Another Japan is in the making

Apr 26, 2011

In this issue:
» India's external debt lower than its peers
» Is a tighter monetary policy really working?
» Petrol prices are set to rise again
» Chinese slowdown could impact Indian exports
» ...and more!

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The US is one of those developed economies that have been the envy of countries around the world. But not anymore. Now, the US is in a state which is looking frighteningly similar to the situation that Japan was in the 1990s. Consider some facts. Japan's 'lost decade' began with a government debt that was equal to GDP. It had a finance system that was deemed too big to fail. There were massive government stimulus programs and bailouts, and despite cheap money via zero interest rates, corporations were more interested in saving than borrowing in order to grow.

The US has already started displaying all the above signals. What is more, there are other signs evident that paint an equally dismal picture. For instance, adjusted for inflation, stock prices peaked in the late 1990s and since then have not really moved higher. To prove his point, Rob Arnott, Chairman of Research Affiliates, opines that credit and consumption does not really mean growth. Most of the growth has been due to a rise in population and inflation but the real measure of prosperity is determined after adjusting for these effects. Thus, if you take the real GDP into account, the current per capita GDP for the US is closer to the peak seen in 2007. This means that the US economy has stood still in the intervening four years.

Not just that, if one excludes the massive amount of government spending, the prosperity of the average American hasn't improved since the middle of the second Clinton administration, 13 years ago. These are startling figures, indeed. Private spending, which also measures the health of an economy, has not really taken off. Minus the local, state and federal spending, private sector GDP is 11% below the 2007 peak.

The US for some reason simply refuses to face this truth. It is willing to dispense money even though that act is undermining the strength of its currency and adding on more to its already bloated debt. The problems that Japan faced do not seem to figure on its radar. The immediate task for the US government is to get its finances in order. But with such massive debt and persisting unemployment, the US seems clueless as far as any meaningful solution is concerned.

Do you think that the US economy is going the Japanese way? Share with us or post your comments on our facebook page.

And while we are on the topic of the US economy, the chorus against the US Fed's loose monetary policy is rising every passing day. Has the central bank's reckless money printing done any good to the economy? Well, it has artificially slowed an otherwise freefall. It has pumped up the stock markets. It has reduced the costs of exports. And, of course, it has also lowered borrowing costs.

But has this been any help to a common American? Not at all. Unemployment rates continue to remain high. Consumer price hikes are pinching the pockets of the common American.

So one thing is quite clear. You cannot pay for your economic sins by monetary prayers. But to say that the US Fed's loose monetary policy has been futile is dangerous. Because now, the Fed does not know how to make an exit. The current bond buying program, i.e. quantitative easing, is going to end in June 2011.

Effectively, the US Fed has created a situation where the economy is between the devil and the deep sea. If the liquidity pumping is stopped abruptly, it's going to be tumultuous. On the other hand, if the Fed maintains status quo and continues printing more money, it is going to have disastrous consequences eventually.

 Chart of the day
The Indian government's fiscal deficit is certainly a matter of concern, but if one were to take its external debt into account, then the country can breathe a bit easier. This is because today's chart of the day shows that India's external debt as a percentage of GDP is much lower than its developed peers. Not surprisingly, Portugal and Greece's debt exceeds their GDP given that the Europe debt crisis began in these countries. The US is in a precarious state too as its external debt almost equals its GDP.

Data Source: The Economist

Indian public should be ready for a crude shock as state run oil firms may raise the prices of petrol by Rs 3 per litre once state elections are over. Petrol prices have faced six rounds of price hikes since June when it was freed. However, since January, the hike has been kept on hold keeping in mind the political consequences as elections approach this May. It is important to note that these firms will not be compensated for selling petrol at lower prices.

Petrol price hike is just the beginning of what is going to hit consumers in the times to come. With crude prices boiling and no duty cuts in the budget, the OMCs have no option but to pass on the price hikes. While this may limit the rate at which oil firms are making losses, they will continue to bleed unless diesel prices are freed of which we don't see any signals as of now.

Greenspan believed in it. Bernanke believes in it. And now, if a leading daily is to be believed, even our own Dr Manmohan Singh seems to have fallen for it. We are referring to the ability of controlling price levels in an economy with the use of monetary policies. Mr Singh argued recently that if the Government were concerned with only curbing inflation, it could very well have done it by pursuing tighter monetary policies. However, as per him economic growth would have gotten hurt in the process. And clearly, this would have done no one any good.

Should we take this statement of Mr Singh at face value? May be not. This is because a scenario where tighter monetary policy hurts growth but still does not take care of inflation is equally likely to play out. Our belief stems from the fact that a tighter monetary policy could end up hurting growth of manufactured products, an area where inflation is relatively benign. It should be noted that the main culprits for inflation are primary food articles, fuel and power and primary non-food articles and minerals. And the reason inflation is running amok here has more to do with supply side issues than any loose monetary policies. Thus, Dr Singh could perhaps be proved wrong in his assessment and the measures he outlined could actually hurt our economy than benefit it.

In a race, if your closest competition suddenly falls behind, you can see yourself winning the gold. Thus, one would think that if China's growth sees a slowdown, India could be a major beneficiary. However, according to a report by Fitch ratings, an economic slump in China could adversely affect Indian exporters. The world could see a flurry of cheap Chinese goods flooding markets due to overcapacity. This would in turn put margin pressure on exporters from India.

But on the other hand, strong growth in the dragon nation has been one of the major reasons for commodity price upswings. So, a slowdown in China could lead to commodity prices falling, benefitting other manufacturers. Either way, we still feel it would take a lot to tame either the Chinese dragon or the Indian tiger.

Indian stock market indices had a weak outing today as persistent selling led the indices to languish in the red. At the time of writing, the BSE Sensex was trading lower by 160 points. Most Asian markets, however, were trading in the red today, while the European indices have opened in the green.

 Today's investing mantra
"If you can find a company that can get away with raising prices year after year without losing customers (an addictive product such as cigarettes fills the bill), you've got a terrific investment." - Peter Lynch

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5 Responses to "Another Japan is in the making"


Apr 27, 2011

Indian Economy is hurting as the funds earned and earmarked for development may be just on paper. So much funds recd thr 2G auction, minority sale of Govt Cos. should have been effectively channelised for the future growth of the Country by improving infra-structure, creating a conducive climate for improving and training human resources. Bring in the best Universities or training centres and improve the pool of talent. There is a burden on some Cities, therefore if the focus is on developing even smaller cities things should definitely improve.



Apr 26, 2011

I couldn't agree more with you. Its the TRUTH. Better US accepts it and takes remedial actions.



Apr 26, 2011

I think inflation needs to be controlled by hook or crook. It may in interim hurt growth, but at any cost should be done.
PMO office has never been right on infaltion numbers as much as MR.Bernanke on US economy. Its about time PMO accepts its fighting a loosing war and act fast and treat the inflation problem on war footing



Apr 26, 2011

In a place like India where growth is high, monetary policies (increasing interest rates) can play a major role in controlling inflation - yes affecting the manufacturing sector, the real estate sector thereby reducing the valuations of real estate, reducing consumption of fuel, raw materials etc. in effect making things cheaper (yeah not as simple as that, but i guess the drift is clear).
America's case is different where there is an issue of deleveraging and hence monetary policies (lowering interest rates) is not jump-starting the economy!!



Apr 26, 2011

I would like to know if similar data is available for India through which we can know if Indian economy has actually progressed after adjusting for inflation.

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