Is India stuck in a rut it can't get out of? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is India stuck in a rut it can't get out of? 

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In this issue:
» India fares badly on the trade balance front
» Is shadow banking in China building up?
» Why the private sector is needed for infra investments
» US Fed has landed itself into a trap
» ...and more!

When Goldman Sachs came out with its report on the BRIC countries and the robust growth rates that they would clock, the world sat and took notice. And they did not disappoint either. For instance, China and India grew at 10% plus and 9% plus for three years before the global financial crisis. As a result, it was hoped that the emerging economies would help in rebalancing growth in the global economy.

India's performance especially improved by leaps and bounds before the crisis. As incomes rose, number of people in the middle income group increased and so did the standard of living. What is commendable is that this growth came about despite the government and its inefficiencies.

But the slowdown in recent times has once again brought into the limelight problems that have been the bane of the country for a long time now. These are poor infrastructure and inefficient economic institutions. An article in Mint points out that this has exposed India to the risk of being caught in a middle-income trap. The middle-income trap is a phenomenon in which hitherto rapidly growing economies start stagnating at middle-income levels. Eventually they fail to rise to the ranks of advanced economies.

So while lack of infrastructure was not such a deterrent to India's success story in the pre crisis years, it is quite obvious that ignoring this issue now will be at its own peril. This is a structural issue that the Indian government needs to address because it will go a long way in ensuring that other problems do not crop up on a regular basis; inflation being one of them. There is no doubt that despite the crisis the advanced economies are in now, they boast of infrastructure that is world class. Unless India encourages investment into the country and takes infrastructural development to the next level, it will be stuck in the middle income rut for a very long time.

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01:26  Chart of the day
That India has a negative trade balance is well known. Weakening exports have been one of the culprits as the global macro environment remains subdued. But India's import bill has also been rising. This has largely been due to a rise in imports of oil and gold. This has put pressure on its trade balance which has slipped in the red effectively making it the worst performer among the BRIC countries. Indeed, its peers China, Russia and Brazil are in a much better shape as they have reported surpluses in the last 12 months. For India, the problem is further compounded by the fact that it also has a rising fiscal deficit that it needs to bring down.

Data Source: The Economist

What happens when interest rates are kept at levels below the rate of inflation? Well, people start speculating in other assets and over time, these speculations become so large that they put the entire financial system at risk. Is such a threat building up in the so called 'shadow banking' system in China? As per a write up written by a couple of close observers of Chinese economy, there is no such threat as of now. Simply because the Chinese banking system does have a high enough risk cushion to absorb losses that could emanate from the shadow banking system. However, if shadow banking keeps expanding then the risk buffer could become inadequate. And it is this possibility that the Chinese policymakers will have to guard against. Having said that, it looks unlikely the Chinese will raise rates in a hurry. As is the case most often, it will eventually require some huge calamity for the authorities to press into action.

In 2008 he earned the moniker of Dr Doom for predicting the financial crisis. In 2012 he predicted that 2013 will be the year of 'perfect storm'. The man who has such a reputation answers to the name of Nouriel Roubini. And this time again he has made some interesting predictions regarding the fate of the US Fed. In fact Mr Roubini has hit the nail on its head with regard to the Fed's exit strategy from quantitative easing. He believes that the cheap liquidity was of no use in stimulating the US economy in the first place. Turning off the liquidity tap at a time when growth is at historical lows and unemployment rate are at highs could be disastrous. This suggests that the US Fed may need to exit monetary stimulus slowly. But a slow exit risks creating a credit and asset bubble as large as the previous one, if not larger. Thus Roubini believes that the US Fed has landed itself into a trap. One that could seal the fate of the world's largest economy.

India's Planning Commission had set a target of average 8% GDP growth during the 12th Five year plan (2012-2017). To achieve this, it had envisaged investments of about US$ 1 trillion in infrastructure during this period. About 50% of these investments were expected from the private sector. But India's growth story could be in danger. As per Plan panel Deputy Chairman Montek Singh Ahluwalia, we could miss the growth target if the private sector does not make the necessary investments.

Already, we are supposed to have grown at 5% in the last fiscal. This has been the lowest rate in a decade! For the ongoing fiscal year, the Prime Minister's Economic Advisory Council has estimated the growth to be 6.4%. This means that the Indian economy would have to grow at an average rate of about 11.3% from FY15 to FY17. Only then, we would be able to hit the 8% growth target.

And this would be impossible to achieve without substantial investments in infrastructure. But the biggest roadblocks to big investments have been poor policies, regulatory hurdles and lack of reforms. Unless the government fixes these issues, private money will remain shy.

The US has been putting strict measures to check the number of immigrants entering the country. But a think tank has advised that highly skilled immigrants should be allowed into the country. This would drive innovation in US and would lead to economic development. Interestingly, a large number of such individuals would be Indians. The think tank has given quite a bit of evidence to support this theory. As per their comments carried by Economic Times, since 2006, Indian nationals have founded 33% of all engineering and technology start ups in US. It has also stated that Indian companies support over 250,000 jobs in US. The second statement is something that caught our interest. You may recall that the second statement was the exact argument put forward by the Indian IT companies against the visa issue that the new US immigration bill has brought up. The Bill effectively discourages outsourcing of work to India. This has added to the woes of the Indian IT industry which has been crying hoarse that the Bill is unfair. Particularly since they provide local jobs in the US. Now the think tank seems to be agreeing with the industry. If their proposals are accepted, things may turn around for the better for the Indian IT companies.

The Indian equity markets erased all their morning gains as they hovered around the neutral zone during the post noon trading session. At the time of writing, the BSE-Sensex was trading up by about 7 points. Stocks from the FMCG, healthcare and information technology spaces were amongst the top performers while those from the realty and engineering sectors were not so much in favour. As for the BSE Mid Cap and BSE Small Cap indices, the same were down by about 0.2% and 0.6% respectively. Stocks markets in rest of Asia ended the day on a mixed note with China and Japan down by about 1% and 0.2% respectively, while Hong Kong ended higher by 7%.

04:56  Today's investing mantra
"The investor of today does not profit from yesterday's growth" - Warren Buffett

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    2 Responses to "Is India stuck in a rut it can't get out of?"


    May 1, 2013

    Yes we could come out of this rut but following route given by failed economies but recalling days of pride/glory for this nation from history provide we are not allured with short term unstable vision less solutions.
    Blaming government will not bring changes first we have to ask ourselves are not we went habitual for all this? Do we tied our shoe less for real change in us and first of all have we diagnosed the real problem in us and do we have sincere desire to get cure from this or its just Armchair person's mental endeavor. If any of us really aspire to bring this nation bring put from a rut which is not years but decades old we should start from our side as purity is the force if we have genuine change in us it is enough to bring the radioactivity everywhere.



    May 1, 2013

    Coming out of the middle income rut is dicey. India is consolidating its corruption busting endeavours, albeit with lot of sound and fury. When the dust settles down and the lower levels of Governance are seen to be corruption free nimble-footed in the medium term there are chances that genuine entrepreneurs instead of crony capitalists who feed the black economy would enter the infrastructure investment activity because it so full of durable profit potential. A lot depends on civil activism, citizens' awareness and young and honest people entering the political arena in a mission mode. There are signs all this could happen. Let us hope for the best. It goes without saying that IT and ITES working in synergy with civil activism etc as stated above will play a crucial role in all this as it will usher in greater transparency and speed in decision making. I personally feel we are entering a promising phase though all of us have to contribute a lot to propel India to a higher trajectory of sustainable and equitable growth which has so mush potential for India.

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