An idea that can save America

May 5, 2009

In this issue:
» Buffett sees no signs of recovery
» Future of Wall Street lies in the past
» Elections will determine S&P rating on India
» No end to power shortages
» ...and more!

Indians can help the US tide over the depression like crisis that the world's largest nation faces. This is what the noted writer and The New York Times columnist, Thomas Friedman, recently talked about in his post for the paper. He wrote, "Leave it to a brainy Indian to come up with the cheapest and surest way to stimulate our economy: immigration."

But the US President seems to be in no mood to listen to the likes of Friedman. Instead, Obama's rhetoric has been to save American jobs by putting restrictions on offshoring. And he continues to bash US companies that have Bangalored* their tasks. As a way to act against offshoring of IT services to India, he has now lashed out at the current US tax system which he believes encourages paying "lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York."

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While Obama's rhetoric might seem right to an American who has lost his job to an Indian techie, the fact that needs to be remembered here is that America, in the first place, didn't become the wealthiest country in history through protectionism. Rather, the recipe for America's success was simple, as Friedman says, "Build this really flexible, really open economy, tolerate creative destruction so dead capital is quickly redeployed to better ideas and companies, pour into it the most diverse, smart and energetic immigrants from every corner of the world and then stir and repeat, stir and repeat, stir and repeat, stir and repeat."

This is exactly what we have heard from Indian IT companies whose managements we have met recently. Their idea is that one way the American and the world economy can come out of this recession and emerge even stronger in the future is through innovation at lower cost.

While most large Indian IT firms have built their businesses around lowering the cost of operations for American and European corporations, even small IT companies are not far behind when it comes to showcasing how our brains can help improve productivity around the world. In fact, some small IT companies we recently recommended through our Hidden Treasure service do exactly the same.

* Bangalored - A term used by Americans to describe loss of jobs due to offshoring to India

If chairman of law firm Sullivan & Cromwell, Rodgin Cohen were to be believed, the future of Wall Street lies in its past. Yes, after years of supposed progress and development in the biggest of financial institutions on Wall Street, and billions of dollars of tax payer money spent on them since the bust of the credit bubble, he expects these institutions to look much the same in the future as they did before the markets collapsed. Infact, a deputy chairman of asset management firm Lazard Ltd. Said, "There's a good chance there are five to seven or eight global institutions, of which three or four will be clear winners and then some others will be good, doing full-service banking and securities business sort of as we knew it five years ago. They will operate with a lot lower return on equity and a lot lower risk profile." But if that is what it takes to get the global economy back on its feet, we are surely not complaining.

When Warren Buffett, the Oracle of Omaha speaks, the world listens with rapt attention. Hence, when the chairman and CEO of Berkshire Hathaway says that he has seen no indication of recovery from the real estate slump that helped cause the US recession, it certainly gives investors something to chew upon. Earlier in the week, Paul Volcker, one of Barack Obama's economic advisors, had said that the US economy was 'leveling off at a low level' and does not need a second fiscal stimulus package.

To which, Buffett has this to say, "You never know for sure, even if there's a leveling off, which way the next move will be." Indices over the world have seen a rally of late but unless and until there are some concrete signs of economic revival, the current rally may not be sustainable. Looks like the world is still a long way off from a significant economic recovery.

While the world may still be reeling under recession, India has something to cheer about. As reported in a leading business daily, key indices that reflect the health of the manufacturing sector in India pointed to a growth in April after several months of economic contraction. For instance, the ABN Amro Purchasing Managers' Index (PMI) gave a positive picture of improvements in business conditions in the manufacturing sector. The reasons for the same are varied. The Sixth Pay Commission and the loan waiver have increased the disposable incomes at the hands of the urban and rural consumer respectively which has gradually propped up demand. Falling interest rates and rising liquidity has also added to this recovery. However, one will have to just wait for a few more quarters to see whether this trend is sustainable.

Recessions and economic slowdowns do not do any good to anyone. But if the Economist is to be believed, the outbreak of the deadly swine flu has meant that slowdowns are actually making a positive contribution to the society at large. How you may ask? Well, by dampening the actual negative impact that a pandemic of such a magnitude could have on the global economy. In other words, since the world is already facing a slowdown, the incremental impact of the flu may not be as huge as during normal times. The article argues that the outbreak of a pandemic has the potential to reduce world GDP growth as it affects both demand as well as supply. Infact, studies show that a global epidemic of the worst kind could reduce world GDP growth by as much as 12.6%. Even a mild one could shave off 0.8%. No one knows the number this time around. But since the world is already in its worst slowdown since the Great Depression, the negative effect of the disease may not be as pronounced. But as the article goes on to conclude, "If a pandemic does occur, it would be a small comfort indeed."

The general elections will have a bearing on S&P's credit rating on India with a revision on the cards depending upon the fiscal policy outlined by the new government. It may be recalled that S&P in February changed its outlook on India to negative from stable with the country's deteriorating finances and burgeoning trade deficit cited as major concerns. As it is there are expectations of a coalition government once again. Plus, fears are rampant about the ability of the new government to push ahead with vital reforms. Further, a downgrade could raise the interest rates paid by the government and companies when they borrow money. As reported on Reuters, Goldman Sachs expects the total Indian federal and state deficit to rise to 10.3 % of GDP, among the highest in the world by the end of FY09. Certainly, the new government has a mammoth task on its hands if the Indian economy has to grow at a strong pace on a consistent basis.

While the summer in India could not have been hotter, the scenario is only set to get worse due to power shortages in the country. Not surprisingly, the shortage has been attributed to projects not getting completed on schedule, a trend which has been visible time and again in the past. For instance, against a target of 11,000 MW of capacity addition in FY09, only 3,500 MW has been achieved. Just to give an idea of the poor state of power in India, hydropower generation in the south, which accounts for 30% of the country's installed capacity of 38,000 MW of such power, has stopped due to less water in the rivers. What's more, of the country's total installed capacity of 147,000 MW, only around 85,000 MW is operational at any given point of time. There are high expectations from the monsoons this year to provide the much needed water required for generation of hydroelectricity. But this is only a short term solution to a serious and chronic power problem.

The Indian markets closed marginally lower today led by losses in the BSE IT (down 3%) and BSE FMCG (2%) indices. On the global front, while the Asian indices closed mixed, the European indices are trading firm currently. As reported on Bloomberg, crude oil prices were little changed at US$ 54.2 a barrel.

 Today's investing mantra
"Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac's talents didn't extend to investing: He lost a bundle in the South Sea Bubble, explaining later, 'I can calculate the movement of the stars, but not the madness of men.' If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases." - Warren Buffett

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