The 'bubble' making factory remains open...

Mar 17, 2010

In this issue:
» A key landmark in Indian manufacturing
» A sovereign wealth fund for shopping overseas
» The solution to India's infrastructure problems
» IIT, IIMs left to private funding
» ...and more!!

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They thrive on the 'greater fool theory'. They are driven by the behavior of perennially optimistic market participants (the fools) who buy overvalued assets in anticipation of selling it to other speculators (the greater fools) at a much higher price. They have led to economic catastrophes like the Great Depression and the latest subprime crisis. They are threatening to bring the fastest growing economy to its knees. Yet economic "bubbles" as they are popularly called, are set to have a longer life.

Cheap liquidity which is the lifeline of global asset bubbles continues to find supporters in its birthplace - the US Fed. Determined to keep interest rates near zero long enough to drown global economy in surplus liquidity, the US central bank has refused to pay any heed to sensible economics. In their latest meeting, Federal Reserve officials repeated their pledge to keep interest rates near zero for an 'extended period'.

Economists in the US opine that the housing market will be able to weather the removal of the stimulus programmes once the economy begins to create jobs and banks ease up on credit. Well, if that is the logic for the US Fed's reluctance to raise interest rates, cheap liquidity is here to stay. For the US Treasury Secretary Timothy Geithner has himself expressed his concerns over unemployment rates in the US remaining elevated for longer than expected. US banks can try to ease up lending only if the US consumers get back to borrowing and spending. Each of these is therefore expected to add to the flow of cheap liquidity into emerging markets and risky assets. While China seems to be happy to accommodate it in its real estate sector, Indian regulators need to ensure that they do not poison Indian stockmarkets and real estate.

 Chart of the day
China's ambitious double digit growth rate in GDP is leaving the world poorer in industrial resources. As today's chart shows, the Chinese economy which is stimulating growth through investments in infrastructure, is consuming nearly half of the world's industrial commodities. While it is not wrong to put the commodities to industrial use, building up excess capacity at the pretext of stimulating growth can be hazardous wastage of limited resources.

Data source: UN International Merchandise Statistics

India will create history this year, reports The Economist. For the first time ever, India's manufacturing will contribute more to its GDP than agriculture. However, we are confused. We do not know what to call such a phenomenon. Manufacturing sector's victory or agriculture's defeat? The Economist has preferred to call it the latter. It bemoans how the agriculture output in India has been a productivity disaster. Soils are getting insensitive to the use of fertilizers and dependence on monsoons has barely come down. And it rubs further salt in the wounds by pointing out the rapid strides that China has taken in agriculture. The truth is that while India has freed industry, agriculture remains a tightly controlled entity. Just to give an example, fixed prices exist for 25 commodities even now and input like fertilizers are subsidized. The end result? There is no incentive for the farmer to switch to other crops.

Furthermore, with the Government using most of the funds towards subsidies, there is hardly anything left for improving infrastructure or spending on research. As the article points out, India needs to stop seeing agriculture as a problem to be nursed and start thinking of it as an opportunity to be grasped. We couldn't have put it better.

One of the root causes of most financial crises in the past has been the free movement of capital across countries. While any country will like to see strong foreign money flows into its markets, a sudden and sharp outflow is what worries it the most. But if there's a tax on such outflows, it sort of deters hot money to flow in and out of a country's financial markets.

One such tax is called 'Tobin Tax' after the Nobel laureate economist James Tobin who first proposed this. The former RBI governor Dr. Y.V. Reddy is a big supporter of this tax. He first suggested such a tax for India's foreign exchange transactions in 2005. And this resulted in Indian stockmarkets going into a free-fall.

Anyways, Dr. Reddy is proposing the Tobin Tax again. In one recent international conference, he said that this tax deserves more attention than what it has received so far. We believe he is likely to gain greater support now given that the underlying causes of the financial crisis have been fully appreciated by economists and policymakers around the world.

One of the most interesting developments in commodities in the last few years is the race between China and India. The race to acquire mineral assets in Asia, Africa and Latin America. So far, China has had the upper hand over India. The Chinese government provides full political and financial backing to Chinese companies. They spent around US$ 32 bn last year acquiring foreign mineral assets. The Indian government does not assist its companies to that degree. But that seems to be changing.

As per Bloomberg, India is planning to carve out a portion of its US$ 254 bn foreign exchange reserves to create a sovereign wealth fund. This fund will help state owned -companies compete for overseas energy assets. In our view, this is a positive development. More funds would definitely help the cause of Indian public sector commodity companies. But China will retain one advantage that India can't possibly match. The dragon nation is far more comfortable backing despots in mineral rich but authoritarian regimes. Democratic India finds it difficult to cozy up to them.

For a country starved for infrastructure, removing roadblocks that hinder the growth of infrastructural development has to be given paramount importance. And so, one hindrance that has to be done away with is that related to land acquisition. In this regard, IDFC has released a quarterly report which states that roadblocks to land acquisition for infrastructure projects, especially in urban areas, can be overcome. This is by allowing owners a share in the gains in real estate prices after the development takes place.

Given that there have been many protests over land acquisition, IDFC has stated that pooling small holdings was a more democratic route in a country such as India. What is more, the report also recommends building a road at the start of any infrastructure project as this will certainly enhance development. Indeed, 70% of the 190 infrastructure projects were delayed last year because of land acquisition problems. Therefore, IDFC's proposal in this regard makes a lot of sense. But whether the government will pay heed is anybody's guess.

The PM's national council for skill development is busy planning the nation's future these days. More specifically, reports state that the government is no longer interested in funding the setting up of new educational institutes such as IITs, IIMs, NIFTs and hotel management institutes. This is because it feels that players in the private sector are more than willing to invest in such institutes. Instead, it feels that the focus of future public expenditure must be on skill development in areas that find it difficult to attract private funding. Particularly, institutes such as Industrial Training Institutes (ITIs) and polytechnics that will help develop high-quality skilled workforce to meet India's future needs.

Managing to sustain the momentum after a buoyant start, Indian markets featured amongst the leading gainers in Asia today. Stocks from the banking, IT and commodity sectors particularly found favour amongst investors. The benchmark index, the BSE-Sensex was up by around 100 points (0.6%) at the time of writing, while its smaller peers, the BSE- Midcap and the BSE- Smallcap indices were up by 0.2% each. European markets have also opened on a positive note.

 Today's investing mantra
"Holding a certain portion of one's wealth in cash is advisable. One won't have to be dependent on the kindness of strangers. One sleeps well." - Warren Buffett

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3 Responses to "The 'bubble' making factory remains open..."

Devang Gardi

Mar 17, 2010

Again, a very poorly written piece of research. A couple of days back you mentioned that even Dr. Volcker is not advocating the removal of the stimulus program and now you are mentioning the the guys sitting in the US Fed are a bunch of morons? Please make up you mind. Let me draw your attention to Dr. Mukherjee's (Indian Finance Minister) statement: even he is not advocating the withdrawal of stimulus and so are not the Chinese. Now, if the two fastest economies are not advocating the withdrawal of their respective stimulus programs, why would you recommend that of the US Fed, especially when economic growth is tentative?
I have a quick trivia for you: What is common amongst all countries that have sovereign wealth funds (SWF)? The answer is that all of them have current account surplus. I have another quick question for you: Does India run a current account surplus? The answer is: NO.
Now, the question is why would not running a current account surplus impair India's ability to have a SWF? The answer lies in understanding the difference between current account and capital account balances. Think of current account as an Income statement (where earnings are generated through higher revenue and lower costs). Think of capital account as a Balance sheet (where cash is generated through asset sale or fund raising). In India's case, where FII inflow is higher than FDI, this is the worst kind of capital risky flows.



Mar 17, 2010

please put date in your report



Mar 17, 2010

At the outset it has to be pointed out that the title of the day's (March 17) write-up is very apt. The greater fool theory cited as the root cause for all major economic catastrophes was very interesting and elucidatory.The view that India should stop seeing agriculture as a problem to be nursed and start thinking that it is an opportunity to be grabbed is a well-considered one.

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