Such a mismatch can keep India poor despite a higher GDP growth - The 5 Minute WrapUp by Equitymaster
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Such a mismatch can keep India poor despite a higher GDP growth

Jan 22, 2015

In this issue:
» Why is Jim Rogers in love with the US$...
» Does size really matter in the cement industry?
» Relationship between earnings and valuations of BSE 100 companies
» ...and more!

Between 1990 and 2010 India's per capita income went up 2.5 times. During the same period, the number of billionaires in Forbes' list went from 1 to 49. Now in a population of nearly 1.2 billion, the figure of 50 billionaires may seem miniscule. But unfortunately the fact that just 1% of India's population controls most of India's wealth is disturbing. And the past three decades has seen this concentration of wealth become acute.

The income divide between India's rich and poor can be attributed to the rate at which real wages of industrial workers have grown over the past three decades. As per the data from Annual Survey of Industries, published by Mint, the real wages grew by just 1% per annum between 1983 and 2013! In fact, the real wages have grown far less than the growth in productivity. And have completely overruled the traditional economic assumption that the two move in tandem. Now the rise in corporate profitability, particularly 1991 onwards, was not just backed by economic tailwinds. The increased mechanization of manufacturing activities also enhanced productivity.

The share of profits for the manufacturing sector has fallen after peaking in FY08. Stalled projects, lower demand from developed economies, high inflation and loss of pricing power have all played a role. But what remains unheeded is the fact that the real wages never managed to keep up with productivity and profitability.

Real wages slumped even as corporate profitability soared
Data Source: Mint

The growing income gap in India's rural as well as urban population cannot be bridged unless and until the real wages are aligned with productivity. The same is all the more important if manufacturing has to take centre stage in India's economic prosperity. While schemes like NREGA may put more money in the hands of unskilled labourers, it cannot be the solution to India's poverty problem.

For investors it is important to remember that 8-10% GDP growth will be meaningful only if the income divide can be bridged to some extent. Without substantial rise in per capita income, India's consumption story will hardly take off. And that will eventually mean companies in the space facing barriers to growth despite being very profitable.

So taking a very long term call on companies that are enjoying high double digit growth rates in the consumption space does have at least one risk. That continued income disparity may never allow topline growth in line with broader economic growth. And hence the premium that you are willing to pay for such companies need to be realistic.

Do you think India's income divide can be a real risk to stocks in the consumption space? Let us know your comments or share your views in the Equitymaster Club.

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  Chart of the day
Besides GDP and per capita income growth, another factor we need to keep a close watch on is the corporate earnings growth. For even as the Sensex breaches new highs at 29,000, the rally can be short lived without the support of earnings growth. There is no doubt about the fact that corporate profits have shown signs of up move over the past few quarters. The excess capacity in several sectors will also help profits move up as capacity utilization improves. Plus control on inflation can help companies regain some pricing power. Expansion of capacities and clearing of stalled projects can add further fillip, albeit at a later stage. However, as the data of BSE 100 companies shows, the growth in earnings has clearly lagged the expansion in price to earnings (P/E) multiple. And although the P/E multiple currently remains lower than those seen in 2008 and 2010, low earnings growth can be a spoiler.

Earnings growth lags PE expansion for BSE 100 companies

In any industry it is the leaders that dictate pricing and rest follow suit, isn't it? However, cement sector may well be an exception here. In an industry, where capacity matters, that led to a consolidation, it is surprising to see how smaller players are literally toying with the big guys when it comes to setting pricing benchmarks. Proximity to buyers and raw material sources is what is helping them. Such a twin advantage enables smaller players to maintain a tight noose on their cost and thus keep prices low.

Considering the commoditized nature of the industry, if a producer is able to keep the end product prices low, rest have to follow suit. Else competitors would gain business as there is no product differentiation. Stiff competition and over capacity situation is further forcing players to indulge in price war. This is where small & regional players who have locational and logistical advantage are dominating the game.

Logistics is the key in this business. For instance, if a player located in central India decides to sell in western markets, transportation cost would kill him. Hence, there are too many small regional players who enjoy a good market share in the regions they operate. They can afford to keep prices low as they save on logistics costs. Proximity to key raw material inputs like coal & fly ash could come as an icing on the cake. Such players can literally distort the pricing in the market they operate. Some small players have tactfully placed themselves so and are exploiting the situation putting larger players in a limbo.

Let's move from a commodity to a currency story. The currency in question here is the US dollar. While the currency may have lost trust of many, it dominates the currency portfolio of legendary investor Jim Rogers. However, as per his own admission, he does not believe in the long term future of the US dollar. In fact, he went on to say that greenback is a terribly flawed currency.

Then why does his currency portfolio have a tilt towards the US dollar?

Well, lack of options is what has made him overweight on the US dollar. To be quite honest, we would have followed a completely different approach to investing than Jim Rogers here. He bought the dollar despite knowing the problems that the US economy is facing simply because there wasn't a better option.

As for us, we prefer to wait and not buy anything unless we believe in it over the long term. Of course, Jim Rogers is shrewd enough to know when to exit. However, an average investor on Dalal Street lacks such unusual skills. Hence, the best strategy for him would be to buy something only when he believes in the long term story. Trying to ride on near term imperfections and imitating what informed investors like Jim Rogers do is certainly not the way to riches for naive people in stock markets.

The Indian stock markets are trading positive today. At the time of writing, the BSE-Sensex was trading up by around 50 points, while the NSE-Nifty was up by 11 points. Gains were largely seen in healthcare and capital goods stocks. Most Asian markets were trading in the green at the time of writing. European stock markets, however, opened mixed today.

 Today's investing mantra
"A phrase like "cost of capital" means different things to different people. We just don't know how to measure it. Warren's way of describing it, opportunity cost, is probably right." - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee and Jinesh Joshi.

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1 Responses to "Such a mismatch can keep India poor despite a higher GDP growth"


Jan 22, 2015


Of course, you are right, the Income gap is increasing just like nature's Big Bang.
What would you do, if you are in-charge of 2000 employees and recently upgraded to Hitech Capital expenses to improve productivity?? (Both Man, Material & Machinery)?? How do you share your Profit & Loss with your Employees?!
I feel the best way is act like Infosys....give Stock options to all employees! (Just not increase the Salaries)!
Govt. has to device Tax schemes, appropriately!
To reduce Income Parity!

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