»5 Minute Wrap Up by Equitymaster

On This Day - 29 MARCH 2011
India faces challenges bigger than corruption

In this issue:
» Avoid long-term fixed-income bets in US dollars
» Hotel chains are focusing on reducing debt
» Ninth NELP licensing round displays harsh reality
» Middle East crisis will not spur another crisis
» ...and more!

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Corruption in India has been in the limelight in recent times what with scam after scam being unraveled with constant regularity. The 2G spectrum scam and the Adarsh housing scam among others have tarnished India's image and sparked concerns of investments slowing down as a consequence. But corruption may not be the big problem that India will have to deal with. At least not according to the legendary investor Mark Mobius.

Mobius opines that corruption takes place across countries and not just in India and hence he does not think that long term investments would be hampered as a result. In fact, he is of the view that unemployment, inflation and water are the key concerns for India.

To some extent Mobius is right. Corruption in India is not new with many scandals unearthed in the past too. But India has managed to grow at a healthy pace inspite of it. Unemployment, inflation and water are certainly bigger issues that the government has to deal with. For instance, although India's GDP has grown at a brisk pace, it has not necessarily created employment opportunities as the unemployment rate at the end of 2010 was quite high at 10.8%. And for a country which is largely relying on its demographic dividend i.e. its growing working population for growth, surely unemployment will be a big evil that could seriously dent India's prospects.

Inflation has been a problem for some time now and although the central bank is raising rates to bring it under control, it is not likely to entirely solve the problem. Some long term measures are seriously in order like improving agricultural productivity, investments in adequate storage facilities and the like so that there are no supply shortages. Water harvesting is also another area where India should focus on in a bid to reduce dependence on the monsoons and conserve this precious resource.

Having said that, as long as the government is caught up in scams and scandals, there will be less inclination to do any productive work and so the corruption problem in India at least cannot be entirely discounted.

Do you think that inflation, unemployment and water are bigger challenges for India than corruption? Share with us or post your comments on our facebook page.

 Chart of the day
India has been battling with high consumer prices for quite some time now. In fact, today's chart of the day shows that prices at the consumer level are still amongst the highest in India as compared to its peers both in the developed world and the emerging markets. Although RBI has been raising rates, not much seems to be the effect as prices are above the comfort limits of the average Indian.

*Consumer prices are for Feb 2011 barring India (Jan 2011)
Data Source: The Economist

What is the most basic purpose of investing? Simply put, it is to improve one's standard of living. And for this to happen, it is very important that value of one's investments grow at a faster pace than inflation. Is this true in the case of bonds? Certainly not if the bonds in question are denominated in US dollars. It should be noted that the US economy will keep running a gigantic deficit for quite some time to come. And in order to make up for the same, it will have no other option but to print money. The end result? There will be far greater inflation few years down the line than is the case now. Hence, in such a scenario, long term bonds that pay a fixed interest rate based on the current inflation scenario may not be the best investment to make. It could well be one's ticket to the poorhouse.

Little wonder, even Warren Buffett feels the same way. He has argued that investors should avoid long-term fixed-income bets in US dollars because the currency's purchasing power will decline. "If you ask me if the US dollar is going to hold its purchasing power fully at the level of 2011, 5 years, 10 years or 20 years from now, I would tell you it will not," he is believed to have said. He concluded that he would much rather own businesses. Our view too is not very different.

The RBI has tried it 8 times in the last 12 months. However, the central bank's efforts to bring down price levels have not borne fruits so far. Especially when it comes to prices of food products. But speculations over whether the economy is overheating have been put to rest. Dr Rangarajan, Chairman, Prime Minister's Economic Advisory Council, believes that the inflation problem in India is primarily cost based. With investment to GDP ratio of 36%, the economy still has sufficient capacity to enhance production and supplies. What is needed is improved productivity. In a seminar hosted by RBI, the former governor also offered some lip service to the government's view on monetary policies. He opined that higher interest rates are the most ideal way to control demand pushed inflation. Notwithstanding rise in crude prices, he confirmed that India should be in a sweet spot if inflation lowers to at least 7.5% by the end of the fiscal. We truly hope that the economist's optimism bears fruit.

Sticking with RBI's rate hikes, the impact of this move was visible in the downward trend in the share prices of stocks in the banking and realty sectors. For it is not an unknown fact that higher interest rates spell tougher times for these sectors. But there is another sector that was impacted by the higher interest rates. And that is the hotel sector. The hotel sector has typically seen higher levels of debt, especially since the slowdown of 2008. Although things are improving in terms of occupancy levels and room rates, the industry is still cautious in its outlook. As a result major hotel chains have been raising funds in recent times to pay off the debt on their books. The idea is to bring down costs as much as possible. And with rising interest rates, the debt is only becoming more costly. Hotel companies like Indian Hotels and EIH have raised funds through stake sales to pay off their debt. This is unlike the previous occasions wherein companies had raised funds for expansion. Despite the better outlook, companies are holding off or postponing their expansion plans and are opting to clean up their balance sheets instead.

The ninth NELP licensing round has been a harsh reality check for India. Despite crude prices on a boil, foreign firms chose to stay away from the bidding. Even the RIL BP deal could not evoke the interest of foreign firms in India's oil & gas exploration blocks. Well, what else should we expect? With unstable fiscal policies and levy of service tax on exploration, the potential in India's energy sources can never be unlocked. The need for an overhaul in NELP regime can hardly be overemphasized. While the licensing round is already a lost opportunity, hopefully, it will wake up the regulators to sort issues with the Cairn Vedanta deal. But are they listening?

The political upheaval in the Middle East and North African (MENA) region has caught everybody's attention. It even inspired the US and its allies to go on a so-called "humanitarian" war with Libya. And we all know why. Because precious oil is at stake. Nobody would have cared otherwise.

Now let's hear what the World Bank President has to say about this. He says that the MENA region turmoil will not trigger another global financial crisis. As a side note, he adds that the impact will be limited to rising oil prices.

Wow! That's such a sweet logic. Rising oil prices don't matter much really. They only fuel inflation. They only undermine corporate profitability and in turn investments. They just deter consumer spending. And they only add to government deficits. That's all that rising oil prices do. The gentleman is so right in pointing out that there is no threat to the global economic "recovery". How we wish everything was so simple!

In the meanwhile, Indian stock markets have been trading firm at the time of writing, after opening on a flat note. The benchmark, BSE Sensex was trading higher by 140 points. Stocks from the power, consumer goods, and banking sectors were amongst the top gainers, while those from the realty space were at the receiving end. The market sentiments in other Asian regions were mixed with China, and Singapore trading flat. Hong Kong and Japan were trading in the green.

 Today's investing mantra
"When you combine ignorance and leverage, you get some pretty interesting results." - Warren Buffett

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