Is the Indian economy a 'boiling frog'?

Nov 22, 2013

In this issue:
» The behavioural side of Quantitative Easing
» Housing prices correct in 10 Indian cities including Delhi
» Govt mulling over new ways to achieve disinvestment target
» How will the IT industry perform in FY14?
» ...and more!

Warren Buffett's 'Siamese twin' Charlie Munger is widely admired for his acute understanding of human behaviour. In one of his famous lectures, he talked about an interesting concept called the boiling frog syndrome.

What would happen if you were to throw a frog into hot water? The frog would instantly jump out to save dear life. But what would happen if the frog was placed in water at room temperature and then heated up at a very slow rate? The frog would most likely fail to jump out in time and hence, get boiled.

Of course, you must have guessed by now that this syndrome is more telling about errors in human cognition than about the anatomy of a frog. Like the frog, people, businesses and governments too fail to notice gradual but definite deteriorations in the external environment. It is only when things reach the 'boiling point' that they tend to realise the quantum of the crisis. But by then it's already too late.

With the way things are going in the Indian economy, we're afraid a similar boiling frog syndrome is unfolding in India. And that India's future could be in grave danger!

While we have come to associate the 'debt problem' with the developing economies, it is getting more and more evident that we have a really big debt problem back at home.

As you would know, India is currently bracing a situation of sluggish growth and high inflation. What impact does this have on companies? The slowdown impacts the revenues no doubt. Add to that persistent cost pressures that tend to squeeze margins. To be loaded with debt in such a scenario is like sitting on a time bomb. You have to service the debt irrespective of what happens to your topline or profit margins. For many companies, it becomes difficult to even pay interest on the debt, leave aside repaying it.

An article in Firstpost shares some shocking findings of a study by Credit Suisse. The report suggests that out of a sample of 3,700 listed companies, the ones that have interest coverage ratio of less than 1 has increased to 34% in the quarter ended September 2013. Even worse, 80% of these companies have had interest coverage of less than 1 in at least 4 quarters during the last two years.

For newbies, interest coverage ratio is used to determine how comfortably a company is placed in terms of payment of interest on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense for a given period. So if the ratio is less than 1, it means that the company does not have enough operating profits to pay interest.

In other words, a large number of Indian companies are in financial distress. They are either defaulting on their loans or undergoing debt restructuring. As per the report, restructured loans of Indian banks have increased to Rs 3.3 trillion. Of this, 55% has come through the corporate debt restructuring route. And the pace of such restructuring exercises is just increasing at an alarming rate.

It goes without saying that banks are the prime casualties when businesses fail to pay interest and repay loans. The bad loans of Indian banks have witnessed a huge surge. In fact, many public sector banks have reported sharp declines in their quarterly profits because of increasing provisions for bad loans.

All in all, the Indian economic environment is in a perilous state. If more businesses are failing than succeeding, you have a very big reason to worry. Because all those small and big businesses together make up what we call the Indian economy.

Do you think the worst is over for the Indian economy or has it just started to unfold? Let us know your comments or post them on our Facebook page / Google+ page

 Chart of the day
Will the Fed taper? Will it not? The world financial markets have been reacting sharply to any taper-related comments from the US Federal Reserve. The Indian stock markets tanked yesterday on renewed fears of the Fed taper. The BSE-Sensex was down 406 points (down 2%) while the NSE-Nifty declined by 124 points (down 2%). Foreign institutional investors (FII) were net sellers yesterday for the first time in a month. After two months of pumping money into the Indian markets, FIIs now seem to be showing signs of nervousness. Today's chart of the day shows that FII trend from April 2013 up to November so far.

Should investors worry about what the FIIs will do next? We believe that the current rally in stocks is largely driven by liquidity rather than positive changes in fundamentals. So any significant corrections in stock prices driven by FII sell-offs should be seen as time to go value shopping. So do not worry about how FII flows will pan out. Rather, be prepared to take advantage when they dump Indian equities.

Should you worry about FII flows?

----- Sensex Crash: Is this just the start of a massive crisis? -----

We have just released the most exhaustively researched report we have ever written in our history.

And this report tells you why the frequent market crashes are no coincidence...

And how the stock market and the economy itself could take a severe hammering in the days to come, making life unbearable for millions of normal people like you and me.

This is something you don't want to miss!

So without further ado, read this letter.

Guys over at have come out with a rather interesting chart. It's called the 'Quantitative Easing Behavioural Cycle'. And it highlights how over the past 5 years, perception towards the Government's quantitative easing program has changed. As per them, the perception has moved from being one of pure scepticism to something that can permanently smooth out the business cycle.

Smooth out the business cycle, really? As far as we can tell, the only perception that quantitative easing has changed is about people's gambling instincts. On account of interest rates being so low and money so widely available, investors have simply taken to speculating in risky assets like stocks and commodities. And guess what, the Fed is happy that this is happening. For it believes this is what will lead to recovery in the US economy. Whatever happened to the old virtues of savings and investing in real job creating ventures. Instead, we have a system that punishes the savers and rewards the creditors. Don't know when this bubble of perception is going to break. Sooner than later we think.

Just yesterday we mentioned how low rental yields in Mumbai market indicate that housing prices have risen through the roof. And correction is just around the corner. While it is difficult to say when the Mumbai market will start correcting, the real estate market in Delhi is already showing signs of correction. Housing prices in Delhi have corrected by 4.5% for the quarter ending September, as per National Housing Bank (NHB). In fact, not just Delhi, out of the 26 cities for which the NHB tracks pricing data, 10 cities have witnessed a decline in prices in the September quarter. We believe these are ominous signs. Declining prices around the festive season indicates that buyer sentiment is at an all-time low. Further, slowdown in the economy and a weak job market has made buyers all the more jittery. Most of them are adopting a wait-and-watch approach as pricing is unaffordable. However, it seems that the correction cycle has begun. But real estate being region specific, one may not witness a large scale correction at one go. However, a synchronized correction which has happened in 10 cities now indicates that the pricing dynamics of the property market are likely to change for good.

The Indian government is not known to be very experimental with reforms nor very innovative in fiscal management. However, it seems the fiscal deficit target and shortage in tax collection has forced a change. The Union Budget had provided for Rs 400 bn to be raised from disinvestment proceeds. However, the market conditions, macro-economic scenario and performance of PSUs have together derailed that plan. The government has so far collected only Rs 13 bn via disinvestments. Tax collections too are well below estimates and can hardly bridge the gap. Therefore in order to not breach the fiscal deficit beyond 4.8% of GDP, the government needs to undertake some urgent and crucial steps.

As per Economic, Times, the Finance Ministry is now toying with the idea of introducing innovative financial instruments. It may be recalled that in FY08, the government had introduced instruments called 'exchangeable bonds'. These are bonds that allow the issuer to unlock a part of its holdings in group companies without immediate dilution in equity. It effectively means that the government can issue bonds that can be exchanged for shares of one of PSUs at a later date. The government could then issue the bonds to, say, Coal India (CIL). In return the government can allow CIL to hold a minor stake in some other PSU. Doing so it hopes to avoid the resistance towards disinvestment and also raise the much needed funds in a timely manner.

The proposed US Immigration Bill may have sent jitters to theIndian IT industry but it is still expected to grow at a healthy pace this year. As per industry body, NASSCOM, IT sector in India is expected to grow by 12% to 14% YoY this year. This is higher than the 10.3% YoY growth seen during the previous year. And this is just in US dollar terms. In terms of Indian Rupees, the growth is expected to be much higher. NASSCOM has also stated that it expects IT exports to grow to US$ 86 bn this year.

Growth in exports would be driven by customers moving to new technologies. The question is whether this growth is sustainable or not. We think that in the short term, there maybe hiccups related to protectionist measures adopted in the sector's largest market, US. At the same time the Euro zone too is still struggling. However these are just short term headwinds. The long term growth story for the sector still remains intact.

In the meanwhile Indian stock markets are trading strong. At the time of writing, the benchmark BSE Sensex was up by 104 points (0.52%). Consumer Durable and Oil and Gas stocks were the biggest gainers. Most of the Asian stock markets were trading lower led by Singapore and China. The European markets opened on a positive note.

 Today's investing mantra
"Warren is one of the best learning machines on this earth. The turtles who outrun the hares are learning machines. If you stop learning in this world, the world rushes right by you." - Charlie Munger

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4 Responses to "Is the Indian economy a 'boiling frog'?"

Akbar Hussain

Nov 23, 2013

Fool's comment like this. How can a human imagine to compare the decision making power to that of frog.I just can not digest this types of comparison. Remaining part is left to the experts to think and find solution accordingly.



Nov 23, 2013

dear sir,

The reliability of the financial statements of the Indian companies is low. The money siphoned by promoters is not assessed. The negligence among bankers in not properly assessing the project and their tendency to bow down to pressure to be investigated. There is a need to have professional administration in Ministry Of Finance. The RBI should be declared as autonomous Institution with nil interference from Government.



Nov 23, 2013

We should not wait till over the Worst. Let worst come and go. Let us work for our goal. Let us work for our betterment. It is not pumping money in to economy that makes it better. It is not foreign (Diect+Indirect) Investment that makes the economy stronger. It is your will power; it’s your trust that makes things better. The term prosperity is debatable. Human intelligence is not comparable with that of frog. The boiling and cooling of water is continuous process. Our little real sacrifice will do wonder.
The earning, the debt, the GDP, the Interest coverage ratio- all need new definition. Just a higher interest coverage ratio doesn’t make a company stronger nor does it contribute to GDP and economic betterment.

Like (1)


Nov 22, 2013

"Is the Indian economy a boiling frog?" The concept of debt to earnings ration and its implications have been well brought out. You have also cautioned the investors.
However, in as much as investors have to remain invested in equities to some extent. it would have been more helpful if you could identify the most vulnerable of front-running or prominent companies, which you feel are handicapped by such debt.
It is like diagnosing a disease and treating it.
Long time subscribers of Equitymaster look up to you for that.

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