It's time emerging nations build their own safety net! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

It's time emerging nations build their own safety net! 

A  A  A
In this issue:
» Leverage ratios in India's corporate sector a potent source of risk
» US stock markets on the verge of crash
» Indian equity markets losing long term foreign money
» PSU banks face talent deficit at top positions
» ...and more!

We all know of evolution as a gradual change that makes a process or system robust over a period of time. Often, it is marked by synergy between the different entities leading to higher efficiencies, sturdier systems and faster mutual growth. Global economy is no exception to this process of change. Over the years, individual economies have shifted from operating solo to having significant interactions. The only difference is that the process seems to have done more damage than good. More so for the emerging nations. If one takes a look at the last few years, the increased connection has made emerging economies more vulnerable than ever.

Take for example the years post 2008 financial crisis. This was the time of ultra loose monetary policy and low interest rates in US. While multiple rounds of unabashed money printing hardly worked for the US economy, it caused unmatched damage to the prospects of emerging nations. The reckless policy by Fed led to flood of capital to emerging economies in search for better yields. And what followed was inflated asset prices and equity markets and pushed up currencies for emerging markets.

So no wonder when US talked about tapering, serious concerns arose in emerging markets. The shifting of foreign capital back to advance economies rocked the currencies and stock markets of emerging economies. India was one of the hardest hit victims of the same. While one can not deny the internal mess that led to the crisis like situation for India; the role of monetary policies of central banks of advance economies can not be ignored.

So one would really empathize with Mr. Rajan who recently criticized multilateral institutions like IMF for letting advance economies get away with policies that had adverse spillover impacts on emerging nations. Mr. Rajan called for analyzing comparative costs and benefits of such policies, including the impact on emerging nations.

One can argue that emerging nations should fend for themselves with enough forex reserves in the event of such shocks. However, there is no limit to piling on forex reserves. While this can make a country less vulnerable, it also leads to slowdown in the global aggregate demand.

To deal better with such situations, Mr. Rajan has proposed appointment of unbiased multilateral body that can oversee impacts of central banks' policies on the global economy. He has further urged for creation of a global safety net administered by such international body that can offer line of credit to a country in case of economic emergency. This would take some pressure off the emerging economies to build on forex reserves and let them focus on growth instead.

These are indeed some noble suggestions and likely to make global economies more stable. However, it is also true that what he has proposed is something that one can hope for and not demand. Before we expect to grow, we need to ensure survival. And for that we need to find solution within. As such, India should focus on taking measures that are really under its control, for e.g. reforms, better policies, efficient fiscal management and stable currency instead of counting on external help.

How do you think India can shield itself from spillover over impacts of advance economies' policies? Let us know in the Equitymaster Club or share your comments below.

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02:00  Chart of the day
Excessive leverage poses balance sheet risk. It also makes interest servicing a difficult task. If one were to go by the IMF's latest financial stability report, leverage ratios in India's corporate sector appear to be a potent source of risk. As can be seen in today's chart, the debt to equity ratio of India's corporate sector stands at 83%. This is highest amongst emerging market peers. When compared to advanced economies, only Greece and Italy have higher debt to equity ratio than that of India.

Higher leverage signifies that India's corporate sector is quite sensitive to interest rate changes. If interest rates increase, the borrowing cost of corporates will rise further. With debt already being at un-proportionate levels servicing the same could be a challenge. This may result in defaults. Higher debt also reflects the inherent non-performing asset (NPA) risk prevailing in the banking system. If corporates fail to repay their loans and default Indian banks may turn vulnerable. This can have serious repercussions on the economy.

Indian corporate sector's Debt to Equity ratio remains high

22% down is substantial money to lose over even a year period. Imagine the entire stock market going down by this much in one single day! If one is thinking that this is a page straight out of a racy, fiction novel, let us set the record straight. Such an event has actually been played out in reality and the day it happened has gone down in history as the Black Monday of October 1987. We are sure many of us wouldn't have been around at that time or may have been too young to feel the enormity of the event. Fear not though. If Marc Faber is to be believed, a similar crash or perhaps a one of an even bigger proportion is looming over the US stock markets currently.

"I think it's very likely that we're seeing, in the next 12 months, an '87-type of crash," Dr Faber told CNBC. "And I suspect it will be even worse", he further added. Now that's some epic prediction we believe. But Dr Faber is not someone who makes a tall claim just to be in the headlines. He certainly knows what he's talking. As per him, the US Federal Reserve is absolutely a clueless organisation and the market was beginning to realise the same. He does not stop here. He goes so far to claim that the valuations of few of the hot stocks are squarely in cuckoo land. They have no earnings as per him and are being valued in terms of price to sales which is not that useful in the long term. Well, we couldn't help but agree.

Foreign institutional investors (FIIs) have been making a beeline for Indian shores on hopes that the BJP will come to power in the general elections. While India's economic fundamentals continue to remain weak, stock markets have not paid heed and are scaling higher fuelled by FII inflows. But what about long term foreign money? Unfortunately, that seems to be pulled out of India. Indeed, as per an article in Business Standard, since January 2012, US and European funds, typically considered long-term investors, have cumulatively withdrawn about US$ 3.8 bn from Indian equity markets. One of the reasons attributed to this is the prospect of recovery in the developed world. The other reason could be India's slowing growth and lack of reforms. FII money has its share of risks. If the money is pouring in because of hopes of a BJP government at the helm, then the tide could very well reverse if the election outcome is not as desired. Basically, it leaves Indian markets at the mercy of short term investors. Ultimately, whichever party assumes government, it all boils down to what it chooses to do as far as introducing and implementing reforms is concerned. If there are considerable positive developments on that front, long term foreign money would certainly find its way once again to India.

The performance of PSU banks has been a big embarrassment for RBI. However, the largest shareholder in the banks, the government, seems to show no remorse! Despite the fact that the problem of high NPAs in most of these banks has been traced back to bad lending. These are cases where the state of the economy or the business performance of the borrowing company cannot be blamed. Instead in most cases the PSU banks' chiefs have colluded with corporates that eventually wilfully defaulted on loan repayment! That raises a doubt about the transparency in appointment of the bank chiefs. Most PSU banks chief are selected amongst the pool of few candidates who qualify based on hierarchical positions. There is therefore very little recognition of talent, skill sets or past track record. And according to an article in Moneylife, talent deficit has come to be the biggest void in PSU banks. For entities that corner 60% of the Rs 80 trillion banking sector, this should indeed be a big worry. However, the government has always preferred PSU bank chiefs who would rather pay heed to the North Block's commands. It is time that with a change of government both the RBI and the Finance Ministry ensure that better talent finds its way to PSU banks.

Asians' love for gold is so profound that they can happily ignore 'The Oracle of Omaha's' take on gold. According to him gold has no intrinsic value and equities are better placed as compared to this 'safe asset'. This undisputable Asians' faith in gold was evident in 2013; when a sharp drop in gold prices was lapped up as a too-good-to be true buying opportunity. The global jewellery demand moved 17% higher last year, according to the World Gold Council. There are no prizes for guessing that India and China alone accounted for 53% of the total physical demand for gold last year. In fact, the gold demand has surged to such an extent that the world's two largest gold consumers have allowed private sector banks and foreign institutions to import more gold in to the countries.

Gold holds huge sentimental value in India and China as its part of their centuries-old traditions and festivals. And with rising middle class and higher disposable income in the Asian regions and uncertainties in the global economy; gold prices are expected to touch new highs in future as well.

In the meanwhile, the Indian stock markets continued to languish below the dotted line. At the time of writing, the benchmark BSE-Sensex was down by 140 points (-0.6%). Most of the sectoral indices were trading in the red with stocks from oil and gas and capital goods leading the losses. Consumer durable and pharma were among the few sectoral indices trading in the positive territory. All the major Asian stock markets, barring Indonesia, were trading in the red. Market indices in Japan and Hong Kong were the biggest losers. Most of the European markets opened the day on a negative note

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3 Responses to "It's time emerging nations build their own safety net!"


Apr 12, 2014

To bolster FE reserve what will happen if Emerging nations
also print notes and limit its use only to buy FE to come in handy as and when FE exodus starts!

This will leave internal strength-building to tackle national growth.We will this way be isolated to some extent from external devilish influence



Apr 11, 2014

Is there any reason why developing countriesdont use gold as medium of exchange rather than USD? I feel prices of commodities can be linked to gold and this will also ensure that USD fluctuations do not cause an adverse impact in exchanging goods linked to gold. For eg, 1 Barrel of oil could be equal to 10 grams of gold. The USD and Rupee can flutuate but the basic exchange mechanism between Oil and gold should not change.


Gautam Khandelwal

Apr 11, 2014

In the globalized world that we live in, capital will always flow towards a country where the return on investment is the highest. So all that India needs to do is offer a good business environment for people to do business in. Good governance, nice infrastructure, a middle class for consuming the products generated by the factories. I guess we all know the solution and therefore, the key lies in implementation.

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