»5 Minute Wrap Up by Equitymaster

On This Day - 10 FEBRUARY 2012
A slowdown here spells trouble for India Inc.

In this issue:
» Buffett's view on gold
» Drug discovery in India looks bleak
» India's current account deficit set to rise
» Investors flee to US Treasuries
» ...and more!

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In India's quest to retain its position as one of the fastest growing economies in the world, one of the factors that it is relying on is consumption. Indeed, one of the reasons why the country was less affected than many other nations during the global financial crisis is that domestic consumption was robust. This was in sharp contrast to China, where the reliance on exports being high, the dragon nation witnessed considerable slowdown as the developed world sank into recession.

When the consumption story in India was being touted as the big driver for India's growth, rural demand was always going to be the key. This is hardly surprising in an economy, where almost 65-70% of the population depends upon agriculture as a means of livelihood. Which is why the recent trends in GDP growth paint a worrying picture. Agricultural output growth is expected to decline to 2.5% in FY12 from 7% in FY11, according to estimates released by the Central Statistical Organisation (CSO), the government's official statistician. The irony is that while food prices have dropped for the average Indian consumer, for the farmers this has resulted in lower farm incomes as a result of which rural families have had to cut back on expenditure. Thus, sales of tractors and agri machinery have slowed in the past three months and so have consumer products. This could be near term blips but inability to address some structural issues is bound to impact the fortunes of companies relying on rural demand to drive growth.

The problem in India is that agriculture depends too much on monsoons and the unpredictable weather patterns in recent years have wreaked havoc on agricultural output. There has also been a shortage of funding seen for projects like the NREGA (National Rural Employment Guarantee Act). It is apparent that the government has to take the initiative to invest significant amounts on ramping up agricultural infrastructure with a view of enhancing productivity and minimizing dependence on the rain gods. With its finances in a state of disorder, this indeed seems like a tall order. At the same time, failure to address this issue will only take the country more than a step away from a sustainable 9% plus GDP growth.

Do you think that a prolonged decline in rural demand will hamper the growth prospects of Indian companies? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
One of the main reasons why any meaningful recovery has failed to take place in both the US and Europe is that debt of those countries has ballooned. Indeed, in Europe many of the countries are struggling to keep head above water and are compelled to resort to austerity measures to bring down debt at a time when growth has stagnated. That is why country debt has assumed importance like never before. So what about emerging nations? Today's chart of the days shows that India's government debt as a percentage of GDP is quite on the higher side. This is in contrast to China, where it is low and so it has more headroom to spend.

Data Source: The Economist

We recently talked about how we are on the same side as Warren Buffett when it comes to value investing. But we don't quite share his view as far as macroeconomic policy is concerned. What about gold? Luckily, we got hold of Oracle of Omaha's freshly minted article on the yellow metal.

In it, he has made his stance on gold crystal clear. He is convinced that 100 years from now, assets like stocks and farmland will compound at a rate much superior than gold. Quite possible we believe. But 100 years is too far out according to us. How about a shorter time frame of just 10 years? Secondly, is gold an asset to be compared with the likes of stocks and farmland or more of a currency like the US dollar. If it is the latter then shouldn't it be compared to the US dollar? Thus, on this there can be no doubts that with the amount of money printing going on, gold is likely to emerge as the most safe-haven currency. Of course, it makes sense to have a portfolio of good quality stocks over the long term. But rather than keep hard cash under the mattress, using the same for buying gold so that it makes a small percentage of portfolio is clearly a much better proposition we believe.

For years, Indian pharma companies have had to bear the embarrassment of being tagged as 'copy cats'. This was due to their skill in creating copy cat versions of the original drugs. Ones that have been patented by MNC pharma companies. Not that the process is as easy as it sounds. For the companies need to reverse-engineer the drug manufacturing process. In the absence of product patents in India, most domestic companies honed their skills in this. But the fallout has been that almost none tried to invest in original drug discovery. The steep cost and risks associated in the drug discovery and clinical trials was also very a big deterrent. Now with patents expiring, many MNCs were expected to tie up with Indian partners for drug research. That would help them bring down costs and also access the generic versions. However, as per Mint, the study conducted by a science journal reveals very few patents being granted to original drug discovery in India. Most of the outsourced jobs to Indian partners by MNCs are less critical and capital intensive in nature. The trend may not bear good returns for the domestic companies in the longer run.

The surmounting fear and panic has led investors in US to flock to one asset class. And this asset class is the US Treasuries. The US Treasury yields have fallen by nearly 2% in the recent past. As per Mr Byron Wein, vice-Chairman of Blackstone, the reason for this is little to do with the 'safety' tag given to government bonds. Instead it has more due to the fact that investors do not know where to put their money at the moment. All they want is an investment option wherein they at least recover the principal amount. With debt troubles brewing in both US as well as in Europe, such investment options have become fewer and fewer. Despite the sharp correction seen in stock prices and legendary investors screaming their case from rooftops, investors are still wary about investing in stocks. We find the whole thing rather strange. So investors do not trust the stocks and companies in these countries because of the country related troubles. But they trust the governments of these very same countries, who are responsible for creating the trouble to keep their money safe? Strange but that's the way it is.

These are testing times, especially for the export market. Exports in India are struggling on account of sluggish demand from the US and Europe, two major markets. There is still a lot of uncertainty coming from Europe in the wake of the debt crisis in the region. Now, on account of an increasing trade shortfall, India's current account deficit (CAD) may reach 3.5% of GDP in FY12. This will be the worst figure in at least eight years! It comes as a sharp increase from the 2.6% levels seen last year. And this is not as bad as it gets. According to India's Trade Secretary, Rahul Khullar FY13 is going to be tough as well. The deterioration in the CAD may increase pressure on the rupee, which fell nearly 16% dollar in 2011. It has so far appreciated by 7% in 2012. But such volatile currency movements and the deteriorating state of the government's fiscal position are not healthy for the country. We hope that the Union Budget has some measures for export incentives.

Food Security Bill, a brainchild of UPA Chairperson Sonia Gandhi, is currently being examined by the Parliamentary Standing Committee. If enacted, it would ensure food for all. But the government is more worried about the efficiency in storage and distribution system for the bill to have any material value. Despite record farm output, inadequate storage and distribution facilities have led to wastages of criminal amount in the past. In fact, if the planning commission is to be believed, just a 10% improvement in efficiency can save as much as Rs 70 bn every year! This pegs the total losses to Rs 700 bn just due to inefficient distribution. It is true that complete efficiency cannot be achieved in India. But the losses are huge by any extent. State governments will have to play a critical role in developing the back end infrastructure if these losses have to be reduced. Only then can the food security bill ensure a piece of bread for every Indian destitute.

In the meanwhile, the Indian stock markets were down on a lower IIP (Index of Industrial Productivity) number for the month of December at 1.8% as compared to November's 5.9%. At the time of writing, BSE Sensex was down by 107 points (0.6%). Sectoral indices presented a mixed picture. While IT and realty stocks led the losses, consumer durables and metal stocks managed some gains. Among the Asian stock markets, China and Malaysia (up by 0.1% each) were the only gainers of the day.

 Today's Investing Mantra
"Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed." - Benjamin Graham

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