A rating downgrade after 14 years?

Aug 10, 2012

In this issue:
» US has a huge wealth inequality problem
» Corn did well during the financial crisis
» Telcos may find it difficult to get loans
» US prefers renting houses than buying them
» ...and more!

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The Indian economy is going through one of its toughest tests at the moment. Despite successive rate hikes in the past, inflation has not come down to the levels that the central bank had anticipated. Meanwhile, GDP growth has slowed down and monsoons have not really taken off leading to droughts in many parts of the country. As if that was not enough, the industrial production contracted by 1.8% in June and has taken many by surprise. This is the third time that the IIP has contracted in the last 4 months and was largely on account of the slump in the manufacturing sector. Further in this, the non-durables output growth contracted 1% meaning that high inflation has played a role in reducing consumption.

As a result, with not much happening on the reforms front and the economic woes only piling on, there is the possibility of India facing a credit downgrade. So far, international ratings agencies have not lowered India's credit rating (which is a notch above investment grade) for nearly 14 years. However, some of them had cut their ratings outlook in recent months following the decline in the country's economic indicators. Indeed, the last ratings downgrade took place after the 1998 nuclear tests.

Ratings of credit agencies could be taken with a pinch of salt. The lack of credibility displayed by major ratings agencies during the global financial crisis is ample proof of that. But that does not take away the fact that India does have a serious problem on its hands. While policy reforms and removing supply constraints would be the obvious answer, it is easier said than done since there are so many difficulties on the political front. The RBI has already done its bit. So all eyes will now be on the latest Finance Minister Mr Chidambaram and how he chooses to tackle these issues. Although it is apparent that some bold steps will be needed to be taken, it is unlikely that the current government will do anything radical that will hurt the sentiments of its voters.

Do you think that India faces the increasing possibility of a credit downgrade? Share with us or post your comments on Facebook page / Google+ page.

 Chart of the day
In India, slowdown in industrial production was evident, when the index contracted by 1.8% in June. But how has it fared when compared to some of its peers? Today's chart of the days shows that despite talks of a slowdown in China, the industrial sector still seems to be growing. Although India has put up a poor show, it can take solace from the fact that Brazil has fared worse. That said, the contraction does suggest that India has a few tough months ahead of it.

Data Source: The Economist

Like many of his fellow economists, Nobel laureate Joseph Stiglitz too is livid with the current state of the US economy. However, unlike them, he has a rather unique theory to explain most of US' economic woes. The problem, he believes, lies with greater inequality. Or in other words, the growing rich-poor divide. The costs pile up when the rich keeps getting richer, he observed in an interview with moneynews.com. He further added that if we go into austerity, it leads to higher unemployment and further increases inequality. This way, wages go down, aggregate demand goes down and wealth goes down.

There is absolutely no doubt that there seems to be a huge wealth inequality in the US. But is that the reason the US economy is going downhill as Mr Stiglitz emphasises? We don't think so. We are of the view that the Nobel laureate seems to be interchanging cause and effect. It is not the rich-poor divide that is affecting the economy. But rather the lopsided nature of the economic growth that's having a negative impact on wealth distribution. Till the time the US society continues to rely on debt as a means to achieve growth, does not regulate financial sector enough and operates on the principle of privatized profits and socialised losses, it will have to live with extreme inequality we believe.

Which have been the best investments ever since the financial crisis broke out in 2007? Precious metals such as gold and silver have been among the greatest beneficiaries. Both these metals returned 143% and 121% over the last five years. But quite a few other investments have also done well during this same period. Take for instance government bonds of the UK, Germany and US. The three have returned 54%, 40% and 38% respectively. It is a different matter that bonds of a couple of these countries may be risky to keep for the long term. One of the investments that did phenomenal during this period was corn. It went up 144% over the five year period. The recent US drought only further boosted its prices.

It must be noted that during this same period, the world stock markets have had quite a lacklustre performance. Indian share markets have returned just 15% since August 2007, when the credit crunch began. The benchmark US equity index S&P 500 returned just under 8% during this period. Hang Seng, the stock index of Hong Kong returned just 5.5%. But that's not all. Europe's Stoxx 600 is still 13% down since inception of the crisis. The worst performer has been Greece. If you would have invested your money in this country's benchmark index, you would have lost more than 85% of your money. This shows how the global economic woes have forced investors to flee away from equities and into relatively safer asset classes.

The troubles for Indian telecom companies are increasing day by day. First they are faced with a regulator which cares more for filling up government coffers than their business interests. Second, it is faced by hyper competition thanks to which they are unable to raise rates and are resultantly operating on wafer thin margins (if any). Third, they are already plagued by heavy debt to take care of their operational as well as capital needs, which in turn are increasing day by day. And now they would find it tough to raise more money at least if they decide to approach the banks.

The Reserve Bank of India (RBI) has laid preconditions for financing telecom companies for the upcoming 2G spectrum auction. The guidelines are meant to protect the banks against possible defaults. But at the same time they would make it difficult if not impossible for the telecom operators to get loans. Especially for the smaller operators. The banks would insist on stricter technical evaluations for projects, higher collaterals and current financial strength of the companies. The only way they would be willing to lend to the weaker companies would be if there is a possibility for tariff increase. But here again the regulator is not keen on tariffs going up too drastically. All in all the bad days for telecom operators are far from over.

Say an average middle class individual wants to buy a house. Which is the one most crucial factor that will determine his decision? The answer is future job security. This is because buying a house normally means borrowing long term funds.

An unusual trend is evolving the US right now. People in the age group of 20 to 34 years are very wary of buying houses. They are more comfortable renting apartments instead. But it's not just about houses. They are wary of making any big purchases. So much so that they are even willing to rent cars and clothes!

This is very telling of a country that is bracing the deepest recession after World War II. The jobless rate has been persistently above 8% since 2009. On the other hand, another time bomb in the form of US$ 1 trillion in student-loan debt is ticking away. The bleak economic outlook and the excessive sovereign debt are likely to weigh on the future prospects of the American youth. Their attitude towards making big purchases is a clear indication of their future job and income insecurity.

After recording scorching growth figures of 45% YoY and 32% YoY in 2009 and 2010 respectively, China's auto sales volumes have slowed down tremendously. Nevertheless, the dragon nation's auto sales growth figures seem relatively healthy, especially when compared to those of India's. During the month of July, which according to the Financial Times is considered a weak month for the motor industry, growth remained at 11% YoY. Passenger vehicles sales volumes are higher by 7.5% YoY in the year till date. Given that the government has eliminated all related tax incentives, this trend is being attributed to factors such as continued GDP growth and increasing urbanization. One can say that similar is the case in India. However, the Indian passenger vehicle sales grew at a slower pace of 7% YoY during the month of July. Sales of utility vehicles and two wheelers declined significantly. The overall economic uncertainties coupled with high interest rates seem to reasons behind the same.

In the meanwhile, the Indian equity markets opened weak and continued to trade in the negative territory throughout. At the time of writing, BSE Sensex was down by 25 points (0.1%). Consumer durable stocks led the losses followed by banking stocks. Among Asian stock markets, Taiwan and South Korea were the only exceptions to the list of losers today.

 Today's investing mantra
"If investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring." - George Soros

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2 Responses to "A rating downgrade after 14 years?"

ajay kaul

Aug 10, 2012

India's Industrial and services sectors will have to compensate for its weak Monsoons.It follows then that what is beyond Weather dependence needs to be attended to urgently to the extent possible.Infrastructure,Energy,capital goods,Processed food and Tourism are key areas that need fillip and quick action.

Like (1)

Kersi Mahudawala

Aug 10, 2012

India faces the increasing possibility of a credit downgrade unless quick remedical steps are taken.The fiscal consolidation is urgently required to control inflation.

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