»5 Minute Wrap Up by Equitymaster

On This Day - 23 FEBRUARY 2010
One number that is scaring most investors today!

In this issue:
» Would interest rates jeopardize Fed plans
» Will India overtake US economy by 2050?
» The skyscraper curse could haunt China this time around
» Former Treasury secretaries support Volcker plan
» ...and more!!

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The biggest problem with the US right now is that it has become an Empire of Debt. Even a conservative estimate puts its debt to GDP ratio at three times to what it was in the 1980s. Hence, unless the US indulges in large scale debt payback, return to business as usual is far from certain.

But the problem with paying back too much debt is that it is a lengthy procedure. The US Fed though is not in a mood to have any of it. It wants prices across all asset classes to go up rather quickly so that some amount of inflation enters the system and economic recovery takes shape. This in turn would ensure that jobs are created, profitability is improved and debt is paid back. But the Fed does not have a magic wand and Bernanke is no magician. All it can do is play its cards well and hope for things to turn out as anticipated.

Thus, an ideal situation would be a slow rise in inflation until some sort of recovery gets underway. A sooner than expected and a huge jump in inflation would once again push the economy down a huge cliff. For it will force the US Fed to raise interest rates and put the recovery at huge risk. Thus, the very medicine that the Fed is trying to revive the patient of economy with will turn into a poison. Back home in India, things are no different. Thanks to Government's efforts of trying to boost asset prices through stimuli, runaway inflation seems to be once again making a comeback. Threatening to eat away at the very recovery that the Government was trying to breathe life into. Thus, it is this inflation number and the interest rates that it would lead to that will hold the key to which way the markets move next.

 Chart of the day
If there is one nation that has powerfully burst onto the global economic scene over the past couple of decades, it is the dragon nation China. Its growth has been nothing short of a miracle. While India has also witnessed very strong growth rates over the same period, it has had to contend with playing second fiddle to its Himalayan neighbour. However, as today's chart of the day shows, if the next few decades are any indication, the Indian growth story could well outpace China. As per the chart, growth in India's economy between 2007 and 2050 is likely to come in at 8.5% CAGR, significantly higher than China's 6.8%. However, this growth may still not be enough to topple China's overall GDP by the time the year 2050 arrives. If there is any solace it is in the fact that both the nations will perhaps have their economic output greater than that of the US at the end of the period. Of course, a lot of things need to go right for India if it were to achieve the projected GDP growth.

Source: LiveMint

The bailout season continues. Now it is time for the government to bail out the FPO of REC that has failed to elicit the desired response from investors. As reported by the Economic Times, the government is likely to approach PSUs like LIC to bail out REC's equity issue, given the poor response the issue is seeing currently. Though almost 96% of the issue has been subscribed as of now (it closed today), it has been largely due to the institutional part being fully subscribed. Otherwise, subscription by high net worth individuals (HNIs) and retail investors has been negligible.

Is the skyscraper curse about to strike again? For the uninitiated, the curse is said to herald the arrival of great economic pain to a country that tries to build an extravagant and a gigantic building. Bloomberg reports that China is building the world's second tallest building in Huaxi, the most prosperous of its villages. This is no doubt emblematic of the enormous progress the dragon nation has made. But some experts do believe that it's not the most productive use of the country's resources. Already, voices that China is staring at a huge real estate bubble are getting louder by the day. The news about the tower being built would certainly add more fuel to the fire.

China has not had its easy ever since the subprime crisis roiled financial markets and flattened developed economies. Its huge export driven economic machinery came to a screeching halt. To bridge the gap, it unveiled one of the world's biggest stimulus programs. It pumped in close to US$ 600 bn dollars. But in an economy where there is already surplus capacity, most of the money got channeled into assets like real estate and encouraged wasteful expenditure. The tower in Huaxi is indeed one such example of its extravagance. While China has taken steps to curb the menace, some feel that the steps are too small and there is a high probability that the Chinese economy could crash in the next year or two. And this would mean another wheel of the global economic engine also coming off. Not a very good sign indeed.

Price is a function of demand and supply. The economic theory is being best played out in the Indian banking sector wherein banks flush with liquidity are resisting to pay a higher price (read interest rate) for deposits. At the same time those short of funds and planning an aggressive growth are willing to pay higher. With the RBI stoking an upward trend in interest rates banks have another reason to entice customers with higher rates on fixed deposits. While some banks have already started upward re-pricing of their fixed deposits others may follow suit, but with a lag. Nevertheless, we believe this differential pricing cannot last for long as the supply of short term low-risk money will be limited.

Finally it appears the Indian IT sector has turned the corner after wrestling with the specter of recession for around a year. Things appear to be on an uptick now. Lately, the sector saw a significant comeback in IT demand across most part of the globe. What's more, multibillion dollar deals are back in vogue. The big 3 of Indian IT (TCS, Infosys and Wipro) inaugurated FY10 with a share in US$ 1.5 bn contract from British Petroleum. Most recently, big businesses in Nordic countries of North Western Europe are planning to award contracts worth US$ 23 bn to Indian IT service providers. In short, the IT honchos appear to have a lot stronger deal pipe-line in 2010 as compared to 2009.

The deals are more broad-based emanating from established as well as emerging areas. In terms of industry segments as well as geographies. We accept that some part of this can be attributed to pent-up demand and vendor consolidation on part of the IT clients. Nevertheless as the businesses round the world aim to cut cost through improving efficiency, they will need to depend more on IT. The case is indeed strong for the Indian IT sector.

How can the next financial crisis be prevented? That is the question facing US lawmakers as they work on a financial regulatory reform bill. There is one person who is clear about what must be done - Paul Volcker, former Federal Reserve Chairman. He says, don't let banks indulge in speculative trading. In his view, this so called proprietary trading is not proper for banks that are bailed out on taxpayer's money if something goes wrong.

In fact, Volcker believes another crisis is inevitable if the practice is not curbed. He says, "I may not live long enough to see the crisis, but my soul is going to come back and haunt you". Interestingly, President Obama agrees. And so do five other former Chairmen of the Federal Reserve. In fact, they are of the view that proprietary trading should be allowed only for hedge funds, private-equity firms etc. These entities will not be bailed out by the government if they fail. Just like other private businesses. We fully agree. Banks often become too big to fail because of the implications on the entire system. Hence, it is only fair that their activities must stay well within conservative boundaries.

Meanwhile, Indian markets are witnessing a fair degree of volatility today with the BSE Sensex trading higher by around 60 points at the time of writing. Banking and metal heavyweights were seen in favor while auto stocks were trading weak. Asian markets closed mixed today whereas Europe has opened largely on a strong note today.

 Today's investing mantra
"A great sign often comes when analysts give up on a company and there are few people making forecasts on the business." - Anthony Bolton

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