»5 Minute Wrap Up by Equitymaster

On This Day - 23 SEPTEMBER 2011
Does 2011 remind you of 2008?

In this issue:
» US economy is doing a Japan
» Is the RBI independent enough?
» Crisis could lead to protectionist policies
» Bidding wars intensify in infrastructure
» ...and more!

Investors the world over are certainly not likely to forget September 2008. In that month Lehman Brothers collapsed and so massive was the scale of sell-off in the global markets, that emerging countries including India were badly impacted. In India too, despite the fact that its economy was better off than the US and Europe, foreign investors pulled money out of the stock markets in droves, causing a meltdown in Indian indices.

And after the drubbing that Indian markets received yesterday, there are fears that we may see a repeat of what happened in late 2008. Between the Lehman collapse and today, emerging countries especially Brazil, Russia, India, China (BRIC), staged a remarkable recovery that saw GDP growing at a much faster pace than its developed peers. This once again brought a flock of foreign investors to their shores as conditions in the West continued to deteriorate. Because of this over exuberance, the kind of liquidity that was unleashed in China and India especially was so strong, that both these countries had to step in and tighten rates in a bid to curb inflationary pressures. And now, prolonged crisis in the developed world and the massive sell-off yesterday has once again exposed the vulnerability of emerging nations to capital flight.

Indeed, even though growth in the emerging countries is expected to slowdown, the latter are still way ahead of the US and Europe who are riddled with excess debt and recessionary conditions. It is not that developing countries are immune to the crisis enveloping the West, but it can be said that over a longer term perspective, the strong growth prospects in the former still remain intact. This means that serious long term investors can find value if they remain invested in these countries with a longer investment horizon. The problem is that because global markets are so interlinked, panic in the Western stock markets is bound to have an impact on emerging markets including India. But any such pessimism should be looked upon as an opportunity by investors to buy good quality stocks are bargain prices.

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 Chart of the day
IMF's (International Monetary Fund) GDP forecasts for 2011 and 2012 do not really paint a rosy picture. As today's chart of the day shows, although China and India lead the pack, growth rates would still not match what they were in the last couple of years. This is not surprising given that both economies are battling inflation as a result of which their central banks have been tightening interest rates. Despite this, both these countries are way ahead of the rest of the pack in terms of growth.

Data Source: The Economist

With the US economy failing to show any signs of recovery despite huge stimuli, comparisons with the late 20th century Japan are inevitable. Thus, it has come as no surprise when Stephen Roach, the famous economist and currently, Morgan Stanley Asia non-executive Chairman, has done exactly the same. Roach has opined that America is in a Japan like situation but the likes of Bernanke and Obama are not willing to acknowledge or even consider this harsh reality. However, he has not chosen to put the entire blame on the current US Fed Chairman and has said that those who ran the Fed before Bernanke deserve blame as well. It should be noted that Japan faced nearly a decade in economic doldrums, a period which is now famously called as the 'The Lost Decade'. It isn't that Japan didn't do anything to escape from this misery. It adopted the exact same policies as the US is adopting currently but they had no effect whatsoever. All it ended up doing was keeping alive banks and corporations that otherwise were nothing but dead. Needless to say, the US is hurtling dangerously towards the very same outcome. A lost decade redux anyone?

If Dr Y. V Reddy would have been an American central banker, the US would have not been in the kind of economic muddle that it is in today! That is the briefest explanation of what an independent central banker can do to an economy. We came across an article in Mint that discusses whether the Reserve Bank of India (RBI) is independent enough. Well, if you ask us, all we can say is that we are lucky Mr Alan Greenspan did not work for the RBI. For an organization is only as efficient as its leaders are. RBI is not constitutionally independent. In fact the Finance Ministry can overrule the central bank's decisions if it deems fit. Over the years Finance Ministers in India have had clashes with regard to monetary policy decisions of the RBI. But it took somebody like Dr Reddy to oppose the then Finance Minister Mr Chidambaram's views and hold a cautious stance on interest rates. He was amongst the very few central bankers in 2007 who refused to lower rates citing inflationary risks from high oil prices. More recently Dr Subbarao too has shown some signs of independence despite being an ex Finance Ministry official. We believe that as long as the selection of the RBI governor remains independent of political pressure, the Indian central bank will continue to do its job well!

The current crisis appears to be spreading across the world. This is the warning signal sounded off by the World Bank's Chief, Mr Robert Zoellick. He has stated that the way things are going the developing world would start sounding off negative signals very soon. As per him, more than 40% of the developing countries have budget deficits of over 4% of GDP. As a result, if things get worse, they would see major drop in asset prices as well as an increase in nonperforming loans. This in turn would lead to protectionist and populist measures being adopted by these countries. Combine this with the troubles in the advanced economies and we have the perfect recipe for a global turmoil. Things could turn out to be different if the emerging markets decide to adopt long term approach to growth rather than adopting a narrow approach. Look to the long term rather than trying to find a quick fix for short term problems. A quick fix does not really help anyone. Just ask the developed countries if you don't believe us.

It's dragon versus elephant again. And this time the standoff is over South Chinese Sea. It is worthwhile to note that South Chinese Sea is one of the world's key shipping routes and is believed to store rich oil and gas reserves. Recently, China has made a diplomatic protest over ONGC's joint exploration plans with Vietnam blaming it for violation of its sovereignty. The area no doubt is strategic. Its ownership will be crucial in bargaining power in future negotiations. It is important to note that Vietnam is one among the many nations that China is involved in territorial disputes with while India has US's support to freely navigate the region.

Maintaining friendly relations with China are of a strategic importance to India. However, knowing how crucial energy resources will be on way to be a global super power, such tussles will be unavoidable. And we believe that in the quest for energy security, it is a reason worth the diplomatic fight.

It is a well known fact that India's infrastructure is in dire straits. And in order to resolve this issue, government has targeted huge infrastructure investments over the next five years. But considering the fiscal position of the government private sector participation seems to be imminent. This presents huge business opportunities for infrastructure developers which has completely changed the competitive scenario in the industry. Fierce bidding and offering negative grants for road projects have been a common phenomenon. The bids, nowadays, have become so competitive that even minor time and cost over-runs could put the margin profile at risk. And considering that the industry already operates on wafer thin margins unanticipated price inflation or bureaucratic delays could make these competitive bids unviable. While buffering order pipeline through fierce bidding secures future revenue visibility it would seriously test the execution skills of these companies. Nonetheless, such an aggressive bidding climate is good for the nation where quality infrastructure is a luxury as against deemed public good.

In the meanwhile, the Indian stock markets continued their southward journey today. At the time of writing, the benchmark BSE-Sensex was down by 150 points (0.9%). Barring IT and FMCG stocks, all sectoral indices were trading weak. Red marks were seen across Asia too with Indonesia (up by 0.8%) being the only exception. South Korea was the biggest loser down by a huge 5.8% and Taiwan was next in line (down 3.6% from yesterday's closing).

 Today's investing mantra
"There are two times in a man's life when he should not speculate - when he can't afford it and when he can." - Mark Twain

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