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The markets are jittery as both the Chinese and Indian central banks are tightening credit. China and India are Asia's most populous economies and as such affect the regional and global economies greatly. The latest move came from the reserve bank of India, which hiked a couple of short-term interest rates, as the rates are both below the level of reported inflation.
Wholesale inflation in India is running at a 16-month high (9.89% in February), while its equivalent of the fed funds rate -- the reverse repurchase rate and the repurchase rate -- are at 3.5% and 5%. Ten-year government bonds are yielding around 8%. Both long- and short-term rates are in negative real territory in India, which is clearly unsustainable.
China is no different, where the government forced lending by state-owned banks in 2009 in order to support the economy. After a record 9.59 trillion yuan of new bank loans last year, the Chinese are likely to try to bring that number down to 7.5 trillion.
Monetary tightening in China is done through various tools, not only interest rates, as the government controls many banks. So directly pushing more new loans through is a form of loosening credit and vice versa (decreasing new loans).
Why you should not worry
Developed economies are projected to have rising deficits and debt burdens in the next five years, on top of a much higher level of indebtedness, while emerging economies are likely to have falling levels of deficits and debt burdens with already much lower levels of indebtedness. High debt levels are likely to restrain growth in the West, and low debt levels are likely to support growth in the emerging world. Economic growth will be higher in emerging markets as the economies grow from smaller bases.
If you're looking to invest in places that offer organic economic growth -- based on a savings-and-investment cycle (not rising leverage ratios like in the West) -- you have to invest in emerging markets, mainly Asia. Monetary tightening in this case is positive as negative interest rates cause more problems than they solve (in the case of India) and only create bubbles and more inflation.
Ways to capitalize on any pullbacks
The best way to capitalize on growth in India is via investing in Indian banks. While its economy doesn't grow as fast as China's, the banking system operates independently of the government so the loans are of higher quality; there is no forced lending. Two big Indian banks already trade as American depositary receipts in the U.S.: HDFC Bank (NYSE: HDB ) and ICICI Bank (NYSE: IBN ) . The valuation of IBN over the years has tended to be generally cheaper, as HDFC has been better managed as long as I have followed it through a tenfold gain (since 2002).
There is an excellent mutual fund run by Matthews Asia funds: Matthews India (MINDX). I mentioned it near the Indian market lows in 2009 and it has performed admirably since. The fund has beaten its benchmark by 20% over the past year, while the benchmark index has more than doubled.
The performance is not as stellar on a three-year comparison, but I have followed the fund family for a long time and I think that investors are better off with Matthews Asia funds than with an alternative. The firm also offers a dedicated China and other Asian funds.
Meanwhile, the iShares FTSE Xinhua China 25 (NYSE: FXI ) follows companies in the Chinese market. This is in a way a bet on Chinese financials, as four of the top five holdings are banks and/or life insurance companies, and one is mobile telecom:
Top 5 Holdings:
China Mobile (NYSE: CHL ) -- 9.8% of index.
China Construction Bank -- 9.4%.
Industrial and Commercial Bank of China -- 8.2%.
China Life (NYSE: LFC ) -- 7.1%.
Bank of China Limited -- 6.3%.
The right emerging markets, like those in Asia, will outperform Western ones over the long haul as they have better fundamentals. As such, pullbacks are buying opportunities.
More on market issues:
- Greece: What the Heck Is Going On?
- Is Europe Still Safe for Investors?
- Google Lives Up to Its Chinese Promise