India sitting on a debt time-bomb?

Feb 27, 2010

In this issue:
» Rogers, Mobius gun for fiscal consolidation
» Sell your stocks, Marc Faber
» Ratings agencies like India's budget
» China still biggest buyer of US securities
» ...and more!

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More than 24 hours have passed since the release of the most important fiscal policy document. Tens of hundreds of pages of number crunching has been done. And a more evolved sense of the budget has now started to find its way through the various media. Little by little, the initial euphoria is now being replaced with cautious optimism. The spontaneous reaction to the budget was all about the FM's heart being in the right place. A studied opinion is now that of the roadblocks that could lie ahead. All in all, the attention seems to have veered towards how the FM goes about practicing what he has preached.

It is not only experts in India who have expressed their opinions on the Union Budget. Renowned financial gurus like Mobius and Rogers have also chipped in with their views on the same. Writing in The Economic Times, Mark Mobius, the expert on emerging markets, has lauded the Government's efforts of trying to rein in fiscal deficit. He believes that fiscal consolidation will play an important role in determining the strength and sustainability of future economic growth. Clearly, this is something that even we had highlighted in our special budget issue. However, Mobius doesn't stop here. He has wished that in the future, he could see more policy changes like rapid acceleration of infra projects, power generation and high speed internet. Strong support for small and medium sized enterprises by reducing paper work and easier low-cost funding for expansion was also on his wish list.

However, Jim Rogers, another successful investor, was not in as generous a mood as Mobius. Talking to BusinessWeek, he took potshots at the FM's target of achieving 10% growth rate and observed that 10% growth with giant deficits and debts just does not work. He believed that spending is still too high relative to income and in 3-4 years, it could all come back to haunt India. Clearly, he seems to be wanting even greater cut in fiscal deficits than what the FM has promised. There is no doubt even in our minds that a high fiscal deficit is one of the biggest roadblocks in India's way of achieving a higher growth trajectory and if this isn't brought under control soon, the potential debt time-bomb that we are sitting on, could have very serious repercussions on our economy. Fortunately, even the FM recognizes this problem and has shown a strong resolve to bring government debt under control. He better move fast on this one!

 Chart of the day
It should be noted that India is one of the most indebted nations amongst all the major economies. And this is certainly not a statistic to be proud of. High levels of debt as compared to GDP forces an economy into a vicious cycle where a substantial portion of the revenues earned by the Government goes towards interest payment. This leaves little room for spending on developmental activities, which in turn hurts economic growth thus forcing the Government to borrow even more and in this way, the cycle continues, which could eventually lead to a sovereign default or hyperinflation. Thus, the FM's announcement that it would stick to the recommendations of the Thirteenth Finance Commission of reducing debt to GDP ratio to 45% by FY15 was indeed a welcome move. Today's chart of the day shows how such a reduction could take place over the years.

Source: LiveMint, Business Standard

He called it right when the stock markets were at their rock bottom in March last year. Now his advice to investors is to Sell. Yes, we are talking about Marc Faber. As reported on Bloomberg he says, "I would look at the market to close probably a bit lower than it started the year in 2010." Given the strong rally the markets have had over the past one year or so, many observers feel that valuations are no longer compelling. We quite agree with that assessment. Interestingly, Faber believes that even if stock markets won't go upwards, it is unlikely to plummet from here either. The reason is simple. Any such fall would be met by more stimulus from governments. In other words, policy makers can be expected to virtually prevent negative returns. While that is good news for investors, we wonder if governments should actually be so involved in ensuring returns from the stock market.

Even as the US policymakers feared the Chinese dumping of US dollar bonds, now comes the report that China remains the world's largest foreign holder of the same - US dollar bonds. China's holdings of US debt now stand at a huge US$ 895 bn, higher than the second biggest holder Japan (US$ 760 bn). Such a big Chinese holding is in itself a big headache for the US. The fear is that Chinese actions regarding these holdings could end up destabilising the US economy. The Chinese can also use these holdings as a political tool to influence American policy. In short, the game has got very interesting!

Data Source: CNBC, Moneynews

We are not so sure if anyone values their approval that much, but nonetheless the rating agencies have liked India's Union Budget 2010-2011. They like the fact that India has steered away from the reckless spending last year to a more conservative fiscal stance this year. Of course, it must be remembered that the spending last year was in the context of the global financial meltdown that was knocking on our doors. Interestingly, the ratings agencies, Moody's, Fitch and Standard & Poor's are in no hurry to upgrade India's sovereign rating. They would rather wait for implementation of the budget proposals. And also how India tackles its inflation situation. Fair enough. We certainly agree that any steps towards a lower fiscal deficit and food price inflation are welcome. But like we said, through bitter experiences, the world has learnt not to rely too much on the grades issued by ratings agencies.

The world markets ended on a mixed note this week. Most Asian markets along with European and American markets ended with weekly losses. The only gainers for this week were India, China and Hong Kong. The weakness in the world markets was a reflection of the unexpected drop of 7.2 % in sales of previously owned homes in the US. This indicates that lack of job growth is undermining government's incentives to bolster the housing market. Further, there was concern regarding Greece defaulting on its sovereign debt. In case of a default, a downgrade in the credit profile of the European countries is expected. This will push up borrowing costs for the countries putting pressure on their fragile recovery.

India managed to end the week on a positive note, ending higher by about 1.5% over the previous week. Germany was the top loser this week, ending lower by about 2.2% followed by France and Brazil, both of which ended lower by 1.6%. Amongst the gainers were Hong Kong (up 3.6%) and China (up 1.4%). UK was marginally down while Japan ended flat.

Source: Yahoo finance, Kitco, CNNfn

 Weekend investing mantra
"The average person can get to know 5-10 companies very well, and once every few years he will come across an opportunity to make a good investment. In principle, you need 3-4 good companies to invest in over ten years." - Peter Lynch

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2 Responses to "India sitting on a debt time-bomb?"


Mar 4, 2010

India after economic relaxation started from regime of Narasimha Rao is consistently raising here indebtedness and now under Manmohan Singh's regime it is high in the peak. Government cover these real truth not by increasing GDP but by forecasting a good monsoon. When at these days monsoon never becoming normal and the Environmental forecasters predict that not only weather becomes abnormal but also in the coming years it will play a catastrophical role by taking lifes of the population as well.



Feb 27, 2010

The FM should have refrained from raising duty on crude and raising the petrol price. Instead he could have raised revenue by imposing export duty on export of raw materials like iron ore and minerals. The precious resources are gifted to China/Japan instead of putting up new Steel Mills and converting it into finished goods and adding value to it. Andher Nagri, chopat Raja.

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