This is why the dollar rally is faulty... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

This is why the dollar rally is faulty... 

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In this issue:
» China to face a US style credit crisis?
» Some reforms announced for power sector
» SEZ program may no longer continue
» Steel output in China rises
» ...and more!

The US dollar had quite a strong run last week. As reported on Moneynews, the Dollar Index, which measures the greenback against six major currencies, gained 2% from Tuesday's low through Friday. The US Fed obviously had a lot to do with it. Stating its view that the US economy is showing signs of recovery, Fed chief Ben Bernanke put forth his intention of a likely tapering of the QE program.

But does the rally in the US currency carry any weight? Not really. Because the foundation on which it is based is quite weak we believe. The recent rally in stock markets around the world has largely been on easy money steroids prescribed by central banks. So if the buoyancy was on account of cheap money, it goes without saying that there will be a meltdown if this money is sucked out of the system. That is why it becomes difficult to believe Mr Bernanke when he opines that the exit from QE will be quite smooth. Because it seems unlikely that the US Fed will end up quitting its loose monetary policies in the first place.

If that is the case, the printing presses will continue to run on. Thus, concerns will once again come to the fore of the fall in the value of paper currencies. The status of the dollar as the world's reserve currency will also be questioned. What it essentially means is that it would be a folly to perceive the US dollar as a 'safe haven' even in relative terms. The problems that the US economy is facing are hardly likely to go anytime soon.

Thus despite the stupendous rally in the last decade, the status of a 'safe haven' investment still belongs to gold. While there are bound to be near term corrections, the case for the precious metal in the longer term still remains strong. Because as long as excess liquidity continues to slosh around in the system, inflation at some point of time is bound to rear its ugly head. And those having some amount of gold in their portfolios will certainly stand to gain.

Do you think that the recent rally in the US dollar is a short term event or does it carry more weight? Please share your comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
Despite a weakening economy and a ballooning debt burden, the US continued to boast of having the most number of rich people in the world in 2012. These are the number of people with at least US$ 1 m of investible assets. As reported in the Economist, this was an increase of around 12% over 2011. Indeed, it seems highly unlikely that the US economy has much to do in terms of adding on to the wealth of the people. Infact, the easy money policy of the US Fed had more to do with it. Cheap money found its way into asset classes causing prices to rise even when the underlying fundamentals remained weak. While China figured in the top 5, India failed to make the cut.

*No. of people with at least US$ 1 m of investible assets
Data Source: The Economist

Are the chickens of bad loans finally coming home to roost in China? It does certainly look like it. The latest sign that something could be wrong came yesterday when Chinese stocks fell 5.3% on news of a credit crunch. Clearly, the incident brought back memories of the US banking crisis of 2007 and 2008. However, if noted investor Mark Mobius is to be believed, the similarity ends right there. As per Mobius, the Chinese Government controls the country's banks. And thus it will be much easier for China to bail its banks out. Besides, China is the owner of the world's largest stock of currency reserves, a neat US$ 3 trillion. It can therefore bring this to use as and when it decides to recapitalize its banking system. While we agree with Mobius, we are of the view that days of 9%-10% GDP growth seem to be over for China. As a result of the overhang of the bad loans and the exports driven structure of its economy, long term sustainable growth could come in much lower for China henceforth.

The woes of the power sector were essentially tied to shortage of fuel. While proposals to ensure better coal supplies from Coal India (CIL) went to and fro, neither the government nor power producers could agree on the pricing. CIL opposed proposals with the fear of having to import coal at higher prices. The power producers on the other hand wanted a free hand to sell excess power at merchant rates. This would compensate them for the higher cost of fuel. The government's new standard bidding documents (SBDs) seems to be taking into account the demands of both parties. These would be applicable for projects where the fuel source is determined in advance. Such projects will either have a captive mine attached to them or linkage will be provided from domestic mines. Moreover, they will be investor friendly given the relatively less uncertainty with regard to viability of the project. To top that, fuel cost is being treated as pass-through in the new bidding norms. Hence for power producers too, this will be a win-win situation. We only hope these reforms help the power sector get rid of the cloud of uncertainty that has marred its fortunes.

In 2006, the special economic zones (SEZ) scheme was announced with much brouhaha. The idea behind this was to bolster economic objectives of job creation and investments. But the going has not been easy. Infact, as has always been the case with government programs, scams and scandals have rocked the SEZ boat as well. There have been allegations of realty scams which have let developers make quick money and at the same time enjoy the benefits of tax exemption. Further, the commerce and finance ministries were at loggerheads over the viability of the program. The latter especially was of the view that the numbers reported by the commerce ministry have been exaggerated. As a result of various issues, the government may therefore scrap the SEZ program altogether. The existing SEZs will be allowed to remain operational. But those approved may not be notified and developers would be allowed to utilize the land for other purposes. This is not to say that SEZs have completely been a damp squib. The data for the last two years show healthy growth in exports from SEZs even when India's overall exports have been subdued. But given that corruption may rot the system even further, it probably makes sense if the program is discontinued going forward.

India has been signing free trade agreements (FTAs) left, right and centre. But they have been of very little help towards the trade of the country. As per Business Standard, the country has signed several FTAs. But the exports from the country have declined by 1.76% in FY13 as compared to FY12. At the same time, imports have shot up. A big reason for this is that these agreements have actually helped our trade partners more than they have helped us. Most of the countries with whom we have an agreement have used it to send their goods into our shores. Many have even used India as a dumping ground. At the same time exports from our country have actually de-grown. This is due to the poor state of manufacturing in our country.

The sector has just been unable to capitalise on the opportunity presented by these FTAs. And this has led to the skewed trade balance that we see. The only way to fix this would be by fixing the problem at its root. That is fixing the manufacturing sector. This would involve several steps not just from the sector participants but from the government as well. The latter needs to change the policies and remove the bottlenecks in the path of investments. Only then will the manufacturing sector become more competitive. Unless these steps are taken, the FTAs would continue to help our trading partners and put more pressure on the domestic companies.

Steel is one of those essential commodities whose demand is closely linked to economic growth. As such, a weak global economic environment means bad news for the steel industry. But global steel output appears to be showing a contrary trend. Steel output grew by 2.1% in the Jan-May period this year.

What are the reasons for this? A look at the country-wise break-up of output gives the answer. China, which accounts for half of the global steel output, saw its output increase by 8% in the year so far. During the same period, developed economies in North America and Europe have witnessed about 5% contraction in steel output.

But given the prospects of a slowdown in China, we wonder if the steel output could be absorbed going forward. Eventually, the excess output would find its way in other economies. And this would weigh heavily on global steel prices we believe.

After opening the day on a volatile note, the Indian equity markets rose above the dotted line during the post noon trading session. At the time of writing, the BSE-Sensex was trading higher by about 200 points or 1.1%. Barring stocks from the healthcare, consumer durables and power spaces, buying activity was seen across the board. Oil & gas and realty stocks were amongst the top performers. Midcaps and smallcaps were not in favour today as the BSE-Midcap and BSE-Smallcap indices were trading lower by about 0.4% each. Other stock markets in Asia ended the day on a weak note with Japan and China down by 0.7% and 0.2% respectively.

04:55  Today's investing mantra
"I like businesses that I can understand. Let's start with that. That narrows it down by 90%. There are all types of things I don't understand, but fortunately, there is enough I do understand." - Warren Buffett

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    3 Responses to "This is why the dollar rally is faulty..."


    Jun 26, 2013

    I disagree to your statement copied here "At the same time exports from our country have actually de-grown.This is due to the poor state of manufacturing in our country"
    The question here is Why our exports are affected? The answer is - Most of the countries are facing foreign curency problem, except few Oil exporting countries. Every country is trying to restrict their imports. Do you think, countries like Cyprus, Spain, Italy and African countries will import goods from India, when they are in deep trouble.
    So, what is the solution? Do not rely only on exports and FIIs to earn foreign curency.
    NRI,s are the source of foreign curency. Try to introduce incentive schemes for foreign currency earners to the country. Secondly, use our Indian companies in oil drilling and reduce the depandency in importing oil, which is deeply draining our foreign currency.


    bhupendra prajapati

    Jun 26, 2013

    I think that if general public as well as corporate of US believe that their economy is recovering than investments/business confidence will improve ( mentally ) which will induce corporate to take a risk of higher investments and capex plan which will reduce unemployment and boost GDP growth so momentum may start.



    Jun 25, 2013

    One way of bringing back the Dollor to its real value in terms of rupee is that we have to ban intraday trading to FIIs--both in cash and F&Os.
    With all the technoloogy and funds (towards margin) they are circulating the money all over the world 24 hrs a day and looting internationally including India.
    Our Government has to realise how dangerous this gambling to India.

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