Is the worst for the Indian economy over?

Jan 21, 2013

In this issue:
» Is there a bubble in the US bond market?
» Royalty payments to MNCs have trebled
» Outsourcing deals to rise for Indian IT in 2013
» R&D investments by India Inc. surges
» ...and more!

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Is the worst over for the Indian economy? After two consecutive quarters of slowdown in GDP, is the economy on the brink of a recovery? Chetan Ahya, Asia-Pacific Economist from Morgan Stanley opines that some signs of better prospects are beginning to emerge. On the domestic side, firstly Morgan Stanley opines that there are signs of a slowdown in government spending from September 2012 onwards (if one excludes interest and subsidies). Further, rural wage growth has started to moderate after almost 5 years of acceleration. Higher wages have been one of the reasons cited for fueling inflation as the demand for food rose. The third are the steps taken by the government to improve the investment climate in the country. These include auctioning of mining rights, transfer of land from farmers to entrepreneurs for industrialisation, awarding of public works projects, telecom licenses and the like.

Let us consider these. We are not too convinced about the reduction in government spending. Majority of its woes on the fiscal front have been on account of rising subsidies, which has considerably strained its resources for more productive spending. So if on excluding subsidies and interest payments (both of which are unproductive), spending has seen a decline, it may not necessarily spell good news. Whether moderation in rural wages leads to lower demand for food remains to be seen. Basic food items will see demand. What will instead lower food inflation is availability of foodgrains at all times supported by better warehousing facilities and reduced wastage. As far as improving the investment climate in the country goes, the reforms introduced by the government are certainly the step in the right direction. But now it faces the bigger challenge of implementing them amidst constant opposition from other political parties.

On the external side, factors such as recovery in the developed world leading to better exports and lower crude oil prices leading to a lower import bill will certainly provide a breather to India. But this is not something in India's control unlike the factors on the domestic side. Overall, the next few months could still be challenging for India with the fiscal deficit taking centrestage. But there is an increasing possibility that things cannot get any worse from here. And if improvements in some of the factors mentioned above do begin to take place, an economic recovery could very well be on the cards. But a gradual recovery seems a more likely bet than a very strong one.

Do you think that the worst for the Indian economy is over and that a recovery will be underway going forward?Share your comments or post them on our Facebook page / Google+ page

 Chart of the day
Exports of the Indian auto sector have not exactly set the pulse racing in FY13 so far. One of the reasons for this has been attributed to the hike in the import duty in Sri Lanka which has considerably impacted demand. And the outlook there going forward remains uncertain. But how have exports performed in prior years? As today's chart of the day shows, exports trend for the 3 main segments in auto have been quite volatile. In the period FY09-FY11, passenger vehicles and commercial vehicles have displayed divergent trends, while performance of 2 wheelers has been relatively stable.

Data Source: SIAM

What do you think of a stock that is trading at a very lofty PE multiple of around 54x? You won't touch it with a 10-feet pole, right? The quality of the firm doesn't matter. Investing at that high a PE is surely asking for trouble. And what if we tell you that the earnings of the firm have absolutely no scope for growth? Well, the decision of not investing can't come easier than this, can it? However, there's a portfolio manager out there who's still bullish on a security with fundamentals similar to what we just outlined. Except the security is not of a listed entity but the US 10-yr treasury.

As per the gentleman, who works for none other than bond giant PIMCO, despite such prices, there is no bubble in the US treasury market. He believe that factors like risk averseness and Fed's mandate to keep interest rates suppressed is providing support to the bond market and keeping bond prices high. To be fair to PIMCO, they do seem well aware of why bond prices are high and that much of this is Fed induced. However, they seem to be banking upon their ability to predict when exactly the cycle will reverse. This is hardly the best strategy as per us. The moment something appears expensive and being supported artificially, one should immediately move out of it. Timing the market seldom works on a consistent long-term basis.

Thanks to regulatory oversight, the interest of minority shareholders in India are invariably compromised. The case of multinational companies (MNCs) is no different. That MNCs tend to offered low dividends, delist profitable ventures and share minimal information has been a concern for long. There have also been concerns about MNCs launching new or more profitable products through the unlisted arm. By doing so, the listed entity only acts as capital raising vehicle. But none of these have roused the SEBI enough to take corrective actions.

Case in point being the latest revelation on royalty payments by the Indian arms of top MNCs. As per Economic Times, such royalty payments have trebled over the past five years. That too at a time when the net margin of these companies has declined from 11% in FY08 to 7.6% in FY12. To elaborate further, the Indian arms paid 2% of their net sales and 27% of their net profit in FY12 compared to 1.7% of sales and 16% of net profit five years ago. We believe that by turning a blind eye to such blatant violation of accountability to minority shareholders, the SEBI is setting a rather pitiable record of being a regulator.

Since the dawn of the global crisis, the Indian IT industry has come under pressure. And it was but natural for this to happen because the industry depends on the developed world for a large part of its revenues. So if the client countries and hence client industries are in trouble, they are obviously not going to award huge deals at premium pricing. For a while the IT companies were optimistic that things would revive when the crisis turned. But now they have learned to work under circumstances that can only be called the new normal. Companies have come to accept that deal sizes are going to be smaller. Pricing is going to get competitive. As a result expecting premium pricing on every deal is not going to work. Interestingly as per Economic Times, the industry is going to see outsourcing deals worth US$ 50 bn come up for renewal in 2013. This is nearly half the total size of the entire Indian IT industry. This will evoke a new era of competition in the sector at least for this year. Companies that are willing to be flexible and deliver superior quality will emerge as winners. The rest will have to take a backseat.

The government has an ambitious target that every family in every district in India should have a bank account. But, this is easier said than done. No-frills or basic bank accounts serviced through business correspondents is one solution. These accounts cost banks an additional Rs 250-500 per account. Profits may also be elusive for at least 2 years. But, even if a few of these turn into regular customers, this could be a golden opportunity.

Currently, only 35% of people in India have formal bank accounts. This according to the World Bank is versus a global average of 50%. Almost 70% of India's 1.2 bn population still lives in rural areas. Covering these people under the traditional banking system has been a goal for a long time. The government plans to directly transfer cash payments for subsidies into these no-frills accounts. This is a move aimed at trying to clean up India's corrupt public distribution system where benefits scarcely reach the end consumer. Rs 3.2 trillion is expected to be transferred under various subsidy and welfare programs. Well, we hope it reaches the right pockets this time.

What is one of the important long-term determinants of productivity and economic progress? The answer is research & development (R&D). The next question that would come to mind is-How does India fare on this parameter? An article in Firstpost says that India has globally topped the growth in R&D investments. During 2012, R&D investments at Indian companies grew at a staggering rate of 35.1%. China ranked second with a growth of 28.1% during the same period. Does this mean it is time to raise the toast?

Consider the following facts before you decide. India total investments in R&D are very meagre. If you compare with other major economies, India is way behind in terms of the quantum of people employed in the field of research. While IT firm Infosys may be the highest R&D spender among Indian companies, on a global scale it ranks 329th. In fact, merely 14 Indian companies rank in the global list of top-1500 entities in terms of their annual R&D investments.

In the meanwhile, the Indian equity markets traded firm on the back of persistent buying across index heavyweights. At the time of writing, the BSE-Sensex was trading higher by 80 points. While stocks from the oil & gas and FMCG spaces were in favour today, those from the auto and healthcare sectors led the pack of underperformers. Stock markets in Asian economies such as Japan and Indonesia ended lower by about 1.5% and 1% respectively.

 Today's investing mantra
"The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts." - Warren Buffett

  • Warren Buffett - The Value Investor

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    2 Responses to "Is the worst for the Indian economy over?"


    Jan 25, 2013

    I agree with Vivek. As Congress tries hard to rebuild it's eroding committed vote-banks, good economics are set to be replaced with bad politics. Wait for the budget,before any predictions either way, is my view.

    And as to if things can get worse? Russia has massive corruption too, but it's lower population can and does survive on oil & gas exports. India does'nt export inflating goods, so things can easily get worse.


    Vivek Aggarwal

    Jan 21, 2013

    I too am of the belief that leaving aside Subsidy Bill will be a mistake while considering any Economic scenario. In fact, I feel, with the elections coming up in 2014 it may actually rise.

    Like (1)
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