When owning money is as scary as owing money

Jun 17, 2010

In this issue:
» India may see double digit GDP growth in FY12
» World slated to have a new commodities superpower
» Government has hopes pinned to monsoons
» Corporate lending set to become much more expensive
» ...and more!

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An interesting article in a leading daily caught our eye. It said 'Germany is the new China'. We have been thinking all along that it is the other way round. China is supposed to be the new Germany, isn't it, the new export machine of the world. But we proceeded with the rest of the article anyways. And then the logic slowly caught us. Germany is indeed the new China.

You see, Germany's exports stood at little under 500 bn euros during 1999. This was the first year of the unified currency euro if you remember. And then a miracle happened. The exports figure for Germany soared and it now stands at a huge 1 trillion euros. In other words, the euro has really helped German exports soar. Germany has one of the cheapest labour rates of all euro nations. And when euro came into existence, it became easy for Germany to export its wares to member countries. But euro nations did not have the money. Enter German banks and the low interest rates courtesy the euro. What followed was a prolific lending binge by German banks. But this could not continue indefinitely. Debt at PIIGS nations, countries to which German banks lent, went up disproportionately and these countries have now come on the verge of default.

Little wonder, Germany has been instrumental in passing a stimulus package in the region of US$ 1 trillion. As otherwise, its banking system will fall like a pack of cards. What's more, its export machinery will also crumble. Sounds similar to the China-US story isn't it? Both China and Germany failed to grasp one basic point. You cannot lend to people who cannot afford to pay you back. Sooner or later, the chickens of defaults will come home to roost.

 Chart of the day
Ever wondered which professions will be most in demand in India in the years to come? Today's chart of the day sheds some light on that. It displays the functional areas where various executives in corporate India feel it will be the most difficult to recruit talented people. A McKinsey survey shows that research & development and corporate strategy are two areas where executives are the most insecure about being able to acquire quality talent in the years to come. That said, finance is one area that already seems to have an abundance of talent. Hardly 1% of those surveyed saw that as a problem area.

Data Source: McKinsey Global Survey May 2010

Before the global crisis unfolded, India had logged in an impressive 9% plus growth in the previous three years. But once the crisis deepened, India felt its impact as well, and GDP growth slowed down to 7.4% in FY10. But the finance minister Pranab Mukherjee is confident that India will break the barrier of double digit growth in FY12.

There are several reasons for his optimism. One is that India has recovered significantly well from the crisis. This is even when its developed peers are struggling to come out of the slump. Exports began showing positive signs from October 2009. Further, as India is doing well despite facing the financial crisis, FDI flow in the country is expected to touch US$ 20.9 bn by December 2010. Mr. Mukherjee has also highlighted the strength of a huge pool of young and talented workforce in the country. He opines that by 2022, India would have 50 m skilled manpower to cater to the country's trade and industry. However, the major challenges to India's growth are poor infrastructure, high inflation and a widening fiscal deficit. India might grow in double digits in FY12. But the challenges that it faces will have to be addressed if this kind of growth has to be sustained.

The bounty of mineral resources can often change the economic and political history of countries. The rise of the US was fuelled, among other things, by its oil industry. The world wars were won on the basis of access to transport fuels. The present day clout of the Middle Eastern nations and the misery of the African countries is underlined by commodities. So it doesn't come as a surprise when an article in Forbes points out that one of the world's poorest regions could become a commodities superpower. We are talking about Afghanistan, where new geological research by the US has thrown up some startling results. Apparently, the rugged terrains of the war torn country have astoundingly vast reserves of iron, copper, cobalt, gold, molybdenum, lithium, niobium.

As per an estimate by the US Defense Department, the minerals are worth over US$ 900 bn. Interestingly, it has certain minerals of military use on which the Chinese have a near monopoly currently. In our view, given the monetary and strategic value of such minerals, Afghanistan's future will take either of two courses. Nurtured by the international community, it will one day become a fabulously wealthy country. Or, it will become a pawn in the game of supremacy between the established powers and emerging giants like China. The second option seems more likely. Not that it is news to the Afghanis who have suffered for decades if not centuries for one reason or the other.

Rising inflation continues to take toll on the living of the aam aadmi. What is more troublesome is the constant rise in food prices. The government knows nowhere to go on this, as it has now become a big political issue as well. Amidst all this, what the government can do is soothe fears regarding future inflation. And it is doing this! It now hopes the monsoons will tame inflation by bringing food prices down. Given that monsoons are expected to be normal this year, the government has pinned lot of hopes on them to save them the blushes!

Banks that are hoping to grow their balance sheets with larger and safer corporate loans are in for disappointment. They have had a rough encounter with risky retail assets like personal loans and credit cards during the economic downturn. And most banks are now trying to woo large and midsized corporate customers. Some have even gone to the extent of offering loans to large corporates at rates that earn them almost nothing.

However this is set to change. Once the 'base rate' system is put into place, banks' corporate lending will become far more expensive. So much so that corporates may find it cheaper to raise money through commercial papers. With large corporate lending forming 20% to 30% of banks' loan books, this is certainly a huge risk. The base rate will ensure that banks lend only when it is profitable to do so. However, the fear is that it may leave banks with plenty of unused liquidity.

Indian markets were trading around the dotted line at the time of writing amidst continued volatility. Stocks forming part of the consumer goods, and oil & gas sectors were amongst the top gainers, while those from the IT and FMCG were amongst the top losers. The market sentiment in other Asian regions were also negative with Japan, and China losing 0.7%, and 0.4% respectively. Hong Kong was marginally in the green with a 0.3% gain.

 Today's investing mantra
"Most companies define "record" earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding." - Warren Buffett

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3 Responses to "When owning money is as scary as owing money"


Jun 18, 2010

Dear Sir

Your articles are very good and informative. It would be better if you add just one or two tips for day traders.

With regards
S. Subramanian


J Thomas

Jun 17, 2010

"You cannot lend to people who cannot afford to pay you back. Sooner or later, the chickens of defaults will come home to roost. "

Change that to "You should not lend to people who cannot afford to pay you back."



Jun 17, 2010

it would have been better if you would have elaborated more on the market volatility, because the markets almost gain 150+ from the negative levels...within few movements!

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