One of the advantages of living in a city with a dysfunctional transport system which belongs in the Stone Age is time the commute provides to read a few books each month. A lot is written lately about the imminent economic collapse of the West and rise of the East, predominantly lead by the Asian giants of India and China. As a rule, investors should discount extreme views expressed during turbulent market cycles, which are attributable to prevailing gloom. The truth about the “new world order” can be found somewhere in the middle.
While there is no doubt about the shift in the landscape towards a more balanced world (how long can 12% of the worlds population dictate to the rest?), the readjustments need not spell the end of the west nor a major collapse of economic power in those countries.
It is important to realise that the world economy is a zero sum game (unless we start trading with another planet), where currently deficits of mostly western industrialised countries are financed by the savings of mostly Asian exporters. Ironically, China not only provided cheaper goods, but also cheap credit (via investing in US government securities) to encourage the crazed consumption binge in the United States, and a few other rich countries.
This toxic party is well and truly over. Though markets have rallied since their lows in March 2009, we are nowhere near a normal situation in the global economy. Raghuram Rajan of the University of Chicago Booth School of Business and former chief economist of the IMF notes in a thought-provoking new book, the underlying “fault lines” that caused the global recession are still with us. As nations increasingly fail to support individuals and ageing populations add to the pressure, austerity is going to be the order of the day in many industrialised countries.
This situation is aggravated by the export dependence of most Asian countries, including Sri Lanka. This dependence of foreign demand for Sri Lankan goods and services makes the Central Bank neatly avoid credit demand locally, to see it emerge overseas.
Prof Rajan describes this situation as a “politically strong, but very inefficient domestic-oriented sector”. The problem is that the countries that used to provide the demand – the US and EU – have over-indebted private sectors. This creates major competition amongst exporters for the remaining weak global demand. Adding pressure to the open world economy is growing calls for protectionism.
Publicly listed companies in Sri Lanka offer little attractively priced opportunities to investors seeking protection or to take advantage of this changing world order. Most companies are indirectly or directly exposed to major consumers in the old industrialised world.
Few companies export final consumption goods bound for growing Asian, Latin American or African markets. Most of the intra-region trade is in intermediate goods that feed in to supply chains in Asia, for eventual final goods bound to either US or the UK.
However, not all is lost as there are some companies who are well placed to take advantage of this new world order. First, soft commodities and food manufacturers would be favourably positioned (although many currently trade at elevated future earnings). Diversified conglomerates with final value added products with increasing market share in the developing world should also provide attractive returns.
Investors should avoid an indirect hit through listed companies who have major dealings with unlisted companies, who are in turn exposed to the declining consumer markets in the US and EU.
While most Sri Lankan exports to these markets tend to be value added, which are assumed to have low volatility in demand, the current crisis has begun to test many of these assumptions.
The biggest impact of the new world order however may well be reserved for the average household balance sheets in Sri Lanka. Vital questions need to be answered by the average citizen with regards to a host of issues impacting their life, ranging from the rationale for spending on overseas education for children to the axioms of superior economic outcomes as a result of migrating to old industrialised countries with much lower growth in the future.
Investors must use their collective power to influence corporate managers of the need to diversify from over dependence on the US and EU for profits and growth. The geographic advantage for Sri Lanka is not going to last for too long (new great game or not).
As Harold James, a historian at Princeton University, points out in “The Creation and Destruction of Value”, small states are about to be overwhelmed again by larger states.
In that struggle, it is imperative that listed companies in Sri Lanka have created future growth opportunities from the right markets. Big is about to become beautiful again. The West is by no means dead. They are however, on serious life support.
(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at kajangak@gmail.com) |
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