The risk that only Dr Rajan is warning us about...

Dec 3, 2014

In this issue:
» An energy war in the making?
» How high are fuel prices in India?
» Is the government really worried about deficits?
» Roundup on markets
» ...and more

The RBI's Monetary Policy yesterday came under criticism for the central bank's stubborn attitude. All that was evident to investors was that the central bank was at loggerheads with a 'growth concerned' government. Its unwillingness to bring down interest rates even as commodity prices and food inflation remained benign seemed odd. However what was lost on most of us were these facts.

It took the US government more than 205 years to accumulate its first trillion in debt in 1981.

It took less than 5 years to accumulate the next trillion.

And when the US government debt crossed US$ 18 trillion last week, it took less than 403 days to accumulate its most recent trillion! At this point government debt stands at 103% of US GDP.

And since the government is determined to keep printing money, one can only expect the trillion creating rate to accelerate in the days ahead.

So why should Indians and particularly the RBI worry about it?

Well, whether we like it or not, when the US sneezes, the global economy catches a cold. The possibility of the US government defaulting on social security, loans owed to banks, China etc is over 100%! And in such a scenario it is only prudent to expect that a mammoth sized global economic crisis is around the corner. By the time the US realizes the damage rendered to global economy, the emerging markets may hardly have enough safeguards to protect themselves. And it is none other than a prudent central bank that can foresee and prepare for such a crisis.

Dr Rajan is probably the only RBI governor to have adequately voiced his criticism on the US Fed's policies. He has been doing so from the time, the grandfather of US QE, Alan Greenspan reigned the Federal Reserve. And while he cannot change the minds of Fed governors, the least that he can do is create safeguards for India.

The unwillingness to allow asset bubbles to be created in India by keeping the cost of capital fairly high is a move in that direction. Moreover as and when there is a flight of foreign capital, the attractive returns here may stem the outflow to some extent.

As far as stoking growth with interest rates is concerned, we do not think that is the RBI's job at all. Unless the government takes some concrete steps to bring in reforms, monetary policies world over have proven to be useless tools for economic recovery!

Hence instead of passing the blame to Dr Rajan, it is time that investors become aware of the impending risks. Investing in safe stocks at attractive valuations, keeping the risks in mind, would be the best long term approach.

Do you think the RBI is right in safeguarding the economy against global crisis? Let us know your comments or share your views in the Equitymaster Club.

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Meanwhile, the US is not just defiant about its monetary policies. It is defiant about its energy production too! The US is currently producing the most crude oil in 30 years! And the prices would need to get much worse before the shale boom dies off. Unlike many OPEC nations that are continuing to sell oil at prices below what they have budgeted for, US shale companies can keep making money even if oil falls further.

According to a report by the International Energy Agency, most US shale gas producers can remain profitable even if oil falls to US$ 42 per barrel (it is currently at US$ 68 a barrel). Needless to say, some energy companies will run into trouble. Those that borrowed heavily for shale gas exploration are particularly vulnerable to bankruptcy. The cost of shale gas exploration is also relatively high. However, the US is determined to prove its energy supremacy over the OPEC.

Having said that, members of the OPEC are undecided about when to stall their economic crisis. The Saudi Arabia is unwilling to cut output and lose market share unless Russia and other non-OPEC members join in. Therefore it will be some time before global crude prices firm up. While this is temporary good news for oil importers like India, the energy war can hurt the global economy in the long run.

 Chart of the day
While we are on the topic of energy prices, fuel prices in India too warrant some attention. Now, one of the key reforms required to curb fiscal deficit in India that was brought in by the government were the energy reforms. And it seems that its timing could not have been any more perfect considering that oil prices have been on a declining trend; currently crude oil prices are trading around levels seen way back towards the end of 2009.

Retail fuel prices in India were on the rise till some time ago as the government was hiking prices to reduce the burden on itself. But, after having linked the same to global market prices, retail prices in India have been on a declining trend. This chart of the day indicates the petrol prices in some of the key economies across the world.

In relative terms, fuel prices in India are not that high

As you can see, petrol prices in India still seem to be on the lower side on a relative basis. Amongst India's BRIC counterparts, energy prices in China and Brazil are relatively on the higher side. While prices in most oil producing nations are lower, some of these nations attract high taxes as well, which is why prices in such nations are more expensive. As for the net importers - a list of which India is a part of - India's prices remain on the lower side.

At a time when the Central government is looking to make changes to improve is fiscal deficit position, it seems that certain Indian states are going all out in terms of increasing their borrowing limits to meet their planned expenditures. Taking the example of states such as Telangana and Andhra Pradesh, it seems the state officials are looking for more fiscal elbow room. While AP is looking at increasing its borrowing limits to 7% of GDP - mainly to fund its infrastructure developments - it seems Telangana government wants to up its borrowing limit to meet its ambitious expenditure estimates; some of which include populist measures such as farm loan waivers and subsidies.

As per us, it would be wise for the governments wanting to take this route to gauge back a few years in time and analyze how the health of the Indian economy on the whole deteriorated as a consequence of such actions. Not to mention the suggested actions by RBI officials - that of bringing in transparency in certain politically influenced sectors and thus increasing revenues in the form of effective tax collection to bridge these gaps - should be taken into consideration as well.

Meanwhile, Indian stock markets hovered around the dotted line during the post noon trading session. At the time of writing, the benchmark BSE Sensex was up by 27 points (+0.1%). Stocks from the oil & gas and power spaces were amongst the key gainers today. Most of the Asian equity markets were trading higher led by China and Japan. Majority of the European markets opened on a firm note.

 Today's investing mantra
"(Value) investing is not a paint-by-numbers exercise. Skepticism and judgment are always required". - Seth Klarman

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10 Responses to "The risk that only Dr Rajan is warning us about..."


Dec 16, 2014

In evaluating any country, debt / GDP ratio matters, NOT the amount of debt. For example, a business tycoon took 1000 crores of debt to buy cement factory. Is he poor?


Devendra Pisolkar Auckland New Zealand

Dec 6, 2014

Dr Rajan should take necessary steps including administrative reforms in banking staff, including own RBI staff. The RBI inspecting officers are do not give a correct picture of particular bank since they are corrupt and under consideration they give their reports.Dr Rajan should express the views with the prime minister Mr Narendra Modi and implement for banking industries improvement.
Thoughts are good !


Subramanain Ram

Dec 4, 2014

Already majority of the Public Sector Banks & SBI are having a very tough time in managing their existing NPAs and to prevent further slipages in the next two quarters which will enable them to present a decent balance sheet. The main problem faced by Public Sector Banks & SBI is the non availability of senior and experienced officers well versed in credit, who have attained super annuation during the last one year and many more are likely to retire during the next couple of years. A huge vaccum has already been created and banks are extremely stressed with regard to quality manpower. No concrete steps have been taken to train the younsters and every CMD or ED who are appointed by the government either did not have the vision or really care to impress upon the finance ministry by apprising them the ground realities.Every CMD of Public Sector Bank is only worried about increasing the size of the Balance Sheet during his tenure and is so selfish that he is more bothered about getting the next plum assignment after the expiry of his term. Corruption is rampant amongnst the top management as their appointement is made solely on the basis of connections they have and their political affiliations. There is no problem with regard to availibilty of funds, but there is no credit off take because the managers are afraid of taking decisions to lend because of non availibilty of quality manpower to monitor the advances. Since they will be held accountable if the advance fails and will be harassed by the top management are hesistant and not willing to take any risks.Even if the rates are reduced banks will not show the eagerness to lend for this reason. Quality borrowers are also scarce to find and it has become very common to observe a relatively new advance slipping as NPA within a very short span of time. Dr. Rajan so far has not initiated any steps in this regard and shown the concern to arrest the slide. May be he is a wizard in Economics and was able to foretell the global financial crisis in the year 2008, but he is yet to grasp the basic underlying problems facing the banking industry which is the acute shortage of quality supervisory manpower without which all the policy measures initiated by the RBI will fail to take off.


Tamil selvan r

Dec 4, 2014

RBI can safegaurd india also by ensuring Stringent Norms for PSU Credits to Politico-Business. You see Mr.Rajan is more bothered at essentials like LPG Subsidy,Food Subsidy,Health Insurance, Education loans for the needy, Agri Power subsidy.


Ravi Challu

Dec 4, 2014

I completely agree with and support Dr. Rajan's point of view. Governments should focus on right policy frameworks and social development models so that a large part of Indian populace that is untouched by economic growth can start participating in the economy. JDM yojna is a step in that direction. Government should focus on how does it create new domestic markets that leads to increase in capital stock. And the job of increasing capital stock by engaging a larger part of the Indian workforce lies with businesses. Funds are available in abundance today both domestic and foreign. And some of them are very cheap, especially foreign. Growth resilience should be domestically fuelled. And that is where the government must focus. Cheaper funds may immediately address the interest outgo and improve company bottomlines but it is not going to drive growths. We need to create new markets in semi-urban and rural areas. And that will drive growth.

"Make in India and sell abroad" may be a great idea but driving growth through a laggard global economy is going to be very difficult. Domestic markets would be insulated from global economies and would make Indian economy more resilient. We could always find competitive advantage overseas on top of a resilient domestic economy.


J Ganesan

Dec 3, 2014

I agree with Mr. Rajan's stance to keep the repo rate unchanged. Let GOI take the first step to cut the Deficit and bring in other reforms promised and bringing in Black Money etc. I am pretty sure Mr. Rajan will follow suit!



Dec 3, 2014

Inflation!!whole sale level, & consumer level!!
When I go to Vegetable shop still I could n`t find any difference!!!Even Grocery, Edible Rice, & Wheat also cost more!!
And I am a common man needs to own a house! was not able to reach the price of a house or house site, even building materials seems to be high enough to prevent a common man to build his own house.In my town prior to the announcement of upgrading it as corporation all Big parties flocked in & Grab all the Land to develop & build apartments,Now all the prices are on roof top!! but common man like me have to believe Consumer inflation nearing to Zero!!! Thank you at least in your article I realize the inflation has come down!!!



Dec 3, 2014

Our RBI Governer's rationale for keeping the cost of capital relatively at higher levels is well founded.It was he who first spoke about sub-prime lending crisis in US during 2007 - 08.In fact we are blessed to have such a person at the helm at RBI who is trying to insulate our Economy from the vagaries of QE of US.Only short sighted Corporates/Politicians not really caring for the country and interested in personal aggrandisement criticise Mr.Rajan


Jimmy Mathew

Dec 3, 2014

Driver should decide the speed of the vehicle, not passengers. Dr. Rajan should asses the road grip and drive.


ramesh b

Dec 3, 2014

very good editorial about RBI! pl keep it up!!

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