Economic Outlook: 'We're Not in the Double-Dip Camp'

As chief investment officer for Asia of venerable Swiss private bank Pictet, Singapore-based Bhaskar Laxminarayan needs to know what’s going on in the global economy. His insights should prove useful for CFOs and other finance executives, both in the context of financial management and personal investing.

Does he foresee a double-dip recession? “We are not in the double-dip camp,” says Laxminarayan. “The reason is simply the underlying macro-economic data across the world, which has started to improve.” What about asset bubbles in China and the possibility that these can stall economic growth there? “People don’t give China the credit that it deserves, especially when it comes to handling some of the macro-driven issues.”
“The central banks have the task of keeping sentiment positive, while at the same time starting to withdraw the policy measures that they took to ease the concerns of last year,” he adds. “That’s the bridge which is not easy to cross and that’s what worries us.” Laxminarayan, who was CIO of Shinsei Asset Management and senior vice president at Alliance Bernstein before joining Pictet in 2007, spoke to CFO Innovation’s Cesar Bacani.
Let’s first talk about the macro-economic environment, which CFOs need to anticipate in their forward planning. Do you see a double-dip recession coming?
We are not in the double-dip camp. The reason is simply the underlying macro-economic data across the world, which has started to improve.
We look at it from two perspectives. One is the underlying [trends in the real economy], which means what’s happening with the jobless rate, with new job creation, commodity prices, inflation, productivity levels, the output gap. And then there is the financial economy -- what is the amount of public debt, what is the amount of private debt, what’s happening with the currency, what is the ability of the central banks and the financial reserves in each of these countries to go through the crisis?
In the real economy, we are seeing a very clear turnaround. It’s much more visible in the process of employment, where we’re beginning to see some troughs. I think unemployment levels have possibly reached the bottom. We’re beginning to see job creation, in fact, beginning to pick up in some parts of the world. We definitely see trade data beginning to turn around across the globe. We are seeing an improved element of production ability. We’re definitely beginning to see a turnaround in industrial production across the world.
We think that the virtuous cycle is beginning to come back, as it has already come back in some parts of the emerging world. It is maybe a few quarters away in some other parts of the world.
When it comes to financial side, this is where I think you’re beginning to see a big divide between the countries that were affected. The US obviously stands out. You’ve seen deleveraging happening both at the household level and at the corporate level. Households are beginning to save a lot more. The corporates are deleveraging their balance sheet – and all that excess has actually been transferred to the public space. The public debt has thus gone up, which is not great news from a central bank’s perspective.
What you don’t want to destroy at this stage is the confidence that’s been built in the last three to four quarters. From the first quarter of 2009, when things looked like they were going from bad to worse, we have seen a complete turnaround in consumer sentiment, in investment sentiment and at the corporate level. The central banks have the task of keeping sentiment positive, while at the same time starting to withdraw the policy measures that they took to ease the concerns of last year. That’s the bridge which is not easy to cross and that’s what worries us.  

You’re saying that the financial economy can derail what’s happening in the real economy?

That can happen through many ways. It could be because the policies were re-rolled back in a much more aggressive manner or maybe interest rates were raised very quickly or maybe it was just the tone of the central banks’ [statements] . . . It could be as simple as that.
But you still think that there won’t be a double-dip recession? Perhaps just moderate growth in 2010?
Yes, but I think you should also expect price corrections, that’s a given. Do I see unemployment numbers again go past what we have seen in the past? Hopefully not. Do we see trade decline like the way we did in the last quarter of 2008 and first quarter of 2009? Maybe not. So I think that is what we have to hold on to.
I think a big part of what was done last year was to [put] a floor on this entire economic situation that’s going on. Having done so, the central banks would still stay on the course to see to it that there isn’t a double dip. I think a lot of people would expect that there would be some sort of jitters. They would be watching out for that, be it the European Union having to deal with a Greece-like situation, or what happened in Dubai, or whether it is Obama trying to dole out his plans from healthcare to finance. You should expect some amount of monthly gyrations. But as long as the underlying trend of economic activity continues to improve, I think people will be OK with that.
What about the banks, though? We saw the financial system practically grind to a halt in 2008. It was difficult and expensive for many companies to find financing. Are we back to normal?
This is not really an Asian crisis at the end of the day. If you were to look at how much assets the world had written down, it was about US$1.7 trillion [as of December last year]. Of that US$1,723 billion, US$1,100 billion was in the US while US$72 billion was in Europe. Asia including Japan had US$43 billion, and a big part of that is Japan. If you took away Japan, Asia ex-Japan, there is literally nothing.
But Asia is part of the global system.
This is why it’s important to make this distinction between the financial aspect of the economy and the real economy. What affects Asia is a downtrend in the real economies. If things like trade start getting affected, yes, that has a direct impact. But mismanagement of the banking system [in the West], it’s not a direct impact, it’s more a derived  impact because people become that much more nervous and they spend less and therefore they will therefore be buying less from Asian countries and trade will be affected.
Are there going to be more write-downs going forward?
I think we have possibly passed the peak in terms of the write-down cycle. Also, there’s been sufficient capital that has been raised against those write downs. If you were to go and look at banks in the US or even in Europe, the banks don’t look in bad shape.  
Really? What about the toxic assets that we were hearing about, subprime loans, losses on derivatives?
In some form you can say they’ve been transferred [to the public sector]; in some form they have basically been written off and they’ve been cleansed through either fresh capital that’s been raised or through support from the government, from the sovereign. That is really the change that we have seen. As to how it will work out, obviously, for all financial systems and banks especially, once you take out the assets that’s not earning, and you recapitalise the banks where you giving it fresh funds, it’s as good as a new bank.
Are the banks in fact lending again?
Yes, they are wanting to lend again. Credit continues to be very slow in the Western world because the individual is trying to save more, so he is not wanting to take on additional debt. The corporate client is also trying to deleverage. But I think all those things are coming to a point where households are getting comfortable with their level of savings, and I think the corporates are also getting more confident about reinvesting, so this means they will not be deleveraging and actually start taking out more leverage.


Some commentators say China can be Dubai 1,000 times, referring to property and other asset bubbles there. 
People don’t give China the credit that it deserves, especially when it comes to handling some of the macro-driven issues. I think that the governance there is actually pretty good, partly because they have seen what has happened with the rest of the world, so they have history to look at as one starting point. If you look at all the attention that’s being paid in China today – be it in terms of the reserve requirements, in terms of what the central bank is thinking about new loans – a big part of that is really that they are worried about asset bubbles in some form or the other. They are expecting some sort of a price running away and they don’t want that happening.
They realised last year that there was a very dire need to do something immediate and the only thing that governments can immediately do is to start creating fixed asset formation. That is why a lot of the projects that were started last year were government-led and were in capacity creation. But they also realise that some of the capacity creation could actually lead to excess, which is why they’re pulling back some of those. You need to do something to get the country up and running, and then once it’s up and running, you can always pull back some of those support levels. Sometimes you do get a little bit of excess to get the country back on its feet. But after that you can always slow things down.
Can the Chinese and the Americans and Europeans, for that matter, pull back the stimulus spending in a way that will not hinder the recovery?
In the US, you’re looking at a structural deficit that has really gone through the roof; it’s expected to go past 7% [of GDP] this year. They’re looking to reduce that by half in the next two to three years. For you to come back to a more realistic 3% kind of number, you’re talking about some pretty aggressive stance that needs to be taken over the next 24 to 30 months.
Can this process be free of any glitches and can there be a smooth ride? Almost never so. It will have its share of ups and downs. But I think what one has to hold on is to see if the underlying economy in all these places are continuing to show a trend that is sustainable. As long as that is true, then I think some of the pain that might happen in terms of prices moving up and down [will be tolerable].  
And that has deep implications on corporate profits and growth.
That could have implications on sentiment, that could have implications on interest rates, that could have implications on liquidity and hence obviously would also affect all the participants, including corporates and households.
You mentioned Greece. If the EU fails to deal with the Greek crisis, how bad will that be, considering that Greece accounts for just 2% or so of the EU economy?
I think what everyone’s worried about is what happens with Spain, what happens with Italy. Is there a contagion effect? This is the first crisis for the region as a whole. They were independent countries before; they are the European Union today. So how they deal with it becomes a benchmark and a reference point for all future situations.
All this uncertainty is weighing on the euro. Do you see it continuing to be weak against the US dollar and Asian currencies, including the renminbi?
We do believe that there is an equilibrium issue with the euro. We think against the dollar especially, it’s still undervalued. Both those currencies are not extremely well-placed due to various reasons, but if you look at the long-run equilibrium, we think that a more appropriate level is something like 1.27, in that region, for the USD-euro.
The dollar rebounded pretty strongly in the last two to three months. When there are doubts about what’s going to happen to the world, you will see that the dollar does well simply because that’s the largest currency that people can move back into.
How about the Asian currencies? If I’m a CFO and I’m looking at matching my renminbi costs with my US dollar revenues, can I expect the RMB to remain where it is today?
The Asian-dollar index has appreciated this year. This has implications for the Asian market, because relative to the Asian currencies, you need a weaker dollar for the Asian markets to grow well. As long as the money flow is still towards Asia, the [Asian currencies] will continue to appreciate against the dollar.
Does it make sense for Asian companies to hedge against a weakening dollar, if they are exporters?
It’s easier said than done because Asian currencies are not easy to hedge. This is really a question to be answered a few years from now. The really significant player at the end of the day is China and we all know that it has a controlled currency. Most currencies here are in some form or other in a controlled environment and give you very limited scope for hedging.
As a company you should probably explore natural hedging – if you manufacture in China, you also sell some of your products in China.
Yes, natural hedging is something that is all in the region. So typically if you were to look at companies today, as to how they are operating and how they are managing their cash flows in businesses, you’re beginning to see that they’re trying to try and match, if not in their own country at least in the rest of the region.
For some markets, China has allowed counter-party deals to be denominated in RMB rather than the US dollar.
You’ve seen that happening in Hong Kong. Basically you can start to use the RMB to settle for things in Hong Kong. And if it extends to other places, that’s one way of freeing up the currency as we go through that entire transition phase. But again, we are in the very early stages from what I can see on that process.
For a CFO, is it a good idea to buy stock in your own company to signal your support and confidence?
In some cases that there’s not much of a choice because that’s how some of them are remunerated, so I would say if that’s the way it is, then that’s the way it is.
The question is always this: Is diversification something that they’re seeking? If they are – and diversification is something that’s critical to almost all investment processes – and if they have the choice of moving away from their own company as investment, it’s generally a good idea to  diversify risk from the job that they’re in, from the company that they’re in, the sector that they’re in. I think there’s always a good reason to, even if not to move completely, at least move part [of investments] to other assets and other industries.
Some CFOs have to take regulatory and compliance issues into account when making personal investments to avoid even the appearance of conflict of interest and insider trading. How may they deal with this?
We at Pictet can design discretionary mandates. This is basically where the bank makes the decision within certain parameters, and therefore it’s not day-to-day managed or controlled by the end client. So it’s left to a policy, it’s left to a much longer-term objective, and it’s left to the bank to decide on what the actual allocation will be, which asset they would be buying. That essentially takes the decision process away from the individual. It’s an independent way of managing the money and takes away any conflict that may arise because of a person’s job or position or responsibility. 



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