What the end of Fed's QE means for India... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

What the end of Fed's QE means for India... 

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In this issue:
» Sluggishness in auto volumes continues
» When value of gold can touch infinity
» Japanese companies see cash stock piles rise
» India's HNI base increases
» ...and more!

The reaction to the Fed statement that it will withdraw its quantitative easing program by mid 2014 only points out to how dependent were the global financial markets on the same. As news began spilling out, equities across geographies fell. Indian stock markets have not been immune either and were down 2% at the time of writing.

So is this pessimism justified? When the global financial crisis struck, the US Fed was of the view that massive quantitative easing programs would do the trick and pull the economy out of the slump. That never really happened. Because they burnt their fingers badly in the crisis, banks took this surplus money but refused to lend. And so this money did not find its way into the economy in the form of capital spending. Besides consumers refused to spend because unemployment remained high and job prospects dim. But that did not stop the Fed from announcing stimulus measures. And so a lot of this money only made a beeline for various asset classes to the point that bubbles started brewing there.

One of the reasons that the US Fed intends to withdraw its program is because it believes that growth in the US economy is picking up. That remains to be seen. Because removal of the QE crutch without economic growth taking place is bound to have an adverse impact on the US markets. Especially since the recent rally was purely on account of liquidity and no fundamentals.

The impact of this will be felt by Indian stock markets as well. What is more, massive FII outflows could have an impact on the rupee at a time when India's fiscal and current account deficit (CAD positions) are precarious. But this is only one aspect which could have a negative bearing on the markets. This is because it has its own demons in the form of slow economic growth, consumer price inflation and fiscal deficit to deal with. The point is that the US Fed withdrawing its QE programs should not be viewed as a negative development by long term investors. If equity markets fall, the discerning investor would surely take this opportunity to buy some good quality stocks at attractive prices with the potential to deliver healthy returns in the longer term.

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01:26  Chart of the day
There is no denying that FY13 was a poor year for the Indian auto industry. As the economic slowdown and firm interest rates took their toll, demand dampened and volume growth was severely hit. But FY14 is proving to be no different. As can be seen from the chart, volume growth in the first two months of FY14 has been very poor for most segments in the auto space. And this is likely to continue unless there is a pickup in economic activity. Most of the companies expect the first half of this fiscal to be challenging as well, but believe things to start picking up thereafter.

*Passenger vehicles,   **Commercial vehicles
Data Source: SIAM

The financial crisis that started in 2008 has left lasting imprints on several sectors. Many have witnessed growth and profitability shrinking for a prolonged period. Others have capacities remaining unutilized and cash flows drying up. But no sector has seen the impact as closely as Indian banking. Being the financer to industrial, services and retail sector, the sector saw a sharp drop in credit demand post 2008. The drop in credit disbursal was particularly large given that the years 2005-2007 saw unprecedented rise in lending. Most banks had indeed gone overboard with their lending activities during this period. However, once the cycle turned, the burden of NPAs was too much to cover. While the government allowed loan restructuring, the specter of NPAs only increased. In the case of the country's largest bank, nearly 25% of the restructured loans turned bad. In absolute terms the amount may be equal to a small bank's quarterly lending! If the last data from PSU banks is anything to go by, there is more pain left. The cash stripped government will find it difficult to capitalize the PSU banks. Hence we agree with the views published in article in Economist that the banking sector will be a stumbling block in the economy's recovery path.

If US continues to print money then the US dollar will collapse. And if that happens then the value of gold would go to infinity. These are the thoughts of former Congressman Mr Ron Paul. He states that if the US dollar collapses then no matter how many dollars you use, you would be unable to buy gold with it. In essence this means that the value of gold would touch infinity. The basic premise on which he has based this opinion is that over time paper self destructs while gold would continue to retain its value.

We do find Mr Paul's thoughts quite interesting. Though his criticism of the Fed's money printing policy maybe a tad too late given Mr Bernanke's recent announcement on tapering off the QE program. Nevertheless what he says is true. If US dollar were to collapse or lose value, then gold would shine because of its safe haven status. In general, we feel gold will eventually shine bright for this reason though we do think that saying gold value could go to infinity maybe a bit of an exaggeration. Nevertheless things are still bad in the global economy. Volatility and uncertainty continues to haunt the developed world. Even the emerging markets have started to feel the brunt of the crisis as they have seen their economies slowing down. During such times of distress, it is best to hold on to gold as an insurance policy. This is why we suggest that investors hold at least 5% of their portfolios in gold.

As you know, Japan has unleashed an unprecedented monetary stimulus program. With the flood of cheap liquidity, the Japanese Prime Minister hopes to revive the flagging economy. The underlying assumption is that the monetary stimulus will lift inflation. This in turn will raise consumer confidence and corporate investments.

But as it goes, such things appear to work only in theory. In reality, Japanese companies are still shy of investing at home. In fact, their cash stockpile has been growing. As per an article in Bloomberg, the cash and deposits of private Japanese companies have shot up to about US$ 2.4 trillion. That's more than the size of Italy's economy. That's higher than even the liquid assets of American companies.

All in all, it seems Japan has set itself on the path of very high risk. There is a big question mark whether it will work. If it falters, it will wreck havoc in the Japanese economy.

These days, there is a lot of talk about how shale discovery has revolutionized the global energy industry. As per new estimates, shale reserves are almost 10% higher of those in 2011. Ideally, this should lead to a sharp correction in oil prices. However, this hardly seems to be the case. The crude oil still trades above US$ 100 per barrel. And as per an article in The Economist, those expecting oil prices in two digits per barrel are likely to be disappointed. This is because unlike in the case of other commodities where price follows demand and vice versa, in the case of crude oil, it is supply that is adjusted to maintain the desired price levels. The leading global oil suppliers like Saudi Arabia are happy to see oil prices at US$ 100 per barrel. This is the level at which global economy is expected to afford oil without impacting the demand. As such, when higher supplies hit the market, spare capacities and supply cuts come along, thus making sure that prices do not get pulled down. As far as shale oil is concerned, it is even easier to scale down supplies as it involves smaller wells. While these spare capacities will be helpful in case geopolitical risks surface in the future, oil prices are likely to stay high.

Income inequality is an evil. And it is the government's responsibility to eradicate this evil. Income redistribution is their prime job. Apart from that, government should also come out with policies that help in the up-liftment of the poor. However, in India the situation is quite opposite. Government policies though pro-poor have hardly had any effect. In short, rich in India are getting richer and poor are getting poorer. Sample this. In 2012, India's high net worth individuals (HNI) base grew by 22.2% YoY. This is the second highest rate only to Hong Kong. Many attribute buoyant stock markets to the rise in the number of HNIs. However, what is worrying is that while the HNI numbers in India are increasing at a buoyant pace, poor's have been eclipsed from this journey. There is hardly any improvement in their standard of living. Reduction in the number of poor's is a true victory of any government. Increasing wealth amongst HNIs is good. But it is just a consolation for a country like India where being poor is considered to be a sin.

The Indian equity markets traded well below the dotted line throughout the day. At the time of writing the BSE-Sensex was trading lower by about 420 points or 2.2%. Stocks from the realty, metal and banking sectors were the worst hit, while those from the healthcare and information technology sectors were amongst the least underperforming. The BSE-Midcap and BSE-Smallcap indices were down by about 1.4% each. Stock markets in rest of Asia ended the day on a weak note as well with Japan and China down by 1.7% and 2.8% respectively.

04:56  Today's investing mantra
"Investors have to remember: corporate profits are going up, but stocks are going up faster. How can that continue indefinitely? Investors can only earn what companies themselves can earn; the government or the markets themselves don't kick anything in. How can you get anything more out of a farm than what it grows?" - Warren Buffett

  • Warren Buffett - The Value Investor
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    7 Responses to "What the end of Fed's QE means for India..."


    Aug 24, 2013

    I don't think anybody knows what the hell is going on. QE or no QE India will remain SONEKI CHIRYA. People here believe in gold and land. There are very few playing the stock market. QE or no QE, India will remain SONEKI CHIRYA.



    Jun 21, 2013

    Nope cut down in QE will temporarily have the markets go down. but what happened yesterday was due to China. Oil shed $3 in a single day. QE cannot have that effect.



    Jun 21, 2013

    When we follow blindly the economic policieies of western countries as a true servant of that country then the dooms day is near by. This is what preciesly happening. So there fore so called highly qualified expert of economics and doctorates are ruining the country. These people may be called as literal educated cunning goons of intellectual deficiet.


    parimal shah

    Jun 21, 2013

    It is the right thing to do - withdraw QE. And it is a boon for honest, citizens. Zombies may interprete it as curse - due to wasted interest.


    swapan lodh

    Jun 20, 2013

    I cannot entirely with the idea as development of an economy depends on other factors.The shale oil output,ecnomic downturn of england anthor eu countries couple with India`s uncertain productivity and china`s contribution into global markets.China`s products are facing fall in demand.


    Borkar M.R.

    Jun 20, 2013

    Is it not that the consumption is directly related to the population or growth in population? If Japanese population is stagnent and where the poulation is growing - China and India - and that poulation has no income cannot have affordability of even two meals, where the goods produced will find the market? Having cash piled up in the treasuries will improve the economy? Will not the Japanese economy crash by this situation? Can u enlighten on this point? - Borkar



    Jun 20, 2013

    May be in the long run if the crisis in theshort period is overcome by good governance

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