Present crisis the tip of an iceberg - The 5 Minute WrapUp by Equitymaster
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Present crisis the tip of an iceberg

Apr 29, 2010

In this issue:
» Greece is just the 'tip of the iceberg', says Roubini
» Ratings agencies go scot free
» Great hopes from the Unique Identification project
» Why the financial system remains risky
» ...and more!

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00:00
 
Greece is just the 'tip of the iceberg'. This is if the noted economist Nouriel Roubini is to be believed. "While today markets are worried about Greece, Greece is just the tip of the iceberg. The thing I worry about is the buildup of sovereign debt," he told an international gathering yesterday.

This is a scary prediction for the already tainted European economies and global markets. Recent credit-rating cuts on Greece, Portugal and Spain have spread concerns across global investors. The European deficit crisis seems to be spreading. This is intensifying pressure on policymakers to widen a bailout package. We believe all this would be a negative for the economic recovery that was just starting to find some wings!

Roubini has also said the US probably will need a combination of increased tax revenue and lower government spending. Europe needs to curb spending. At a time when central bankers are busy pumping in cheap money into the markets in the name of stimulus, any cutback on government spending isn't seen coming anytime soon.

Anyways, as we wrote yesterday, if these European countries actually default, there will be an impact on emerging markets like India. But the impact would just be a knee-jerk i.e., short term. Whatever it is, it could provide you with opportunities to buy into your favourite stocks at lower prices. The idea is to not take cues from the 'price action' that will follow a Greece default, but to take a call on stocks' 'valuations' and then act.

01:12
 Chart of the day
 

Source: Economic survey 2010

Infrastructure is perhaps the Indian economy's most pressing need. It is the government's job to provide it. But it makes sense to rope in the private sector in whenever possible. They are able to bring in capital, expertise and cost reducing technology. But such public private partnerships (PPP) are not easy to stitch together. As the chart of the day shows, southern and western Indian states have done a better job at attracting PPP projects. Large states like Uttar Pradesh (value of PPP contracts Rs 21 bn) and Madhya Pradesh (Rs 78 bn) pale in comparison. In our view, India's heartland must help their economic cause. And it begins with infrastructure.

01:41
 
Investors globally seem to preparing themselves for the big crash. However, some words from Templeton Asset Management chairman Mark Mobius could help allay some of these fears. Investors are expecting another round of liquidity tightening led by Greece's debt default. Central bankers and financial regulators are all in support of an EU bailout. But Mobius believes that a default by Greece would be the best way to ease the European fiscal crisis. He believes that the crisis is unlikely to sustain for long or affect the prospects of emerging markets. Mobius also cited the fact that although the Greeks are rich, they are reluctant to pay taxes. This is due to mismanagement and corruption in the government. He therefore supported the idea of letting the 'Too Big' to fail this time. Else, its bailout could drag other nations in the EU to a debt crisis as well. We wish the central banks would agree with his logic.

02:23
 
The Unique Identification (UID) programme is truly one of its kind. Labeled as 'Aadhar', this project will cost US$ 2.2-4.4 bn to implement and will provide most of India's 1.2 bn citizens an identity. Indeed, this project is set to become the largest biometric database in the world. Providing UIDs is expected to play a significant role in bolstering India's economic growth. For one, it will provide proof of existence to millions of poor who have been denied their basic rights simply because they do 'not exist' on record. Second, it will cut down on waste because the UID will obliterate the creation of duplicate and false identities. As Nandan Nilekani, the UID chief, highlights, "It all boils down to a lack of proper identity, and the exclusion is debilitating. At the same time, India is clocking 8% growth. So it is clearly creating a huge divide; if we want people to be included in the growth story, we need to recognize the people the system doesn't recognize." Indeed, we could not have agreed with him more.

02:41
 
'What's in a name?' - this sentence from one of the dramas written by the legendary playwright Shakespeare has perhaps left an indelible impression on his millions of followers. And the answer too wouldn't matter much to them. But try putting up the same question to financial institutions in the US that were staring at bankruptcy a couple of years back. And they are most likely to say, "If only the triple A rated securities that we invested in by the trillions would have been called by some other name, we wouldn't have faced the disaster that we faced back then".

Indeed. It is the ratings agencies who lulled them into buying junk securities by labeling them as triple A. Thus, an editorial in FT is piqued that while the US Government is trying to bring full scale financial reform in the country, very little is being done about the ratings agencies. And it is not as if this is the first instance of the ratings agencies failing. They have failed on quite a few occasions in the past as well. The article thus argues that if the ratings agencies are not doing the function they are supposed to do, why give them a special status. It is time the Government became very strict with the ratings agencies and initiated some sort of action. According to the paper, the best place to start would be to remove their 'regulatory licenses'. This would go a long way in reducing the halo effect around them. And investors will no longer be tempted to trust them blindly. Not a bad idea at all we should say.

03:25
 
Ugly surprises in finance come in two varieties. Scandals and crises. Scandals happen when people act in ways they are not supposed to. Whey they get in trouble for acting in a perfectly legal manner - that's a crisis. The global financial crisis happened because the developed world allowed bankers to take on too many conflicting roles. Often without checks and balances.

In an interesting article in the Financial Times, Martin Wolf, its chief economics commentator, suggests some solutions. Reduce the leverage ratios of banks. In other words, increase their capital requirements. Especially during economic booms. Make sure a large part of their assets can be easily valued by central banks. Have a long lock-in period for stock options given to bankers. That way they do not benefit from short term profits. Move derivatives contracts from private placements to public exchanges. Let the government and not companies pay rating agencies.

In our view though, no matter how the rules are designed, they are never entirely fool proof. Hence, incentives are equally important. Financial institutions, their employees, ratings agencies and investors at large must be incentivized to aim for long term profits and avoid piling up risks. The Indian economy is not yet a full blown market economy. In addition, we have a prudent central bank in charge. But, as and when we provide more freedom to the financial system, we must build the right incentives.

04:27
 
Meanwhile, though the Indian stock markets were a tad volatile today, the major indices managed to comfortably hold on to their gains until the time of writing. The BSE Sensex was trading higher by about 69 points aided by buying activity amongst consumer durables, realty, metal, banking and auto stocks. However, FMCG, IT, telecom and healthcare stocks were seeing overall declines. While the other key Asian markets closed on a negative note, the European markets have opened in the green today.

04:55
 Today's investing mantra
"The best protection against inflation is your own earning power. If you are the best teacher, you will command earning power and get your share of the national economic pie, regardless of the value of the currency. The second best investment is in a good company." - Warren Buffett

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4 Responses to "Present crisis the tip of an iceberg"

V.VIJAYAMOHAN

May 1, 2010

Your writing on rating agencies is very good. Rating agencies must be re-rating companies and countries every half year or at least once a year.
In India too, rating agencies are rating on certain occasions. Whether the rating holds good after 1 year is mostly not reviewed. Where a company has failed during last 1 year, this must be noticed again by rating agencies. In other words, audit reports must be seen by rating agencies and they must re-rate all companies based on them and on other news and events. Lots of reforms are due - if we have to ensure that companies and countries do not fail as they are doing at present.

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MRJoshi

Apr 30, 2010

Your view on rating the rating agencies is very good. The rating agencies and some volounteer agencies that "select" prominent men in finance world, similarly need to be scanned to testify their credentials. The Satyam bubble is best example. The Satyam CEO was chosen as best CEO just the year before the scam broke out and lots of sceletons tumbled out .

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Murali Krishnan K

Apr 29, 2010

The failing 'rating agencies' should be punished and damage suits be filed against them. Removing the regulatiory licences will tantamount to 'letting them loose'. They will start another agency with a different name.

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vinod Raturi

Apr 29, 2010

Investing Mantra clearly brings out the fact that one has to continuously develop his skills and be saleable in the market.

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