Echo bubbles are hardly uncommon

Of late doubts are being expressed by important players on Wall Street that the rising commodity price bubble....

Of late doubts are being expressed by important players on Wall Street that the rising commodity price bubble,especially oil and food items,could derail the growth story in emerging markets by forcing central bankers to hike interest rates ahead of time. It could particularly impact net commodity importers like India. Ruchir Sharma,managing director,Morgan Stanley Investment Management,which manages around 25 billion of assets across emerging markets and 2.5 billion in India,responded through email to questions posed by IE on this matter,and how it could impact the Indian economy.

Excerpts:

There are doubts that another series of asset bubbles,especially in commodities,can derail recovery. What are the indicators?

I think policymakers have to realise that easy money alone cannot recreate boom conditions of the 2003-07 era. A lot of excess liquidity pumped into the system is now heading towards unproductive assets,in a way that could derail the recovery story. Nowhere is this worrisome trend more evident than in the commodity pits. The sharp rebound in commodity prices has been highly unusual for this stage of the economic cycle,especially as inventories are still rising suggesting demand is weak.

Can you elaborate on this?

Estimates suggest that the average daily trading volume of key energy futures contracts running at a staggering 15 times world demand. Just five years ago,the norm was that trading volumes for various commodities would be around 4-5 times the actual demand. It is remarkable to see how emboldened speculators have become all over again despite the rout they faced in commodities last year once the bubble burst.

However,history suggests that echo bubbles are hardly uncommon. There have been several instances when bubbles in the same asset class have resurfaced shortly after the original boom-bust cycle.

What do you think is the commodity linkage?

With agricultural prices,from those for various vegetables and sugar too joining the commodity party,food and energy prices,which on average account for one-third of the consumers basket in developing countries,is prematurely leading to inflation worries for policymakers. In contrast,credit growth of banks in almost every emerging market 8211; with the obvious exception of China where the banks were told to lend aggressively remains anemic.

When could this bubble burst?

If central banks start to tighten policy then the echo bubble will begin to unwind.

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If the echo bubble unwind how much will equity prices correct?

In such situations the thumb rule is equity prices will correct by 25-30 after which they will move sideways for some time.