The dangerous downside to the state election results

Mar 7, 2012

In this issue:
» Does India face the risk of stagflation?
» Railways increases freight rates
» China must seek its cotton bales elsewhere, India bans cotton exports
» Marc Faber bets on metals as he sees a war in W Asia
» ...and more!

--------------------------------------------------- Don't Miss! ---------------------------------------------------

He's the Oracle of Omaha.

He's the world's most successful investor.

Your guess is right.

The Warren Buffett Quiz. Click Here to participate.---------------------------------------------------------------------------------------------------------------

Yesterday was a special day for the country. The results of the state elections in 5 states including the key state Uttar Pradesh were announced. Contrary to popular belief, the ruling Congress party suffered a setback in 3 out of the 5 states. These results are being viewed as a symbol of things to come. Most importantly most economic experts fear that this loss would result in the much needed economic reforms being put on the back burner.

The government may take this loss and decide to push more populist measures to win back voters' interest. This would mean that we would not see the much needed policy reforms coming up anytime soon. The policy measures on issues like land acquisition and subsidies are sensitive issues for the government. Reforming these may result in loss of votes. But leaving things as it is would mean dragging the country's growth and its future.

However, this may not be the case. The government has already come under severe criticism for dilly dallying with the policy reforms. If it fails to spur investment and growth for the country, then the loss of confidence would hurt it much more. The Reserve Bank of India and the Prime Minister's Economic Advisory Council have already cautioned the government on the need for fiscal consolidation. In fact the forthcoming Union Budget maybe the ruling government's last opportunity to prove that they are committed to the overall economic well being of the country.

The current government has not really done much to support the economic health of the country till now. Therefore, it may decide to adopt a self serving approach and go ahead with the populist measures. But if it does that, then India's economy would sink into a downward spiral. But would the government actually be so greedy and give the country that final push over? This is something that remains to be seen.

Do you think the government would adopt more populist measures instead of going ahead with policy reforms? Share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
Food has always been a big portion of consumer expenditure in India. Both on the urban side as well as on the rural side. But things appear to be changing. Though food still constitutes the largest portion of consumer spending in India; as a percentage of total expenditure, it has been declining. From nearly 48% for urban and 59% for rural in the early 2000, the expenditure on food has now come down to 41% and 54% respectively. At the same time, expenditure on non food items like consumer durables and services has gone up. This is a general trend observed in countries that witness increasing per capita income. As income levels go up, consumers generally tend to increase their spending on more discretionary items like durables and cut down on the basics like food.

Data source: The Mint

You wouldn't have failed to notice that India is suffering from low growth rate at the same time that inflation is rocking its economic boat. And the irony is that it can't take enough strong measures to slow down inflation as it will end up hurting economic growth further. In economic parlance, such a situation is called as stagflation. The Wall Street Journal believes that India is certainly going through one of its own stagflationary phase. To be fair though, India's Reserve Bank of India (RBI) did try hard enough to take the air out of inflation. It raised rates for as many as 13 times between 2010 and 2011 but to no avail. The spending spree of the Government meant that most of RBI's efforts counted for nothing. Thus, while growth did improve, there was a significant drop in the quality of the same, reflected in higher inflation numbers.

So, where do we go from here? We believe that the onus rests firmly with the Government of India. It will have to slow down its fiscal excesses if it were to get Indian economy out of this vicious stagflationary circle. As mentioned earlier, the state election results would have dealt a big blow to this plan.

Now that the state assembly polls are over, the economy is back to business as usual. Yesterday the Indian Railways withdrew the 4% exemption on fertiliser and food grain loading rates. At the same time, it has also hiked freight rates of other commodities by about 10-15%. It goes without saying that this will put an upward price pressure on goods ranging from coal to fertilisers. This move was undertaken in a bid to save the state-run transporter from a financial turmoil. The Railways is expected to report freight earnings of about Rs 700 bn in the fiscal year 2011-12. The freight hike could raise its earnings by up to Rs 180 bn.

The Railways claim that the freight hike will not pinch the common man. This is because the additional freight burden would be absorbed by agencies like the Food Corporation of India (FCI) which are primary customers of the Railways. The Railways may deny it. But we believe that the freight hike will certainly put some inflationary pressure in some form or the other.

The government of India recently banned cotton exports on grounds that declining production in the current crop season may increase prices. Banning exports is expected to assure supplies to the domestic factories. However, it may also have repercussions in the Chinese cotton markets. China, over the years, has been steadily accumulating cotton. Be it from India or rest of the world. In fact, right now China's cotton reserve is so huge that it can easily accommodate 15% of the global demand.

In April 2011, China had announced a plan to build cotton reserves if the prices fall below a certain limit. This artificially inflated cotton prices across the world. So, the question that comes straight to our mind is where are the prices headed next? With China accumulating cotton and India banning exports, plain vanilla economics says that prices should rise. However, the consensus is otherwise. This is because output in almost every cotton producing country has increased except for US. Secondly, the demand has also declined due to higher cotton prices. So, while the world is currently shielded from volatility in prices due to higher output, China's effort to corner the market appears threatening.

As tension in Iran mounts, the world has been on the edge. Crude prices have already seen an upward trend on disruption of supplies. And fears of a war breaking out between Iran and Israel have emanated. In this regard, noted investor Marc Faber asserts that war between the two nations is a certainty. It is just a question of when. And so, he proposes investing in precious metals. His rationale is that when war breaks out, the US is sure to join the bandwagon. This means that it will need funds to finance the war and given that it is already running a huge deficit, the US Fed will resort to printing more money. More printing will lead to a fall in the value of paper currencies notably the dollar and so there will be a flight to precious metals such as gold. We are not sure of how the Iran situation will pan out but if the US Fed does print more money, then gold is sure to rise higher.

The Center hasn't managed to maintain control of its fiscal balances. This will be a key challenge for the new government as well. High prices of crude oil and other commodities are expected to increase the subsidy burden for this year. The subsidy level is expected to reach 2.5% of the country's GDP, the highest level seen in a decade. The current level may even surpass the high point seen during the FY09 financial crisis when the subsidy figure stood at 2.3% of GDP. Deregulation of petrol has thus not had much effect on the subsidy bill. Diesel, kerosene and LPG still remain subsidized and account for a bulk of fuel consumption. Freeing diesel prices can have a positive impact on government finances. However, such a move would not fit well with the country's political agenda.

In the meanwhile, the Indian stock markets to languish after opening the day in red. At the time of writing, BSE Sensex was down by 97 points (0.6%). Stocks in the metals and energy space were leading the losses. All the major Asian stock markets closed the day in the red as well.

 Today's Investing Mantra
"I deal in facts, not forecasting the future. That's crystal ball stuff. That doesn't work.." - Peter Lynch

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "The dangerous downside to the state election results". Click here!

14 Responses to "The dangerous downside to the state election results"


Mar 8, 2012

The results prove that the anna effect may have been forgotten by the Congress leaders but the people memory is not that short. The large turn out and the final results prove that. Morteover it is high time the dynasty rule of the gandhis is left aside and the Congress thinks about the country rather than work on the whims of people who are definetly not well qualified to take our country to better growth rates.
Thanks Damani


George Elava

Mar 8, 2012

The election debacle is a warm signal to the parties at the centre. It is a warning to the leaders of the Congress if their inactions continues to progress in arresting the countries vital problems of price rise and national securities, by the completion of the 2nd term ends, the party would be totally wiped off even from the Congress stronghold Southern States. The leaders should not rely upon the Nehru family totally. Of course they have sacrificed their lives to the nation much much more anybody else in the country. That doesn't mean that the whole responsibility should be passed on to the foreign-bride of the family and her 2 reluctant children! It is high time to think and act swiftly, my dear Congressmen!



Mar 7, 2012

this is rubbish analysis, we are one of the more sound financial system inthe world better than Japan, even better than China (I say because let Chinese run the the largest democracy like us and still mantain the finance systen good). this is critical analysis which is totally rubbish all communal and muscle power and local centers are rising that means more instability is going to come in country.

Like (1)


Mar 7, 2012

The powerful indian government should bring atleast a portion our money deposited illegally abraod and can keep fiscal defit under control. This is the easy way to control our government finnnce as selling PSU shares by goverment is considered by econmists as neccassary. who will do this and save the poor people of india

Like (1)


Mar 7, 2012

Let me draw an analogy here first.
Imagine having a pack of wounded tigers and currently in a place with human habitation. You can see one of the following reactions:
1. Attacks the human near by, kills, and moves on.
2. Continues to go on a rampage with anger.
3. Decides the injury is enough - and finds its way to the forest.

The current UPA government is in a similiar situation. It can temporarily do some funny things; continue on a rampage with populist approach; or decide to take a step back and look at the long term.

Now all tigers will not think the same way; so every one in UPA government will recommend one of the three paths (or variants there of).

So we now are in a wait-n-watch to see which group will be able to drive the next step...

Like (1)


Mar 7, 2012

Congress lost the election because its policies are against voters' interest. Who are the voters? The common man of India. Only a handful of capitalists are benefited form these policies. So when you say that leaving things as it is would mean dragging the country's growth and its future, you are acting as an advocate of these capitalist class. The government should immediately reverse it policies. In Kerala when Communists were ruling the state for last 5 years there was no suicide by farmers. Now Congress is ruling and within a short period 45 farmers have committed suicide. Any do you still mean to say the policies of the Congress party is good for the growth of the country?

Like (1)


Mar 7, 2012

Future of the country FIRST, all else next!!! When will our greedy,narrow minded,power hungry & corrupt to the core politicians realise? Cut down social spending(a major part of such funding is eaten up by the lower level polticians and executive) and spend on infrastructure,atleast for a year and see the result.What good is the so called Upliftment schemes do,when the country is going to dogs?

Like (1)

amalaraj marian

Mar 7, 2012

I have feel that the government has no option except to push reforms. Point a) because unless there are any reforms comming by there wont be growth no growh itself means lesser revenue by way of taxes. Similarly if the big ticket reforms dont come by there is no chance for them to show to the country their acheivements. It would take atleast 2 years to fruitfy these moves for any tangiable outcome of result. The other goodies that the government would like to give to have a populistic stand can still come by in the next budget of sometime in the mid term policy anouncements
so the the message is growth first and then everything else.

Like (1)

M X Mathew

Mar 7, 2012

The UPA-1 (read Mr Manmohan Singh) could risk the govt on Nuclear Policy. Why it cannot risk the govt and challenge the constituents of UPA-2 on progressive policies? It has nothing to lose as of now, but only can gain from where they are today. 'TINA' or 'TINAS' may be for the Congress, but what are the compulsions for Mr Singh to continue to head a 'non-performing' govt? He should end his otherwise illustrious career with some positive strokes.

Like (1)


Mar 7, 2012

Indians are getting into regional politics with more decision making power. The DELHI POWER CENTER is loosing it strength now it a bunch of politician without any Vision of future of India . family oriented leadership soes not have any value. So many Changes have taken place.Now it is performance based vote bank .. Fed up with reservation/levy/exemptions etc.. To make things happen in their regions people may support any type of activities which is not listed in the book of rules.

Like (1)
Equitymaster requests your view! Post a comment on "The dangerous downside to the state election results". Click here!