»5 Minute Wrap Up by Equitymaster

On This Day - 6 DECEMBER 2013
Can India ever deal with crony capitalism?

In this issue:
» Bitcoins facing real test
» Infrastructure issues marring the prospects of Indian economy
» What is happening to rural consumption boom story?
» What is scaring retail investors?
» ...and more!

Nothing seems to be going well for the Indian economy these days. The economy has been hit hard by a slew of scams in the last few years. And it looks like it will be a long time before the dust starts settling. Yet another skeleton has come out of the closet in the coal scam case. As per an article in Indian Express, the Central Bureau of Investigation (CBI) while probing the coal blocks allotment scam has recovered a diary from the offices of the Aditya Birla Group that could be a cause of embarrassment for many. The diary lists around 1000 payments made to politicians across parties over a period of 10 years by a Birla company. While this sounds shady enough, what makes it murkier is that the payments coincided with Lok Sabha and several state assembly elections. Further, the CBI has claimed to have found unaccounted cash worth Rs 25 crore at Hindalco office. Ironically, the events that could taint the reputation of Aditya Birla Group Chairman Mr. Kumar Mangalam Birla have come around the same time when he has been chosen as the Business Leader for the year 2013 by a reputed financial daily.

The only positive we can look at in the whole matter is that the issue is being now probed and brought to public knowledge. While it is yet to be established whether the management has been involved in the wrong doing, this is just another reminder of the shady nexus between big corporate houses and politicians. Such endemic crony capitalism has caused immense harm to the economy and investment climate in the country. The corrupt politicians and corporates have found out a win-win way to feed their respective ambitions. The large corporate houses shell out huge money to fund elections. In return, they seek high return on investment in the form of preferential treatment while carrying out business activities, irrespective of their competence in the latter. It's a win-win deal for both with the least regard for the critical resources in the country and the interests of the Indian economy. This is indeed no way to run either a business or the Government.

The unrestrained greed of corporates and politicians has led to a breeding ground for corruption in the country. Already the country is out of favour as far as macro economic environment is concerned. On top of that, such events strike fresh blows to investor sentiments. No wonder that overall trust level on Indian corporate is declining.

We believe that investors have an important lesson to learn from such incidents. That is, not to get carried away by big names but choose the companies with robust fundamentals, management integrity and sound corporate governance practices.

Do you think the shady nexus between large Indian corporate and the Government is a huge threat to the Indian economy? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
For public sector banks in India the road to prosperity is a long way ahead. Bearing the burden of nonperforming assets is not their only dilemma. They also need to avoid the high incidence of corporate defaults in a prolonged weak economic cycle. In addition the working capital cycles of relatively healthier corporate have also got stretched. All this at a time when the banks' own profitability is under pressure. Neither is there much scope to raise lending margins. Nor are the treasury portfolios offering any relief. On the contrary even mark to market losses have wiped out profits for many banks. As per rating agency ICRA, the gross non-performing assets (NPAs) of PSU banks may go up to 5% in FY14. This will bring it closest to the levels seen in 2002. And the painful journey of getting asset quality back into shape will be a long one for most. Investors therefore need to be very careful about investing in PSU banks rather than getting drawn to their valuations.

Public sector banks in bad health

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In a world where the value of hard fiat currencies is being called into question on account of reckless money printing by central banks, the virtual currency Bitcoin is finding a lot of takers. So much so that it has become a hot topic of conversation. So far, bitcoins do not come under any regulations. But it now appears that the popular, virtual currency will face its first real test. And this is in none other than China. The enthusiasm for bitcoins in the dragon nation has been greater than elsewhere. So much so that it accounted for a third of the global trading volume. But Chinese regulators have decided to come down hard on the currency. Indeed, as reported on Reuters, regulators have banned the country's banks from trading bitcoin. China is obviously in no mood to let bitcoins co-exist with the Chinese Yuan. It will be interesting to see whether other countries also follow suit. One thing is certain that the rise in bitcoins cannot continue forever and like any asset class or currency is bound to witness corrections.

Ask any well meaning expert the biggest problem that India faces towards its journey to higher growth. 9 times out of 10, they are likely to use the word infrastructure. Indeed, it is the sorry state of the infrastructure in the country that is not allowing us to become more productive. However, it has recently come to light that infrastructure is affecting country's growth prospects in an indirect manner too. In fact, the damage here could be as large as its direct repercussions on the economy. LiveMint reports how NPA crises that most PSU banks in India face are a result of the collapse of the infrastructure boom of the past decade.

Clearly, no other sector has hurt the finances of the banking industry as much as the bad loans from the infra space. Agreed that on account of delays, a lot of infra projects find themselves with no revenue generation options. However, there is too much concentration of loans among just a few large firms. Besides, the banks most affected have mostly been PSU banks. This raises doubts about the existence of under hand deals and palm greasing in disbursing infra loans. Having said that, the importance of infrastructure development cannot be emphasised enough. And therefore, an effective lending mechanism for the sector will have to be given a serious thought. However, any mechanism will not be able to stay profitable unless Government eases up bottle necks to infra development.

The rural boom enabled consumer companies to wither the urban slowdown until now. Higher disposable income led to increasing demand for consumer products. And this led to higher growth for consumer companies despite the urban portfolio witnessing slower growth. However, over the last 3-4 quarters even the rural demand has taken a backseat. Higher inflation has started creating a hole in rural pockets as well. This has resulted in downtrading; a phenomenon where consumers opt for cheaper products. The RBI's monetary policy tools have been ineffective. So, unless inflation subsides the rural purchasing power is not going to return. However, there are other factors like monsoon, skill enhancement and employment guarantee acts which have boosted the spending power of rural people. With these factors having a major influence on rural disposable income we feel that the current downtrading trend is more short term in nature. And the rural demand may pick up soon once inflation subsides.

Retail investors have been pulling out of the Indian stock markets. Is it only because of the subdued economic condition that has impacted corporate earnings, and in turn, the stock prices? We believe this is not the only reason. Another major reason for the investors' wariness towards stocks has been due to mistrust of corporates. Investors have lost heavily by investing in companies with poor corporate governance, fraudulent behaviour, corruption, etc. Many promoters are also known to take decisions that may be detrimental to the interests of minority shareholders.

This seems to have worried the Securities and Exchange Board of India (SEBI). As a result, the market regulator has been trying to tighten norms to bring in more transparency in corporate dealings and to ensure protection of investors against malpractices. Here is one such move that the SEBI seems to be considering.

As per an article in The Economic Times, companies may now have to seek the approval of shareholders if they plan to divest stake in major subsidiaries. As such, companies may be mandated to disclose the financial performance of their subsidiaries, benefits from sale, consideration amount and the names of the parties involved. In addition, the market regulator also plans to mandate companies to disclose their policies on related-party transactions. If such steps are initiated and implemented correctly, we believe it will go a long way in reviving the trust of retail investors.

In the meanwhile, Indian stock markets were trading above the dotted line. At the time of writing this, the benchmark BSE-Sensex was up by 78 points (0.4%). Stocks in the banking and capital goods sector were leading the gains. Asian stock markets were trading mixed with Indonesia and China leading the losses, while the Japanese market was trading in the green. The European markets have mainly opened on a positive note.

 Today's investing mantra
"Stop trying to predict the direction of the stock market, the economy or elections." - Warren Buffett

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