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A rate cut may not take Sensex higher

Jun 14, 2012

In this issue:
» The real reason behind decline of western societies
» Promoter pledging at its lowest in last three years
» Warren Buffett's commodity bet for the 21st century
» Should Infosys buy back its shares?
» ...and more!

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The whole of Dalal Street is keenly looking forward to June 18, 2012. After all, it's the day when India's central bank will take the all important decision of the short term direction of interest rates. A rate cut, especially after the dismal industrial production figures of recent times, is all but certain now. Also expected is a stock market rally as a response to the rate cut. However, if a leading brokerage is to be believed, the rate cut will do hardly little to solve India's economic woes. On the contrary, it may well end up making the problem worse than it is right now.

We, for one, see quite a bit of merit in this argument. You see, monetary policy actions like a rate cut is useful when a country is facing recession. But what is staring India in the face is not a recession accompanied by a low inflation. It is in fact facing a phenomenon known as stagflation. Simply put, India's economic growth is falling off the cliff at the same it is facing an inflation.

According to us, in order for economic growth to be strong and have low inflation, there should be a fine balance between consumption and investment. But this does not seem to be happening in India in the past few quarters. Government, on account of its high fiscal deficit, is skewing the fine balance of consumption and investment towards the former. Thus, not enough investments for future capacity creation are able to see the light of the day. Not to forget the endless delays faced by the manufacturing projects even if money is made available to them.

Although the consumption story is helping us grow to some extent, even that depends on continuous spending by the Government. Once that slows down, growth will further come down and inflation will move correspondingly higher. In fact, the process is already underway if the recent spate of news about worsening GDP growth is anything to go by.

Thus, it is clearly evident that the main problem lies with wasteful spending by the Government. And hence, if we were to ensure a sustainable long term GDP growth and low inflation, fiscal deficit will have to be brought down meaningfully. This will ensure that the money that is freed up will be spent on investments and augmenting long term capacity. Thus, investors would do well to not expect major fireworks till the time the Government takes some bold steps.

Do you think a rate cut by the Government will help the economy recover? Share your views with us or you can also comment on our Facebook page. page / Google+ page.

 Chart of the day
It is a well known fact that based on purchasing power parity, India is amongst the biggest economies in the world. Today's chart of the day further confirms the fact, albeit in an interesting manner. It highlights how an average McDonald worker in India will be able to buy 0.4 big Macs with his hourly wage rates. The same stands at 2.2 for developed regions like Canada and Western Europe. While the difference does look like significant, it is a lot less as compared to the GDP per capita difference between India and these developed regions.

Source: The Economist

Economists and policymakers have failed to cure the problems of the Western economies. In fact, that is a very polite blame. They are rather culprits who have created all the mess. The truth is that the Western economies seriously need psychiatrists. Most of their economic and financial crises are rooted in neurotic behaviour. During the last couple of decades the world saw a series of crises. The fall of the Soviet Union and the Asian crisis are two noteworthy examples. In each of these instances, the Western economies reacted by not exercising caution. But rather by increasing risk.

Professor Mark Stein opines that their responses were driven by a mix of denial, omnipotence, excessive self-regard and hyper-activity. Even in their response to the 2008 financial crisis, they paid no heed to the lessons from history. For instance, the great Athenian civilisation had an immense sense of omnipotence and an urge to triumph over the Spartan enemy. It was this behaviour that ultimately led to their collapse. There is hardly any reason why history will not repeat itself.

Cash is king. It is a phrase that holds true for every company. But what happens when a company has excess of it? Or most importantly when does more become too much? Well if the company has been generating free cash flows consistently and does not have any concrete acquisition plans then plenty is too much. In other words, the cash should ideally be given back to the shareholders. Such is the case with the country's second largest IT company, Infosys Ltd.

The company has a cash pile of Rs 200 billion which is growing by the month. At the same time, it has a major risk aversion to acquisitions which could dilute its healthy return on equity numbers. While the latter is good, but it also means that the company has no concrete plans on how it would utilize this cash. When a management cannot find a better use for its cash pile, it should seriously think about returning a part of it to its shareholders. The company has maintained its dividend payout at 30% over the years. Maybe it is time for it to raise this level. But will Infosys do so?

Not so long ago, the words 'promoter share pledging' evoked horror amongst investors. Those were the days prior to 2009. Promoter share pledging data was then confidential. Hence reports of share pledging were akin to insider information. Common investors had no information on when and what proportion of promoter shares were pledged. Instances of promoters of small companies' promoters losing controlling stake therefore came as a thunderbolt. Margin calls on pledged shares led to the promoters losing their stake to the banks and financial companies. In the bargain, investors were left in the lurch. As a result, investors became overtly cautious about leveraged companies where promoters' pledged shares were disproportionately high.

Not that promoters have stopped pledging these shares. Securities And Exchange Board Of India (SEBI) mandated this information to be made public since 2009. Even after that, companies with high debt and poor cash flow have resorted to promoter share pledging. Some as much as 95% of promoter holding. Investors too have lost no time in dumping these shares given the uncertainty about their future. But as some large companies accumulated more cash, they have taken corrective measures. Promoters of several blue chips from the Tata Group, Mahindra & Mahindra, Hero Motocorp, Dr Reddy's etc have released their pledged shares . This certainly is a good move in volatile markets. Moreover, it offers comfort to investors looking at long term visibility. That promoter pledging in Indian stocks is currently at the lowest levels in 3 years, is also very comforting. All the more reason for Indian investors to not lose sight of the long term prospects of their favorite stocks.

That the legendary investor Warren Buffett does not hold much regard for gold is a fact well known. But that does not mean that he is not interested in precious metals. Infact, Buffett's latest investment is in what many say is the most precious metal of the 21st century. And this is not gold as many would think. Rather it is tungsten. Two things about tungsten make it an interesting bet. First, it is a metal that is super-hard and used in a wide range of applications. This is because of its ability to withstand extreme heat. Also, in many cases there is no substitute for this metal. And second, supply is running out fast. This is because China currently accounts for 80% of global tungsten supply. But it has cut short its exports by imposing quotas on foreign purchases. That is why other nations are looking at alternative sources of this metal.

Sensing an opportunity, it is hardly a wonder then that Buffett is keen to grab a share of the tungsten pie. Thus, his Berkshire Hathaway recently invested US$ 80 m in a tungsten mining project in South Korea giving Buffett a 25% stake. Sangdong Mine is expected to produce half of the world's non-China tungsten and account for 7% to 10% of total global tungsten production when it reopens in 2013. Whether this investment will work remains to be seen, but given Buffett's strong track record we will not be surprised if this indeed turns out to be a success.

Meanwhile, after a brief stint in the positive territory, indices in the Indian equity markets have gone back into the negative territory. Sensex was trading lower by around 150 points at the time of writing. Heavyweights like ICICI Bank and L&T were seen driving a significant part of the decline. Other Asian indices also closed lower today. Europe too has opened on a negative note.

 Today's investing mantra
"A horse that can count 1 to 10 is a remarkable horse not a remarkable mathematician" - Warren Buffett

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    Equitymaster requests your view! Post a comment on "A rate cut may not take Sensex higher". Click here!

    4 Responses to "A rate cut may not take Sensex higher"


    Jun 15, 2012

    rate cut will not help market for longer time n politics crisis which is mounting on present government will lead to fall in market in coming months.
    If no major reforms implemented in coming month i.e. FDI in Retail / Aviation , things will be difficult for indian economy.


    Rajiv Malhotra

    Jun 15, 2012

    A rate cut may push the sensex up which may not sustain as problem lies more within the domestic factors such as waistfull expenditures (free distribution of goods by states to the common man for vote attractions causing immense loss to the exchequre , NEREGA- where cause of assistance is not reaching the proper benificiaries but being mis-utilized yet leading to misutilization of funds. The governments inability to take and implement proper policies. One of the biggest factor which may hamper the growth of the economy in the long term is the reservation system. I feel it is high time this system should be abolished and equal oppurtunities be valued for all classes. It is time of competition and the able should get their worth which in return would help boost the economy. Ofcourse corruption is yet another major setback in our country and till thiss termite is dealt with severely, things may remain as they are or even worsen.



    Jun 15, 2012

    Rate cut will give temporary relief like a pain killer tablet, but it is not the cure.The lowering of rates may also have adverse effect, the money will flow to different investment avenues. The rupee appreciation will take place only if our exports increase. Reduction in oil prices may not affect much, because consumption has proportionately increased.


    g r chari

    Jun 14, 2012

    A rate cut may be a cosmetic relief for the stock market and it's feel-good effect is unlikely to wear-out in a couple of days. India's investment-grade rating has already been down graded and the nation is likely to be the first BRIC country where it's sovereign debt rating is likely to be classified as junk. Of course, the country's economic managers & FM, in particular, (even the ex-FM and now HM) are, as usual, in a denial mode, given their ostrich-like attempts to solve the economic problems the country is facing. Indian economy is undergoing a vicious cycle of low growth, high inflation, low investment, currency depreciation & low consumption, each one feeding on the other. A classic case of becoming a banana republic if corrective steps are not taken on a war footing.

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