»5 Minute Wrap Up by Equitymaster

On This Day - 8 NOVEMBER 2011
Do you prefer lower inflation or higher growth?

In this issue:
» Stiglitz gives his opinions on rating agencies
» Wealth gap in the US has considerably widened
» Can Indian IT replicate its high growth of the past?
» The flipside of Bihar's healthy economic growth
» ... and more!
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If you had to make a choice between higher GDP growth for India and higher proportion of savings, what would you choose? But, wait a minute. Will not higher GDP growth automatically translate into higher savings for Indians? Not really, because we have that dreaded monster inflation to deal with.

So far, bringing inflation under control had been the primary objective of the Reserve Bank of India (RBI) as successive rate hikes in the past have proven. However, inflation has not yet come within the comfort levels of the central bank, but GDP growth has slowed down. India Inc. has felt the pinch on its profits as higher interest rates have taken their toll. So much so that there are increasing talks that the RBI should pause its tightening measures and give breathing space to the Indian economy so that it can grow.

But will that be in the interest of the average Indian? Indians have one of the highest savings rate in the world. And most of these savings are parked in government debt. The latter is predominantly internal (98% of GDP) and denominated in rupees and inflation brings down the value of government debt. Thus, a growth-oriented RBI may not bode well in the Indian context as India's debt is predominantly funded by domestic savers and inflation will hit the saving population the most. When inflation runs higher than the rate of return offered by provident funds, small savings schemes and bank deposits, it is tantamount to a huge tax on savers as seen in the last two years.

Thus, the average Indian is hit hard by inflation on two counts. One is by eating into savings, and the second is by indirectly weakening the balance sheets of institutions holding government debt. Moreover, because India does not have capital account convertibility, the saver cannot take his money out of the country. What this means is that although both the scenarios (notably higher GDP growth and lower inflation) are important for the well being of the Indian economy, when it comes to choosing between the two, inflation control should take precedence. After all, lower rate of savings will automatically make Indians wary of going on a spending spree and for India Inc, which is relying on the Indian consumption story among other things, such a development will only make things more difficult for business.

Should the RBI and the government give first preference to controlling inflation or bolstering GDP growth? Share with us or post your comments on our Facebook page / Google+ page.

 Chart of the day
India may not rank that high on the Human Development Index when compared to many other countries. But that does not mean that it has not seen improvements. As today's chart of the day shows, both India and China have seen significant change in human development since 1980. And one of the reasons for this has been the stupendous growth in GDP. In contrast, the US has hardly seen much growth in this regard and the current recession is not expected to do much for the country either.

*Human Development Index
Data Source: The Economist

While looking for worthwhile long term investment opportunities we look for businesses that have strong moats. Even if the margins and balance sheet look mouth watering, the business may not be compelling enough if the management is poor at capital allocation. Also, the long term sustainability of a business hinges on the management's ability to foresee changes in the business trends. Proactive alterations to the business model can make it insulated to economic and market trends. That the business model of rating agencies is flawed at the core was proven during the crisis of 2008. Instead of being independent raters, the agencies derive their revenue from the subject of scrutiny.

In addition, the rating agencies often provide consulting services to the rated clients thus cementing the conflict of interest. Ironically, none of this has changed in the last 3 years. In an interview to a business daily, renowned economist and Nobel laureate, Joseph Stiglitz gave some candid opinions on rating agencies. Stiglitz believes that the agencies are profit maximising firms that can make money by giving ratings. What really surprises us is that despite the regulatory whip and media criticisms, none of the rating agencies have attempted any change in their flawed business model. Moreover, most remain highly sought after by new issuers of capital.

Wealth gap, traditionally measured as a difference in net worth between two population sample sizes has revealed a startling fact about the US economy. Currently, the wealth gap between the older and younger generation in US is about 47:1. While it is true that people accumulate assets as they get older (gap typically remains high) it may be noted that this ratio has almost doubled of what it was in 2005. Thus, the gap has widened not due to asset accumulation by older ones but due to fall in income of younger generation amidst rising unemployment. Fall in home prices has also resulted in depreciation of net worth for younger Americans. Contrastingly, older generations had bought homes way before the boom and have effectively seen their housing wealth appreciate! It may be noted that net worth includes a person's house; other possessions and life savings. Now, this fact raises a very important argument. US typically spends huge amount of money on health and safety of its senior citizens. But the current wealth gap reveals that older people are already better off than their younger counterparts. So, may be its time Barack Obama & company partially channelize those funds to people who actually need it.

Most industries follow the popular 'S-curve'. They have a sharp increase in growth rates in the earlier years. As they mature, the growth rate starts to plateau out. The reason we brought this up is because of an article on the Indian IT industry that caught our attention. The article, carried by a popular magazine, questions if the Indian IT industry is entering into the next phase of the S-curve. This means whether growth in the industry is now plateauing or flattening out. It is true that as an industry grows in size and maturity, it becomes increasingly difficult for it to grow at the huge rates as it did in its nascent or younger stage. For the IT industry, this seems to be panning out on two fronts. On one hand, the industry itself has reached a more mature phase. On the other hand, even its customers have reached a more mature stage of outsourcing. As a result, receiving incremental orders may slowdown (in terms of growth rates).

At the same time, increasing labour costs and attrition rates have also brought margins under pressure for most of the IT firms. As a result, the big question now is what next? The industry needs to enter a new phase of growth and that can only be brought about through innovation and higher end services like consulting. These form a miniscule part of the industry's revenues currently. Only if the firms concentrate on increasing this, can they achieve the stellar growth rates that they have in the past. Otherwise, the Indian IT industry will most likely fall into the mature industry growth phase. And that would be much slower than their historic rates.

What is positive for someone could often be exactly the opposite for someone else. Say for instance, a healthy person is bad news for the doctor. Ditto is the case of Bihar. After years of stagnation and illness, the state has been in the limelight for rapid economic growth in recent times. Great turnaround for Bihar! But as it turns out, this hasn't been too good a thing for real estate and infrastructure firms in other parts of the country. Why? The answer is simple. The state had been one of the biggest exporters of migrant labour to other states, comprising about 50% of the unskilled workers employed in these sectors across the country. Now thanks to increased government expenditure and private investment there, rural migration has fallen significantly, almost by 30% in recent years. This has not only caused labour shortage but has also pushed up wage costs for real estate companies. While the economic progress in Bihar bodes well for its people, the supply of cheap migrant labour to other places is set to decline.

In the meanwhile, the Indian stock markets continued to trade weak on account of selling pressure in heavyweights. At the time of writing, the benchmark BSE Sensex was trading down 70 points (0.4%). Except for consumer durables, all sectoral indices were trading in the red led by realty and healthcare space. DLF and Sun Pharma were seen losing the most amongst blue chips. All major Asian indices performed mixed today with stock market from Hong Kong leading the pack of gainers.

 Today's investing mantra
"The four most expensive words in the English language are - This time it's different." - John Templeton

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