Is debt a ticking time bomb for India too? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is debt a ticking time bomb for India too? 

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In this issue:
» PM speaks up at the fag end of his term
» Fed committed to maintain its accommodative policy
» A decline in funds mobilised through NFOs
» Does low govt interference make Bitcoins a safe bet?
» and more....

A company with high amount of debt can be like a ticking bomb. When things are going well, it would be benefit from many aspects: Low interest rates, high margins which allow it to service its debt with ease, easy funding options, amongst others. However, when the tide turns, things become difficult. Forget repayment! But even servicing the debt can become a challenge. And then to save itself from bankruptcy, drastic measures are required to be taken. Some of which include asset sales, employee layoffs, reduction in investments; actions which are not warranted, but are unavoidable during such times.

Now let us take this to a broader scale; on a country level for instance. A way to gauge the debt levels of countries is the debt to GDP ratio - how much debt has a country taken in relation to what it produces. This indicates its ability to pay back and service its debt.

Now, when someone says that this ratio is the worst it has been in over 200 years, it would make anyone get up, take notice, and worry! As per Moneynews, a research paper by Harvard economists suggests that the western world or the developed part of the world is broke. So broke that harsh measures would be required to get its economy back on track! These might include defaults and savings tax on private wealth. What makes the situation seem worse is that such measures have not been used since times of the Great Depression and the post World War-II era.

In 2014, the governments' gross debt to GDP ratio is estimated to be at about 110% levels for all advanced economies. Quite a contrast to the 33.6% level of the emerging economies. The latter have seemingly managed to lower their debt levels in the past five years. And this is what the solution is as per the authors of the research paper. Explicit restructuring would be the only resolution.

When one views the scenario back in India, things do not really seem all hunky dory. Especially when compared to the debt statistic of its peers. India's debt to GDP stood at about 66% in FY13, which is nearly double that of the emerging nations. Plus, with the twin deficits, there does not seem an easy way out anytime soon. While one positive, as highlighted by Dr. Rajan recently, is that India's external debt is not something to worry about. However, to meet its expenditures plans, the government will have to continue borrowing from within the country. Unless drastic measures are taken, this would only lead the debt ballooning to unsustainable levels. Moreover this could also crowd out private borrowers, thereby increasing the borrowing costs for corporates. And as you would very well know, that is not good situation for any economy.

While not much can be done until the next government comes in place, the only hopes are of the ongoing efforts towards managing the financial situation of the country go as planned.

Do you think India will face a crisis situation because of its debt position anytime in the future? Let us know your comments or share your views in the Equitymaster Club.

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01:15  Chart of the day
Equity participation in mutual funds is a good way to gauge the sentiments of retail investors. Whenever the markets go through gravity defying phases, investors lined up to cash in on the rise. Today's chart of the day focuses on the new funds launched by mutual funds and the funds they mobilised through the same over the years. As you can see, the amount of money raised in the pre-2008 phases was way more then what has been the trend in the past five years. In fact, the total funds mobilised through these schemes in the last five years did not even add up to the amount of funds that were raised in the year 2008. In 2007, Rs 293 bn were mobilised by mutual funds. The total sum raised from 2008 till 2013 (till November 2013) stood at Rs 330 bn. As such, it does give a good indication of the kind of euphoria what was surrounding the markets at the time. Not to mention the mutual funds themselves cashing in on the same by launching newer schemes. One would do well to remember the themed funds were quite the around that period.

A good indicator of investor sentiments?

As reported in the Financial Times, the volatile markets (which keep the investors jittery) in addition to the SEBI's assertion to merge schemes as well as the clampdown on the undifferentiated schemes launched by the asset management companies have been key reasons for the lesser number of schemes launched in recent years.

For investors investing in mutual funds, we have only one simple suggestion. That of following the practice of low P/E investing from a long term perspective!

He is a man of few words. Quite literally! However, Prime Minister Manmohan Singh's address to the citizens of India, at the fag end of his term, was a vocal one indeed. The usually reticent PM not just cited his reluctance to accept another term but also defended his stance. That his attempts at curbing corruption and taming inflation had been rather unsuccessful were not completely denied. However, Mr Singh expressed hope that his clean image will be held up by historians as against his ineptitude as a PM. What was also a surprise were Mr Singh's critical remarks against the leader of the BJP. Now, while also this makes for an interesting pre-election debate, investors would rather keep such comments at bay. Taking cues from such debates about election results and investing on that basis can be very risky. As far as the PM's hopes of being pardoned for not being proactive, we believe that the chances are slim. A democracy like India will certainly hope for leaders who can act touch against the malaise of corruption. For leaders who would rather compromise on governance than give up their coveted seats, the country may have little tolerance.

In the last month, the Federal Reserve (Fed) decided to taper its QE program. This came as a surprise to many as the US economy was still on tenterhooks. However, signs like improving job market induced the tapering decision. The Fed believed that the extent of external stimulus required to support the economy can be curtailed as it was showing signs of revival. As a result, it decided to cut the bond buying program by US$10 bn per month.

An unexpected taper led many to believe that the near zero rate policy may also come to an end sooner or later. However, the Fed chairman has made it clear that it will pursue with its accommodative policy as long as it is needed. And it is in a no hurry to take hawkish stance so soon. It may be noted that after the global recession in 2008, the Fed resorted to a near zero rate policy to boost its economy. And this has had limited success to an extent with economy showing signs of improvement. But the Fed believes that it is too early to say that the US economy is completely out of the woods. Hence, it is committed to maintain an accommodative policy for the time being. While an easy money policy may induce spending and boost economy in the short run it sows seeds of inflation for the future. And this can have cascading effect on any economy in the long run.

Since the global crisis in 2008, fiat currencies have been under fire on account of loose monetary policies by central bankers. These easy money policies have debased the value of paper currencies compelling investors to look for safer alternatives. Little wonder then that gold has seen a spectacular run based on the fact that it is a store of value and a hedge against inflation. But the clamour for gold has been so strong that regulations have increased for this precious metal as well. This has then led to the rise of Bitcoins.

The key here is that investors are increasingly looking for medium of exchanges which involve least government interference. Bitcoins, in this regard, seemed to fit the bill because it is not backed by any government. The other factor working for it is that the amount of Bitcoins in circulation is limited. This is in stark contrast to paper currencies which are being printed by governments at will. Does this then make Bitcoins a safer bet? Not really. Because of the growing popularity of Bitcoins, prices were rather volatile in 2013. Moreover, the increased possibility of governments finding ways of bringing this virtual currency within its regulatory ambit cannot be entirely ruled out. Further, just like it is for any asset class, there is no reason for the bull run in Bitcoins to go on forever.

Stocks began the new-year by catching their breath after a historic rally that saw major world indices set dozens of highs throughout 2013. For the week, global stock indices were mixed. For the full year of 2013, the US markets rose 26.5%, their best showing since the late 1990s. Economic data released this week were largely positive, with global manufacturing gathering strength, US consumers feeling more upbeat and both the US labor and housing markets continuing to recover. However, the US markets ended the week marginally down by 0.1%.

US manufacturing activity grew in December at its fastest pace in 11 months, as the HSBC Markit US manufacturing purchasing managers' index rose to 55.0 from 54.7. Eurozone manufacturing activity expanded faster than it has since mid-2011, with Germany and the Netherlands leading the way. The rate of growth in Japanese manufacturing was at a seven and a half year high. All the major European Indices ended the week in the red.

The Indian equity markets started the week on a negative note. The losses were negligible and similar price action repeated during the following two trading sessions. However, on Thursday, during the first half, the NSE-Nifty surged, but failed to sustain itself as the bears struck back and dragged it substantially lower from early morning highs of the day. This was followed by a gap down opening on Friday but modest recovery towards the fag end of the session pulled the index up. The Indian markets finally closed the week down by 1.6%.

Performance during week ended 03 Jan 2014
Source: Yahoo Finance

04:55  Weekend investing mantra
"Some people seem to think there's no trouble just because it hasn't happened yet. If you jump out the window at the 42nd floor and you're still doing fine as you pass the 27th floor, that doesn't mean you don't have a serious problem. I would want to address the problem right now." - Charlie Munger
Today being a Saturday, there is no Premium edition being published. But you can always read our most recent issue here...
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3 Responses to "Is debt a ticking time bomb for India too?"


Jan 8, 2014

Although you released a very negative report on the Indian situation some time back and its potential impact on investors. Still you later said that you are not bearish which is contradictory. India's debt to GDP should be measured combining govt+private debt and we would be in the region of 150% which can be very high.


Santimoy Ghoshal

Jan 5, 2014


Like (1)

sundar rangan

Jan 5, 2014

PM in his press conference mentioned that 2G and Coalgate were UPA I scams and that 2007 election victory of UPA meant people didn't consider these as anything serious. He went on to lynch Modi for 'presiding over massacre'. By same logic, Modi was twice elected back as CM, so does he not enjoy the same immunity which PM claimed. Also, in Modi's case, courts have held him innocent; then whom do you trust? Congress Spokesmen or the noisy useless media?

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