»5 Minute Wrap Up by Equitymaster

On This Day - 10 AUGUST 2010
FIIs are outdated, here come FRIs

In this issue:
» Food production in FY11 set to improve
» Global trade seems to be recovering
» Reforms have not really helped the poor
» Banks will have to lend more, says FM
» ...and more!!

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India's GDP growth reaching 10% plus seems to have become a top priority for the Indian government. And one thing that it is contemplating in this regard is to open India's equity markets to Foreign Retail Investors. All with the aim of further reforming Asia's third largest economy. These investors would primarily be wealthy foreign nationals of Indian origin. It must be noted that at present only foreign institutional investors (FIIs) could invest in Indian markets. Individual investors were not allowed to do so.

FII inflows in the past have stirred up considerable volatility in the Indian stockmarkets. One need look no further than the past couple of years. When the global crisis was at its peak, FIIs withdrew money in droves. And therefore contributed to the plunge in Indian stockmarkets. What is more, FIIs have also influenced the recent rally in the markets. This is by pouring in US$ 11 bn into Indian equities in the year so far. Little wonder then that their investments have been branded as 'hot money'. As the motive for investing for the longer term has not really been there.

The perception seems to be that more inflows into India would boost the country's economy. That would certainly be the case with respect to foreign direct investment (FDI), which is longer term in nature. As far as foreign retail participation is concerned, the key determinant would be their investment horizon. For you as the investor, this development alone would not be sufficient reason enough to invest in equities. What is important at all times is to pick up those companies with good managements, strong financials and reasonable valuations.

 Chart of the day
Bad monsoons last year wreaked havoc on agricultural production in FY10. This led to food shortages which in turn caused food prices to soar. But as today's chart of the day shows, food production in FY11 is set to improve. By all accounts, monsoons so far have not failed to disappoint and should play their part in bolstering farm output.

Data Source: CMIE

As per Economist, by May 2010, emerging economy members of G-20 were importing and exporting around 10% more than their pre-crisis peaks. Infact, even rich-world trade has recovered from the trough. Although it is yet to make up for all the ground lost since the start of the credit crunch. It should be noted that this is in stark contrast to The Great Depression. Here, volume of world trade had fallen by a huge 25% within three years of the enactment of the America's hugely protectionist Smoot-Hawley Act of 1930. This act had raised tariffs on more than 900 goods and was followed by a series of retaliatory action by other countries.

However, no such act raised its ugly head during the recent financial crisis. And this enabled the global trade to quickly bounce back. Interesting to add that countries like China and India have actually reported an increasing share of rich world imports in their overall imports after the crisis.

But all is still not well. Unemployment in developed nations still remains pretty high. And in view of this, rich countries could well be forced to raise tariffs. They even have the headroom to do this in the absence of any significant development since the Doha round of trade talks. Thus, the specter of higher tariffs and consequent fall in global trade continues to loom large. This is till the time the developed world continues to have a jobless recovery. India though has relatively less to worry about this than its northern counterpart, China.

In FY10 most banks chose to remain conservative in terms of incremental borrowings. Poor credit quality of some agriculture and retail portfolios and burden of restructured loans forced them to do so. Inability to grow their low cost deposit base very quickly also deterred banks from getting aggressive in expanding balance sheets. As a result, they failed to match the central bank's target of loan growth of 18% and deposit growth of 20% in FY10.

However, this time around, the government is keen on the banks catching up on growth targets. In the upcoming meet with the Finance Minister, the government owned banks may have to make a commitment to stay on course. A close review of the banking sector's performance by the Ministry is appreciable. However, we believe that forcing the government banks to take up 'social' mandates that are unprofitable for their businesses is unfair to the minority shareholders of the entities.

A recent study by the National Council for Applied Economic Research threw up some interesting but rather unfortunate results. The top 20% of India's population enjoyed more than 50% of the national income in FY10. This may by itself not seem very surprising. But add to that the fact that in 1993-94, about 37% of India's people earned over 50% of national income and the picture that arises does not look very encouraging. Further, 60% of India had a mere 28% share in total income. This figure stood at 39% around the period of 1991.

The years from 1991 onwards are considered to be reform years for the country. Evidently, the freeing up of the economy has benefited some sections of society much more than others. An Economic Times report points out that this disparity is more to do with the fact that a vast section of Indian society do not have the means to increase their earning power. Due to this, some people are finding themselves in a better position to grab the opportunities a growing economy is throwing up. Clearly, subsidies, support prices and employment guarantee schemes are not proving to be enough. It is education and skill development where more focus should be. As the saying goes, give a man a fish and you feed him for a day. Teach a man how to fish and you feed him for a lifetime.

We recently wrote about the government making it compulsory for listed companies to raise public shareholding to 25%, with at least 5% dilution a year. This move was feared to have some impact on the markets given that the amount of dilution was estimated as huge.

A part of that fear has now been quashed. This is given that the government has now exempted PSUs from this rule of raising the public shareholding to 25%. This follows the two major share sales from PSUs ( NTPC and NMDC) that drew weak response from investors. We wonder if private firms will ask for a similar exemption as well!

It is perhaps the most pressing of all economic concerns for the Indian government today. We are indeed talking about inflation. Both consumer and wholesale price indices are in double-digits, making Indian inflation the highest among large economies. But any solution to the problem is difficult due to the structural bottlenecks in India's fast growing economy. The slow pace of infrastructure creation means supply of basic goods and services struggles to keep up with rising demand. This shortfall is at the heart of rising prices. The worrying factor is that inflation can often feed on itself in a vicious cycle. This will ultimately affect India's competitiveness internationally. Usually, central banks use monetary policy to solve the problem. But what is worrying is that monetary policy has little impact on food inflation - the area hurting India the most.

After opening flat, markets have sunk deep into the red in the afternoon session. The BSE-Sensex was trading 107 points lower at the time of writing this. Stocks from the oil & gas and banking space were trading flat while IT and auto stocks dragged down the markets. Sentiments were negative in Asia, with all markets showing declines. China was the biggest loser, followed by Hong Kong.

 Today's investing mantra
"When purchasing depressed stock in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt." - Peter Lynch

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