»5 Minute Wrap Up by Equitymaster

On This Day - 14 FEBRUARY 2011
What should Infosys do with its cash?

In this issue:
» Is the US headed towards another depression?
» US banks' bounty for Indian IT companies
» Where's the credit-deposit ratio of banks headed?
» Indian economy at crossroads
» ...and more!

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Indian IT major Infosys has been hounded by analysts and investors into utilizing its excess cash that it has built up over the years to acquire companies, or pay higher dividends. At the end of FY11, Infosys had a cash balance of Rs 129 bn or approx. US$ 3.3 bn. Now if you think this is huge, consider the cash that the US tech major Apple holds - US$ 50 bn at last count!

Why do these companies need so much cash? Why don't they just pay it off to shareholders as special dividends? Isn't holding so much cash a waste given that this asset earns returns of no more than 4-5% (in India), while the business can earn 14-15% from its operations?

We don't think so! In fact, the comparison of 4-5% returns for cash with the 14-15% operational returns that a business can earn by employing this cash isn't correct. This is like comparing apples to oranges. Like a business must earn around 14-15% returns annually to justify its cost of equity capital, the cost of cash lying on the balance sheet must be equated only with what 'cash' can earn. And that rate is around 4-5% in India. So cash just needs this much return to break even. And thus, it is 'not' an unyielding asset on a company's balance sheet, unlike the popular perception.

But this does not mean that all companies must hold on to high levels of cash. Not at all! To resolve how much cash a company needs, you must understand what the company can do with its cash. If it earns strong return on equity by employing it into its business (like Infosys or Apple do), high cash isn't a problem. But for a company that is prone to making bad investments or overpaying for acquisitions, cash is safer in the hands of its investors.

What do you say? What's the best way a company should utilise its excess cash? Share with us, or post your view on our Facebook page.

 Chart of the day
Today's chart shows the credit-deposit ratio of Indian banks that form part of the BSE-Bankex index. As we see, the ratio has increased over the years. This means that banks have lent increasingly higher amount of money for every rupee of deposit they've received over the years. The ratio currently stands at around 0.7 times (or 70%). We expect this to moderate going forward led by lower credit growth (due to rising interest rates). Higher deposit mobilization from banks on the back of recent rise in deposit rates will also led to a reduction in the credit-deposit ratio in the medium term.

Data Source: CMIE Prowess

Indian stock markets had a good start to this week's proceedings. The BSE-Sensex was trading with gains of around 420 points (2.4%) at the time of writing this. Today's gains were largely led by stocks from the auto and engineering sectors. Among other key Asian markets, while China closed with 2.5% gains, Hong Kong and Japan were up 1.2% and 1.1% respectively.

Job creation is one of the biggest worries of governments across the world these days. Noted economist and professor of Columbia University Jeffrey Sachs has an interesting take on this. In an interview to Economic Times, Sachs cited the US' foolhardiness in creating jobs through a bubble economy. But he believes that India and China have adopted better methods for the same. Primarily, improving the quality of workforce.

Sachs has emphasized on India's solid footing when it comes to sustaining long term growth. But he has also warned that the quality of labour cannot improve without appropriate government policies. Not the ones formulated in the past decade for freeing up the economy. But the ones that can take India a step ahead in its goal of becoming an economic power to reckon with. Policies that can ensure that labour force is skilled, employable and healthy. Also ones that can help millions of middle class Indians contribute to the economy's growth. This will entail improvements in social and physical infrastructure.

Most importantly, Sachs believes that India cannot copy the policies from the US or China or any other economy. But needs to develop them in house to ensure that the country's long term needs are met. "You cannot read it in the book, you cannot take it off of a shelf, you are going to have to invent it. This is exciting on one side, but also rather difficult." These words from Jeffrey Sachs sum it up well.

India is at the crossroads once again. Inflation has been high for quite some time now and the RBI is taking steps to increase rates and bring inflation under control. But this could pose the problem of a slowdown in growth. And this at a time when India has just recovered from the global crisis. The key here really is astute policymaking. True, that one of the reasons that inflation is high is because off too much money chasing fewer goods. And this excess money has been the product of expansionary monetary policies in the US. But more importantly, India's inflation has remained high on account of an adverse impact on food production. This can largely be attributed to various structural problems. Notably that of lack of adequate investments in agriculture and storage facilities. Indeed, India's strong growth in GDP will have not have much meaning unless agriculture keeps up pace as well. For that policymakers will have to come out with some good solid plans. Whether this will eventually pan out remains to be seen.

The Indian IT industry has another feather to add to its hat. It has already seen its deal pipeline growing in recent times as clients have opened up their purse strings. Now, top US banks have announced that they plan to outsource projects worth nearly US$ 5 bn this year. These projects would mainly be in the areas of IT and back-office operations. The deals are likely to include advising banks with respect to compliance and regulatory norms as well as working on the ongoing integration programs. By sending nearly half of the integration projects to India, the banks would be able to lower their costs significantly. The projects are good news for companies like TCS who earn a major part of their revenues from the banking industry. Now how well this will go with the Obama administration, is yet to be seen!

John Maynard Keynes, the famous macroeconomist had a very important observation to share. He argued that during economic depressions, the Government should hire people to dig up trenches and then refill them. This, he believed would stimulate economic activity and hence, push up the country's GDP!

This argument could well be correct if one believes that economic prosperity is nothing but an increase in GDP numbers. However, Doug Casey, a noted financial writer implores you to take a look at things from a different perspective. He has argued that such an activity is nothing but a sham. This is because he believes that digging and refilling trenches does not improve the living standards of people and does not increase the real wealth of the society. And hence, such an activity should not be encouraged at all.

Casey has further noted that US President Obama's policies are nothing but akin to doing what Keynes highlighted. He believes that Obama is trying to solve a problem of overconsumption and debt with more overconsumption and debt. Thus, there is no way that the living standards of US can improve with such measures even if the GDP does. To sum up, Casey has made a sober reminder that we are not out of the woods yet and a depression greater than The Great Depression could actually be ahead of us.

 Today's investing mantra
"Do not buy the hype from Wall St. and the press that stocks always go up. There are long periods when stocks do nothing and other investments are better." - Jim Rogers

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