unequivocal facts to the contrary. Part of it, of course, is that most investors are fundamentally bulls, and issues like the Obama stimulus, auto bailouts etc are treated as positive signals--in my view, as you know, these rescue packages are actually bearish indicators. - Rakesh


On Jan 03 10:41 PM freefall51 wrote:

> Rakesh,
>
> keep going. I like your articles.
>
> BTW, I think the latest mini-bull is just based on a temporary lack
> of sellers after the recent tax loss sell-off and due to the fact
> that the indices hit a major uptrending support line. The market
> tries to sneak in an upswing on low volume. This is not logical to
> me given the overall conditions but the market proves me typically
> wrong.

Jan 04 01:04 AM

[Rakesh Saxena:]

Thanks freefall51. As far as the market is concerned, it will be interesting to see how long this mini-bull run can go on in the face of clear and unequivocal facts to the contrary. Part of it, of course, is that most investors are fundamentally bulls, and issues like the Obama stimulus, auto bailouts etc are treated as positive signals--in my view, as you know, these rescue packages are actually bearish indicators. - Rakesh


On Jan 03 10:41 PM freefall51 wrote:

> Rakesh,
>
> keep going. I like your articles.
>
> BTW, I think the latest mini-bull is just based on a temporary lack
> of sellers after the recent tax loss sell-off and due to the fact
> that the indices hit a major uptrending support line. The market
> tries to sneak in an upswing on low volume. This is not logical to
> me given the overall conditions but the market proves me typically
> wrong.

Jan 04 01:06 AM