India's growth is coming at a heavy price

Nov 2, 2010

In this issue:
» FIIs raise stakes in 25 of 30 Sensex companies
» QE2 is just another bank bailout plan
» China's importance in the global economy
» PM urges oil companies to scout overseas
» ...and more!!

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Things so far have been going hunky dory for India. The country's GDP has been growing at a fast pace. And expectations abound that in a few years time, India's GDP growth will surpass that of China. But this growth has come at a price.

While the strong growth is indeed commendable, the problems that have come along with it are high inflation, a big current account deficit, an appreciating rupee and inflow of foreign money. Inflation, in particular, has been really gnawing at the RBI for some time now. The central bank has said that though inflation has shown some signs of easing, it continues to be beyond the comfort level. The wholesale price index (WPI) has fallen from its April peak of 11.23% to 8.6% in September, but it is still above RBI's FY11 forecast of 6%. Further, high food inflation continues to persist even when monsoons have been good this year. This has largely been attributed to the change in consumption patterns as incomes have risen.

That said, the central bank believes that its policy tightening measures since October 2009 are beginning to pay off. Further, it remains upbeat on India's GDP growth. This is due to factors such as the normal monsoon, strong industrial growth, the sharp rise in excise duty collections, strong growth in corporate sales, robust consumer demand and increase in demand for credit from the private sector.

But again, because of this growth, inflow of foreign money and the value of the rupee have been rising and are posing fresh set of problems for the RBI. And with the US Fed most likely to announce another huge round of quantitative easing, fears of asset bubbles forming will continue to persist.

 Chart of the day
The growth of the global economy is still expected to be on shaky ground in the medium term. Not surprisingly, emerging economies are growing way faster than their developed peers. However, despite GDP growing in 2010, most nations are likely to see slowdown in growth in 2011. But that may not be the case with India. As today's chart of the day shows, India is expected to maintain GDP growth in both 2010 and 2011 at 8.4% plus. Even China, which despite growing faster than India in 2010 would see its growth moderate in 2011 at par with India's.

Data Source: The Economist

As per an Economic Times report, FIIs have increased their stake in 25 out of the 30 Sensex companies during the September 2010 quarter. And this has, quite logically, driven up the prices of these stocks. For example, HDFC Bank saw a large rise in FII ownership during the quarter. As a consequence, its stock is up nearly 30% over a mere three month period. At the same time, RIL saw a fall in FII shareholding, thus causing an over 9% fall in its price. Such instances draw light to two blatant facts, which when put together, reveal a discomforting picture.

One, FII buying or selling has an overwhelming effect on stock prices of Indian companies. Two, FIIs are an impulsive and capricious lot. The fundamentals of India and its companies do not change very drastically from time to time. But the herd driven buying and selling from FIIs does. The current tide is in favour of stock prices. However, this does not mean that this will always continue to be the case going forward. Hence, investors need to wait for the right time to buy stocks at attractive prices. And not base their investment decisions on what the FIIs are doing.

Here's another one on the Quantitative Easing II or the QE2 as it is popularly known these days. The US economy is counting on this new effort to get itself out of the woods. However, a write up on seems to have thrown some cold water on these expectations. It argues that QE2 is just another bank bailout plan and not a main street recovery plan. The write up goes on to say that the US Fed has misread the problem facing the US economy in a big, big way. Bernanke thinks that the US is facing a banking crisis. However, in reality what the country faces is not a banking crisis but rather a household balance sheet recession. Here, people are hell bent on reducing their leverage and hence, will not borrow no matter how much quantitative easing is done by the US Fed. Thus, the new round of easing is nothing but another trillion dollars or may be more gone down the drain. Our view is certainly not very different from this.

Since the onset of the crisis, China has been in the limelight of the world stage. While the developed world has been reeling under pressure, China's growth numbers have been spectacular. A 9.6% growth in GDP is considered as slow for China. Economists and experts feel that China will lead the world out of the slowdown. True, it accounts for nearly one fifth of the world's GDP growth. But its markets only account for 1-2% of the world's GDP. While Chinese markets play a vital role to its immediate neighbors, the exports from other countries to China only contribute 1-2% towards their own GDP. While it is true that exports have a rippling effect in the economic development of the country, however, the ripple benefit alone will not lead to a very spectacular growth for the country. Therefore, while China will certainly contribute towards global recovery, it does not appear that it alone can also pull all the countries out of their miseries.

Who benefits the most when price for a commodity is on a continuous upmove? Obviously the persons who hold the maximum quantities of the same. Similar seems to be the fortune of the IMF (International Monetary Fund) with the rise in gold prices. The global regulatory body has accelerated the sale of the yellow metal given its high demand and attractive pricing. In fact as per Reuters, if sales continue at the current pace, the IMF could complete the disposal of 403.3 tonnes of gold or one eighth of its reserves by the end of 2010. With the state of the US economy and the reserve currency (dollar) showing no signs of stability, central banks may continue to buy gold. In such a scenario the IMF's sales are but well timed.

If there was one external factor that could bring India's growth to a standstill, it would be the insecure supply of 'black gold'. Demand for crude oil is expected to grow by 40% over the next decade. However, domestic supply is expected to expand by only 12%. India already imports 4/5ths of its oil requirements. With demand only expected to grow in the future, the government has been encouraging its oil companies to purchase stakes in overseas oil fields. This will help bridge the long term demand-supply gap. China has been spending big bucks lately to secure overseas assets. State-run ONGC is now said to be in the running to purchase Exxon's stake in an Angola oil field. Indian firms needs to be a lot more aggressive on the acquisitions front; else they will be left behind in the global race for this precious natural resource.

Volatility plagued Indian indices in today's trading session as they oscillated to either side of yesterday's close. The BSE-Sensex was trading higher by about 9 points at the time of writing. While stocks from the capital goods and consumer durables sector found favour, auto and oil & gas stocks were at the receiving end. Asian markets were trading mixed today at the time of writing.

 Today's investing mantra
"Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management, and limited exposure to hard times." - Warren Buffett

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