As the Bombay Sensex bobs up and down, I am amused by explanations emanating from stockbrokers. Some attribute fluctuations to the latest quarterly results, others to the ups and down of oil prices, still others to Indian economic and political events. Such analysis is mostly rubbish. Indian markets today are part and parcel of global markets, and move in line with global trends. Local events matter, but are subsidiary to global ones. Whenever local stock market trends fall below global ones, it is probably a good time to buy.
This was certainly the case when the stock market crashed after the NDA was beaten in the last election. Foreign investors were spooked by the possibility that the Left Front would dictate to the Congress, and so freeze economic reforms. That did indeed happen. Yet, after a pause, the Sensex boomed again, to heights unimaginable a year ago. A major local event was drowned out by a global trend, the rush of money into all emerging markets.
The biggest global trend today is what the new head of the US Federal Reserve Board, Ben Bernanke, calls a glut of global savings. He says record US current account deficits, representing an excess of spending, are mirror-images of excess savings in China and elsewhere. Across Asia, savings exceed investment, and so countries that used to run current account deficits now have surpluses.
This global glut of savings, especially the Chinese glut, is driving up global asset prices, including the Sensex. To that extent, the Sensex boom is driven by the Chinese savings boom. Savings rates are more stable than fickle investment fashions. That is good news: a Sensex collapse is less likely than in past cycles.
In the early 1990s, fast-growing Asian countries used to run large current account deficits, representing a shortfall of savings relative to investment. The shortfall was financed by capital flows from rich countries.
But after recovering from the Asian financial crisis, virtually all Asian countries have been running large current account surpluses. This is partly because of greater caution in policy, partly because investment has moved from East Asia and South-East Asia to China. Higher remittances from overseas nationals have also raised savings, notably in India.
China’s savings rate is now 50% of GDP, the highest in recorded history. This exceeds even its high investment rate of 45%. Foreign direct and portfolio investment further raises the savings surplus, which has no outlet within China, and so ends up in the country’s forex reserves. China’s forex reserves now total $ 769 billion, more than India’s entire GNP!
The global savings glut has been exacerbated by high oil prices. This has diminished the current account surpluses of some Asian countries, though not China’s. But the surpluses of oil exporting countries have gone through the roof.
In the 1970s, oil exporters went on a spending spree, ended in a mess when oil prices fell. They are determined not to make that mistake again, and so are saving their surpluses in funds abroad to ensure incomes for future generations. Russia, now a big energy exporter, had a trade surplus of $ 113.4 billion in August, more than even China’s $ 93.1 billion.
So, the savings surpluses of Asia are being exacerbated by those of oil exporters. Other commodity exporters are joining the party. Booming commodity sales gave Brazil a trade surplus of $ 41.2 billion in September. For the same reason even Argentina, historically a low saver, now runs a small current account surplus.
The global savings glut desperately seeks investment outlets across the globe. It has driven down interest rates across the globe, to extraordinarily low levels by historical standards. In real terms, the 10-year US bond has a zero or negative real return: US inflation is running at an annualized rate of around 5%, higher than the 10-year treasury yield of 4.6%.
Given such low real interest rates, the global glut of savings is naturally looking for assets with a better yield. Stocks in mature economies like the US already have high price-earning ratios, limiting prospects for appreciation. So the global glut has gone into the housing market, into junk bonds, and the stocks of emerging markets. That explains the boom not just in India but across emerging markets. The Sensex is up 20.8% this year, but that is nothing compared with the rise of 94.2% in Egypt, 62.7% in Colombia or 52.4% in Russia.
Is this a cyclical boom that will soon end a bust? In preceding decades too, sporadic bursts of global optimism sent billions into emerging markets, and every time the boom proved temporary. When excess optimism gave way to apprehensions of risk, billions flowed back from emerging markets into safe havens like the US. In 1995, an increase of no more than two percentage points in the US interest rate was enough to drive billions of FII investment back to the US, causing a crash in emerging markets.
A major difference this time, I believe, is the global savings glut. This is structural, not an investment fad. So it will tend to continue even in a recession.
Analysts fear that US consumer spending could suddenly fall, ending the current global economic boom .That is certainly a risk. But its immediate impact will be to raise US savings, and hence the savings glut. With a lag, increased US saving could cool the global economy and so reduce savings in other countries. But this process will take time, and the decline in savings elsewhere may not fully offset the increase in US savings.
I do not believe that the business cycle has disappeared, or that markets will move only upwards. But I do sense a structural change. I believe that emerging markets like India will no longer be investment avenues of last resort. They will continue to be in global portfolios even in difficult times. If so, the Sensex boom will be more durable than in earlier cycles.