'India's Services Sector-Based Economic Model is its Problem'

Image: Edgar Su / Reuters

Gary Dugan of RBS

Gary Dugan is the CIO, Asia and Middle East, of RBS (Royal Bank of Scotland) Wealth Division. In this freewheeling interview to Forbes India, he talks about the recent currency crash in Asia, where the rupee is headed in the days to come and why you would be lucky, if you are able to find a three-bedroom apartment anywhere in one of the major cities of the world, for less than $100,000.

Q. What are your views on the current currency crash in Asia?
People are trying to characterise it as something that has happened in the past. I think it is very different. It is different in the sense that we know that emerging markets in general have improved. Their financial systems are stronger. Government policy has been more prudent and their exposure to overseas investors in general has been well controlled. I don’t think we are going to see a 12-month or a two-year problem here. However, countries such as India and Indonesia have been caught out and the money flows have brought their currencies under pressure. So, it’s a problem but not a crisis.

Q. One school of thought suggests that we are going to see some version of the Asian financial crisis of 1998 over the next 18 to 20 months...
I totally disagree with that. The rating agencies have looked at Indonesian banks and they have said that these banks are well able to weather the problems. If you look at India, the banking system is also enabled to weather the problems. It is not as if there is a whole set of banks about to announce a significant writedown of assets or lending. The only thing that could go wrong is what is happening in Syria. If oil prices go to $150 per barrel then the whole world has got a problem. Emerging market countries would have an inflation problem and that would only create an exaggeration of what we are seeing at the moment.

Q. Where do you see the rupee going in the days to come?
There is still going to be downward pressure. I said right at the beginning of the year, with a little bit of tongue-in-cheek, that in theory the rupee could fall to 72. At 72 to the dollar, in theory, [India] clears the current account deficit. I never expected it [the rupee] to get anywhere near that, certainly in a short period of time. But some good comes out of the very substantial adjustments, because pressure on the current account starts to disappear. Already the data is reflecting that. Where the rupee should be in the longer term is a very difficult question to answer.

Q. Let’s say by the end of the year...
(Laughs) I challenged our foreign exchange market experts on this and asked them what is the fair value for the rupee? I ran some numbers on the hotel prices in Mumbai relative to other big cities, and not just New York and London, but places like Istanbul as well. India is the cheapest place among these cities. Like The Economist’s Big Mac Index, I did a hotel index, and on that you could argue that the rupee should be 20-30 percent higher. But, if you look at the price that you have got to pay to sort out your economic problems, the currency should probably be closer to 70 than 60 for the balance of this year.

Q. One argument that is often made, at least by government officials, is that because the rupee is falling our exports will start to go up. But that doesn’t seem to have happened...
It takes a while. I was actually talking to a client in Hong Kong last week and he said that warehouses in India have been emptied of flat screen TVs, and they have all been sent to Dubai because they are 20 percent cheaper now. It is a simple story of how the market reacts to a falling currency.

Q. But it’s not as simple as that...
Of course. A part of the problem India has is that its economic model is based on the services sector rather than manufacturing. The amount of manufactured products that become cheaper immediately [after the rupee falls], and everyone says I need more Indian products rather than Chinese products or Vietnamese products, is probably insufficient to give a sharp rebound immediately. Where you may see a change, even though some of the call centre managers are a little sceptical about it, is that call centres which had lost their competitive edge because of very substantial wage growth in India, will immediately get a good kicker again. It would certainly be helpful, but I would say that it normally takes three to six months to see the maximum benefit of a currency adjustment.

Q. What are your views on the stock market?
I am just a bit sceptical that you are going to see much performance before the elections. I always say it is a relative game rather than an absolute one. If all markets are doing well, then India with its adjustment will do fine. Within the BRIC countries, India is at the bottom of the pack in terms of relative attractiveness.

Q. One of the major negatives for the stock market in India is that private companies in India have a huge amount of dollar debt...
It is definitely a reason to worry. People are dragging all sorts of bad stories out. When there were bad stories before, people were just finding their way through it. And India has a wonderful way of working its way through its problems and has been doing that for many, many years. Remember these problems come to a head only if the banks call them to account. I think there will be a renegotiation. It is not as if a very substantial part of Indian history is about to go under because someone is going to pull the plug on them.

Q. Most of the countries that have gone from being developing countries to developed countries have gone through a manufacturing revolution. It is something missing in India...
It is. You look at the stories from the past five years, and the waning strength of the services sector in India in the international markets comes out. A good example is that of call centres that have gone back to the middle of the United States from India. A part of that came through currency adjustment. You can say that maybe the rupee was overvalued at the time when this crisis hit. But it is true, in a sense, that India has got to back-fill a stronger manufacturing industry and it has got to reinforce its competitive edge in the services sector.

Q. What is holding back the Indian services sector?
A number of structural things. I talked to some service sector companies at the beginning of the year. And one of the things I was told was that I have got all my workers sitting here in this call centre, but now they cannot afford to live within two hours of commuting distance. Why did that happen? That is not about the services sector. It is about the broad infrastructure and putting people at home, close to where they work. There are a lot of problems to be solved.

Q. There has been talk about the US Federal Reserve going slow on money printing (or tapering). How do you see that going?
Everyone has got to understand that the principle of quantitative easing is to generate growth. So, if there is enough growth around they will keep tapering, even if they get it wrong by starting to taper too early. They will stop tapering if growth is slow. Secondly, a number of Federal Reserve governors are worried about imprudent actions of consumers and industrialists, in terms of taking cheap money and spending it on things that they typically do not need to spend on. A good example is speculation in the housing market, something which created the problem in the first place. So they want to choke such bad behaviours. They will probably start tapering in September. The only thing that may stop it from happening is if the Middle East situation blows up. The US didn’t think it was going to get involved a few weeks ago. Now it is.

Q. Isn’t this kind of ironical, that the solution to the problem of propping up the property market again, is something that caused the problem in the first place?
That’s been very typical of the United States for the last 100 years. Every time there is a problem you ask people to use their credit cards. Or use some form of credit. And when there is an economic slowdown because of the problems of non-performing loans, then you get the credit cards out again.  

Q. Why is there this tendency to go back to the same thing that caused the problem?
It is the quickest fix. And you hope that you are going to bring about structural changes during the course of a better economic cycle. So, people don't bring the heavyweight policies in place until they have got the economy going again, and sadly the only way you can get the economy going again is to just make credit cheap and encourage people to borrow.

Q. Inflation targeting by central banks has come in for criticism lately. Because a central bank works with a certain inflation target in mind, it ends up encouraging bubbles by keeping interest rates too low for too long. What is your view on that?
These concepts were brought in when central banks thought they could control inflation. If you look at one country that dominates the world at the moment in terms of product prices and in terms of the inflation rate, it is China. Your monetary policy isn’t going to change the behaviours of China. And some of the flare-ups in inflation have been as a consequence of China, and therefore monetary policies have no impact. Secondly, the idea of controlling inflation worked for 20 years of the bull market. Then we got inflation which was too low. So, we have changed it all around, to actually try to create inflation rather than to dampen inflation. I don’t think they know what tools they should be using. The central banks are using the same tools they used to dampen inflation, in a reverse way, in order to create it.

Q. And that’s where the problem lies...
For nearly two to three hundred years, the world had no inflation, yet the world was a kind of an all-right place. We had an industrial revolution and we still had negative price increases, but that did not stop people from getting wealthy.

Q. Many people have been shouting from the rooftops that because of all the money that has been printed and is being printed, the world is going to see a huge amount of inflation. So please go and buy gold. But that scenario hasn’t played out...
Chapter one of the economics textbook is that if you create a lot of money, you have got a problem. Chapter two is that there is actually another dimension to this and that is the velocity of money. If you have lots of money and if it happens to go around the world very, very slowly, it doesn’t have any impact. And that has been the point. The amount of money has gone up considerably but the velocity of money has come down. To date, in the Western world, there is little sign of the velocity improving. We are seeing this in the lending numbers. Even if banks have the appetite for lending money, nobody wants to borrow. Someone’s aged 55, and the job prospects are no wage growth, and the pension is tiny, I am not sure that even if you gave him 10 credit cards, he’ll go and use any one of them. And that is the kind of thing that is happening in Europe, and to some extent, in the United States.

Q. Yes, that's true...
The only money going into housing at the moment is the money coming from the institutional market, as they speculate. If you look at students coming out of college in the United States, they have come out way down with debt. There is again no way that they are going to go and take more loans from the bank because they have already done that in order to fund their education.

Q. There may be no inflation in everyday life but if you look at asset inflation, it has been huge.
That’s right. People just find stores of value. Gold went up in its last wave. If you look at Sotheby’s and Christie’s in the art market, they are doing extremely well. The same is true about the property market. Prices have gone up to $100,000 in places which are in the middle of a jungle in Africa. Why? There is no communication. No power lines there. It is just that people have money and are seeking out assets to save that money. Also, there has been cash. If you go to Dubai, 80 percent of the house purchases there are in cash. So, you don’t need the banks.

Q. Can you tell us a little more on the Africa point you just made?
I did laugh when Rwanda came to Singapore to raise money for its first ever bond issue and people were just discovering these new bond markets to invest in, purely because they did not know what to do with their money. So someone said that I am building in a Rwanda or a Nigeria, and people just ran with their cash, buying properties and buying up land wherever the policies of the government allowed. Sri Lanka just closed the door on foreign investors because you start to get social problems as the local community cannot afford properties to live in. It was amazing how commercial many of these property markets became, even though in the past they were totally undiscovered. And as we have seen with many of them, you take considerable risk with the legal system. The world has got repriced. I always say that if you can find a three-bedroom house below a $100,000-$150,000 in a major city, you are doing well anywhere in the world today.

Q. In Mumbai you won’t find it even for that price..
Yes, though five years ago it was true. It is impossible now.