Why interest rates will be a tailwind to India's GDP growth... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Why interest rates will be a tailwind to India's GDP growth... 

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In this issue:
» Dividend payouts at a five year high
» AUMs of Indian mutual funds could double in 5 years
» Do asset managers pose risk to the financial system?
» India's energy intensity makes it vulnerable to oil shock!
» ...and more!

00:00  Chart of the day
Bad governance, global asset bubbles, regulatory risks and corruption have together left a bad taste in our mouths. So much so that any rosy outlook makes us skeptical. The sharp run up in stock prices after the change of government is making investors cautious. Most are wary of correction in valuations if the economic revival story turns out to be a damp squib. Even the possibility of high GDP growth seems like an impossible dream to many. Whether or not the new government will be able to get rid of bureaucracy in decision making is a significant worry.

In order to get things rolling faster, the government will need a lot more than good intent. Moreover, in order to facilitate manufacturing and consumption growth, both commodity prices and inflation need to be benign. Well, it is certainly difficult to take a call as to whether everything will fall into place for India's economic resurgence. However, there is at least one factor that gives India a huge advantage over emerging peers to leap frog towards growth. And that is interest rates! Allow us to explain how...

As much as the UPA government chided the central bank for its stubborn monetary policy, its successor has a lot to thank the RBI for!

No doubt the NDA will have to make every effort to ensure that the much needed reforms see the light of the day pretty soon. Plus the management of PSUs at both centre and state level need to be both ethical and efficient. And the business environment in India should be lucrative enough to attract both domestic and foreign long term investors. But even if these things take a while to fructify, which they will, there is not much to panic. For the very possibility of interest rates moving lower from the level that they are now, will itself stoke GDP growth in the near term.

If one looks back at the benchmark interest rates in India (here we are referring to repo rate) during low GDP growth periods, the gap between GDP growth and interest rate has never been so wide. More importantly, unlike in other economies, the period of growth revival and fall in interest rate will be in tandem. So, while the rest of the world sees an upward movement in interest rates thwarting their GDP growth prospects, in India fall in rates could actually stoke growth.

Interest rates have never been so high during low growth periods
Repo rate is the benchmark rate at which the RBI lends to commercial banks.

So the difference between the previous bull run and this one is that usually the GDP growth cycle starts with a very low interest rate. But right now, in India, it is starting with high interest rates. So, if in the next 18-24 months, interest rates do come down meaningfully, the government will get enough leeway to make India's economic revival sustainable.

If the government and the RBI work together to keep inflation under control, interest rates could literally be the tailwind to India's GDP growth in the years ahead.

Are you skeptical about India's economic revival? Which factors are you most worried about? Let us know in the Equitymaster Club or share your comments below.

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Companies choose to utilize profits in two ways; either plough back into the business or dole out dividends to shareholders. Those who invested in stocks with high dividend payouts would have had a bumper year in FY14. This is because as per an article in the Economic Times, the dividend payouts during the year surged to 30.8% of net profits. This stood at 28.2% a year ago and around 23.5% five years back. In absolute terms, according to data compiled by the ET Intelligence Group, more than 1,000 companies paid US$ 22 bn in dividends in FY14. So what led to increased payouts? The primary reason appears to be economic slowdown. As demand waned and capacities remained unutilized, companies were not too keen to invest in capex. And so they had excess cash lying with them which they chose to give back to share holders in the form of dividends. In terms of sectors, public sector undertakings (PSUs), FMCG, IT and pharmaceutical companies were the ones that paid higher dividends. This probably provided some consolation to investors who last year were hit by volatility in the stock markets and slowdown in GDP growth that impacted company earnings.

Whether the pace of these dividend payouts sustains going forward remains to be seen. Assuming that the Modi government's reforms lead to an economic revival and demand surges, companies may prefer putting cash back into the business to capitalize on various opportunities. In such a scenario, the dividends paid out to shareholders could probably stay at the same levels if not decline.

The Indian mutual fund industry is likely to see good times ahead if the Association of Mutual Funds in India (AMFI) is to be believed. Very recently, the assets under management (AUMs) crossed the massive Rs 10 trillion figure. This number has doubled in the last five years. However, the same is expected to touch Rs 20 trillion five years down the line. Given the strong hopes of the growing economy, the proportion of financial savings is bound to increase as the preference for physical assets such as gold and real estate will come down. The fact remains that mutual fund investment are very under penetrated in India, forming only 2.5% of investments. Bank deposits form as much a 60%.

Having said that, we cannot help but think of this development as a classic mistake made by investors. We have written about this earlier as well - Investors tend to enter markets when they are not cheap. And with the broader markets trading at above average valuations, the possibility of such investments making good returns is much less as compared to investing when there is a good amount of uncertainty; a period when valuations are way more attractive and in favour of long term investors. We suggest investors not go overboard with the "this time is different" theme. While investing in stocks is a must in our view, if one wishes to invest in current times, we recommend investors start SIPs with good funds and as such not put in all their money at one go.

We all know how the credit crisis dealt a huge blow to the global economy. As a result, efforts are underway on a war footing to identify any systemic risks that could lead to a repeat of the situation. And it is mostly the banks and the insurance companies that have come under the scanner. More recently though even the fund management industry has found itself at the receiving end of such a scrutiny. As a matter of fact, the first such study has already been completed. And it identified systematically important non-financial, non-insurer financial institutions. The second on the other hand is likely to cover their activities. However, the question that begs itself is whether asset managers pose the same kind of risks to systems that leveraged entities like banks and insurance companies do? Well, we live in a vastly interconnected financial world. Therefore, any financial institution that is too big to fail matters. Thus it is only right that these firms also come under scrutiny. However, what is more important is the steps that are being taken to prevent a repeat of the crisis. It is here that the real mettle of the regulators will be tested.

While India has myriad economic issues to sort out, one that needs urgent attention is the mess in the energy sector. Thanks to poor regulations and structural issues, the country stands highly vulnerable to an oil shock. The latter is not a one off event, but seems have become a frequent phenomenon in the last few years due to the ongoing troubles in the key oil producing nations. This time, the region happens to be Iraq.

What is more concerning is that while oil is a key necessity for almost all economies, India happens to be facing the maximum risk from any probable oil crisis. The reason for the same is high oil intensity. Which means that India needs more oil than most of its peers to produce the same amount of economic output. Talking statistically, India needs 717 barrels of oil to produce a million dollar of GDP. This is more than double of what Bangladesh needs and almost three times of what Germany requires. While other economies have learnt lessons from the oil crisis in past and are much more robust now in dealing with such shocks, India fares poorly in this regard. The reason is not high usage of oil but wasteful consumption. At the heart of this inefficiency lie poor policies in the sector and lack of enough domestic production. Other economies like US have sorted this issue with shifting to resources like natural gas. However, in India, the energy policies provide little incentive to invest in oil and gas exploration. Even though we are relatively richer in coal reserves, the mining sector has its own issues. As such, the dependence on oil is unlikely to be substituted by coal.

As an article in Livemint suggests, oil imports account for 80% of India's energy imports but cater to only one third of energy demand. No wonder, whenever there is any disturbance in oil producing nations; we are the first ones to feel the shock waves. We hope the new Government will learn lessons from the oil crisis and take necessary steps to fix the issues in the sector.

India needs more oil for the same unit of economic output
Data Source: Livemint

Geo-political tensions continued to weigh down the global indices. With heightening risks of supply disruption from Iraq, global crude oil prices have spiked to a nine-month high. This coupled with subdued economic data took a toll on the markets in the West. The upcoming week may continue to mirror similar trends. With crude oil price spiral gathering momentum, markets across continents are expected to remain weak. Moreover, lack of encouraging key macro economic variables from the U.S. and the U.K. economies would imply continued selling pressures across global markets. Back home, the story is no different. Deficient monsoons, heightened inflationary risks, widening current account deficit and of course the weak global cues are expected to keep the Indian Indices under pressure. The BSE Sensex closed on a flat note for the week ended June 27th 2014.

Performance during the week ended June 27th, 2014
Data Source: Equitymaster

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5 Responses to "Why interest rates will be a tailwind to India's GDP growth..."


Jul 5, 2014

I wanted to post my own comments. However, before doing so, I went through the comments already posted by some on the subject. The thesis-like comments by Sri B.M.Shah more than fully covered some of my points and my comments are naturally rendered redundant. I fully endorse his comments and appreciate his sincerity in venting his views for the wholesale betterment of the country, economy, and the quality of the Indian mass. Surely they reflect an agitated mind aiming at securing a better and corruption-free and transparent future for the country. But alas, what is mindset of today's IBCs and that of JN Tata, GD Birla and KN Bajaj ? Twain shall never meet. Greed is the order of the day now and as Mahatma Gandhi had put it, even all the resources of the entire nature will not be able to satisfy the greedy. Shah is suggesting the Narsi Mehta's poem " Vaishnav...." to be the watch word for IBCs. In the present day circumstances one only has to hope against hope for it to become a reality. His views if accepted and implemented, which I doubt very much, would certainly lead to utopia in the life our country.

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Jun 29, 2014

In india Interest rate is very high where as in developed countries of Europe and USA and even in Asia interest rate are very low. How Indian Industry will compete in globlisation era with products cost of these countries where interest rate is very low. As per me high interest rate is main hinder in the growth of Indian economy.

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Nicky Kotian

Jun 28, 2014

While we laud western countries for their lower interest rates, we conveniently overlook their strong social security systems. In India retirees have nothing but interest income to live upon & with mounting inflation, increasing medical costs, this reduced interest rates would be a death knell for this big chunk of India's population.
Let us first put some sort of social security in place for these senior citizens and then talk of reducing interest rates
Nicky Kotian

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Jun 28, 2014

There seems to a lot of talk about politician-ministers' qualifications to justify a portfolio given to him/her. In this context, one may remember BBC serial 'Yes Minister/Yes Prime Minister' which presented some ridiculous though unpleasant truth about how ministers work, take decisions, mostly guided or even misguided & some times even overwhelmed by bureaucrats.

For the country to get the best from its elected politician-ministers, basic requirement for a minister's position should be:
(1) Sincerity (beside honesty) to do work assigned to him/her, with country, and not his/her party as priority,
(2) Preferably a master's or a post graduate degree; as my professor once said "acquiring a master's degree makes you a better thinker". If not so, then the minister should have a proven track record of a good thinker. This will enable him/her to grasp his/her ministry issues quickly and fully to take objective decisions,
(3) Achiever, administrator, implementer (in short, go-getter), to deliver whatever is decided &
(4) Good communicator with own staff, party, opposition and public about his/her ministry issues.

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Jun 28, 2014

Root Cause of India’s Ailments
Much has been said and written about what is ailing India and Indian economy or progress, but not so objectively. Here is an attempt to look at the issue more objectively, offering some thoughts to ponder on..
Corruption, lack of infrastructure development, reduction in or even removal of subsidies, fiscal deficit reduction, political unwillingness to make more reforms, policy paralysis (a word which gets lakhs of claps) have remained in the fore-front of almost all discussions in the media, written and visual for almost a decade now and it is said that nothing seems to be changing for better, as things are getting worse and more reforms are needed to tackle the situation.
Root causes of all these are missed out in the discussions. In the pre-independence era, JN Tata, GD Birla, KN Bajaj and other industrialists helped politicians (who were more like statesmen than politicians) in the movement for India’s independence, at the same time establishing industries for economic growth/self-sufficiency. For these persons, making profit was not the only motive to start the industries. They helped India to be on the industrial map and contributed to the economy. Then until 1991, we had license and quota raj and much of what we are experiencing today is culmination of how we developed India in these 45 years. We did well in many areas and failed miserably in others. Poor & needy babus and politicians were transformed to corrupt, rich and greedy ones by a class of our society to get things done by the government for their business. Now, this phenomena is termed as “difficult or complicated” doing business in India.
Since 1991, Indian policies and economy are reforming and opening up to tune up to market forces step by step. Businesses have prospered and continue to do so and so also businessmen/industrialists and the gap between the rich and the poor is widening. The growth is not so inclusive and benefits of the reforms done are not reaching the poor or the large mass of Indian population. The government is held responsible for all these. Is this mainly correct? Look at how Indian Business Community (IBC), which consists of small, medium & large business houses/persons/groups (termed as India Inc. or Corporate India, SME and so on), is behaving. It seems that the reforms since 1991 have mainly benefited them immensely and they still blame the government for all the bad things that are happening or have happened until now. They want more from the government, as there is no limit to their greed to profiteering. A good, objective, dispassionate look at what IBC is doing, will tell us the truth behind India’s ailments. Let us examine.
1. Interest rates have fluctuated and so also the cost doing business on borrowed money, but a Re 1 or Rs. 10 share of many companies is fetching them 100 to 500 times its unit value through book-building route. They are able to make large investments/acquisitions using this money and yet they crib about high interest rates hurting their business and lobbying with RBI/government to reduce interest rates.
2. Market values of many companies have soared and so also net worth of individuals (directors/CMD) who use this money extravagantly to build large mansions, buy private jets and what not. What these individuals will do with wealth (in terms of thousands of crores of Rupees) so amassed? There is no limit to greed & selfishness of these persons/groups. Greed to expand business and greed to make huge profit are two different matters. The former is justifiable. CSR is a buzz word of IBC. Instead of charging higher price for their products and services, thereby making huge profits and then taking philanthropic path (the Bill Gate way), IBC should reduce prices, making their products affordable to larger masses. This is real CSR.
3. IBC is pressing government to reduce fiscal deficit, subsidies to farmers/on fuel prices but not to increase tax rates and at the same time control inflation. How do they expect anyone to do these? Increase in diesel price is surely going to increase inflation, because IBC immediately increase prices of their products/services, starting spiral of price rise everywhere. They want tax breaks/rebates through special concessions given to industries so that their profit margins increase. Is this not some kind of subsidy, given to IBC? This is indeed a double standard. IBC should learn to do business cost-effectively and make moderate profit, instead of begging the government to give them more concessions.
4. No one from IBC or even leading economists advises government to stop increasing emoluments to government employees through Pay Commissions without getting some things like productivity of these employees in return. Incentives, pay rises have to be based on quid pro quo. This is one way to reduce fiscal deficit.
5. IBC generally await increases in diesel price so that they can increase sale prices of their products, which are generally disproportionate to the diesel price increases and they make more profit. Has any one from IBC correlated diesel price increase with increase in costs/prices of products and increased their product/service prices accordingly? This is an important factor to curb inflation.
6. GAAR may sound unreasonable to many, particularly when it is retrospectively. Let IBC introspect as to, how many large companies are constantly finding ways and means not to pay tax to the government, when they have earned huge profits. Should they not part with at least some of it through GAAR or even voluntarily to the government. for developing the nation. These companies contribute large sums to political parties to get goodies in return from these parties when they come to power, but not to pay the government, what is according to them “unjustified tax”. These companies employ retired government employees (Babus) to advise them to find and methods to work on loop-hopes, which these babus have left in the government policies & procedures. Why do IBC need liaison offices in Delhi? IBC tell political parties to be transparent in their donations. Why do they need to donate political parties at all? IBC donate to parties only to get favors in return. The question of transparency does not arise if donations are not given at all. Why IBC & their association need to congratulate politician-ministers, spending large sums, in print media, when they tell their investors to save forests by opting for e-reports?! Meetings between ministers & company executives should take place in camera for transparency/minutes of such meeting should be made public.
7. Many erstwhile MNC, now Indian companies with their parents overseas, have made a kill out of Indian population, by acquiring smaller home-grown consumer goods companies and have started selling the same products of daily use at 4-5 times prices and continue to do so. They make huge profits and their company shares quote at 300-1000 times their face value and much of the profit goes to the parent companies abroad. For this reason more & more MNC are pouring in India. Should they not reduce prices of their products so that Indians benefit. They can even sell more of their products if prices are reduced and still maintain the top- and bottom lines of their business.
8. A new trend of buyback/de-listing of shares has started by some MNC (even Indian companies, who have no concern for their countrymen), when their business in India has become exceedingly profitable, using initially money of Indian investors. They do not want the profit to be shared by Indian investors. This is nothing but avaricious/greedy attitude of MNC (also India Inc.) and their counterpart IBC in India.
9. The government is only being blamed for the scams, forgetting that they are possible only if there are two parties involved in these scams. Who is the party other than the government ministers & babus? Some of IBC. By making babus & politicians corrupt, IBC have encouraged them to make complicated laws & rules, making it difficult to business in India. Now, IBC is calling on the government to simplify laws & rules, to simplify doing business in India. Is this not strange?
10. Even though inflation has reduced, milk prices, newspaper prices (whose major earning is advertisement) continue to increase. Prices of imported items like CD/DVD went up by Rs 5, as USD was at Rs 65, but now with USD at Rs 60, these item prices remain higher only. IBC is literally cheating their country men.
11. Women, who present themselves in skimpy (almost naked), provocative dresses, postures and acting, in movies, TV serials, TV and printed media ads (for example: women’s under-garment ads) and persons creating such materials are largely responsible for rape incidents, because they adversely affect immature, fickle-minded males (bachelors, married ones with wives living away, adolescent students and the like) and get them into rape acts out of desperation. Even the language in movies/TV serials these days has gone nothing short of arousing kind, adding fuel to the fire (provocation) of rape incidents. Women and business persons (advertisers and ad/movie makers) should seriously think of restraining themselves and find non-provocative ways (with respect to dresses and acting/talking) to present women decently in ads, TV serials and movies.
12. IBC is also responsible for increasing in-discipline among Indian youth, (who is being praised in every way, certainly for their talent) by giving ads of fast car, tire ads, two-wheeler ads, which show driving at risky speed. IBC’s only objective in these ads is to beat their competition, with no concern to people on the streets. They should think of better ways in these ads, with safety of driver and people on the road, as the prime concern. While promoting/selling imported vehicles/technology in their ads, IBC should also promote discipline to use them.
13. One of the effective ways to reduce corruption is to make IBC morally and truly committed to stopping corruption voluntarily and also visibly, because making stricter laws will only result in more corruption. A statement (like those of Mission and Vision) of Oath Moral Values, by the Chairman/Managing Director of companies, on behalf of the company directors, managers and employees on the first page of the company brochures and annual reports and in each and every establishment (office, factory and so on) would achieve this end. The poem, “Vaisnav Jan To Tene Kahiye”, (with its translations in Hindi & English) of Narsinh Mehta, which was close to the heart of Gandhiji, should be on the first page of every company’s annual report, to remind every one in the company, values of business and life. Also any person (from PM down to supervisor) heading an organization/government department/section/office should spend about 30 minutes every day to manage by walking around (MBWA) in these areas at any time of the day, unannounced. S/he would then know the pulse of what is happening and stop wrong-doings from happening.
14. Most MNC are here to take advantage of huge market and lower material and labor costs (compared to their home countries). Even then they sell their products at more or less the same prices as in their own countries and their products are inferior to the original products. Is this fair to Indians, who earn them huge profits? They get such business ideas from their counter-parts like Indian MD/CEO (mostly fresh or experienced hotshot MBAs) , whom they employ here. This is a thorough misuse of management education by IBC.
15. IBC is interested only in wealth creation (profiteering) for themselves and have no attitude for innovation to create new gadgets, equipment/machines, processes, which are fundamental to economic development of a country and to be ahead of other countries. Indians are perceived to be making some new drug molecules and IT software. Can any of our companies equal Chinese companies in manufacturing machines, gadgets, chemicals or even big river, power projects? IBC can only think of acquiring (some times hastily, because they do not know where to use their excess cash) businesses abroad instead of innovating at home. Some of the IBC cannot even run them efficiently and so sell them off. They blame (will continue to do so, even if there is a change post 16th May) the government for all their evils.
16. In India we have both wholesale and retail corruption. The former is at policy levels, involving politicians and babus in ministries of the central/state governments and large business houses. This type hurts economy having far reaching effects on it. The retail type is at local authority levels and it hurts a common man the most. The former is most dangerous for the country as a whole and it is in the hands of IBC. to stop it. If the wholesale corruption reduces, the retail one will follow it.
17. In most western countries, contracting companies/contractors contribute a lot to the economy and well-being, by supplementing efforts of larger companies/governments, in developing new products/services, infrastructure projects & so on. They are respected. In India, contractors (a set of IBC) are strange creatures, go-in-between the government (babus & politicians) and other large companies, to do lousy work and promote corruption. Examples: bad roads construction & maintenance, poorly constructed houses and what not. Their work needs to be checked and then only paid for.
18. Why do IBC need famous actor/actresses, sportsmen & such persons (so-called brand ambassador, an MBA hype) in their ads to promote their products? These persons are any way filthy rich and become richer from earnings from the ads by IBC. Instead, IBC can employ less famous, but persons having good acting talent/skill/looks, needing to pay less, reducing cost of the ads (ad-spend) and thereby reducing cost of their products & services and pass price reduction to customers. This will also mean equitable/inclusive distribution of wealth to more needy persons.
19. IBC also practices to give false, misleading information in the media about their products to stay ahead of competitors. Look at ads of washing machines, detergents, shampoos, skin products, toothpaste & what not, claiming to perform no where near real performance. Is this not cheating, unfair to their fellow-beings?
20. IBC & MNC look at per capita consumption of goods in India to make & sell such goods, without any regard to dwindling of limited resources in India or worldwide, beside increase in pollution. They want, for example car sell to increase, which increases limited iron ore/crude oil consumption, and then they want the government to remove supply-side constraints to curb this factor of inflation. Per capita consumption figures often hide as to how much of a goods-item has reached the needy/have-not people. For example: It is important that anyone having no vehicle gets one instead of the person having one vehicle gets one or two more. In both cases, per capita figure has increased misleadingly.

Large corporations (India Inc. or Corporate India, business houses like Tata, Birla, Reliance, HUL, many more and their associations, like CII, FICCI, Assocham, just to name a few), have to take a lead in reducing the evils of in-discipline, immorality, irresponsibility and profiteering, by emulating thoughts in the above paragraphs. Medium and small companies/groups, babus and politicians will then fall in line. After freeing India from shackles of British empire, IBC has now an important role to play in freeing Indians from shackles of all aforesaid evils. IBC have to recognize that reforms are not a monopoly of the governments. It is high time that IBC reform themselves to become like JN Tata, GD Birla, KN Bajaj and many such erstwhile patriot-businessmen to lift Indian economy and reduce poverty in India.
IBC should also recognize that even new government cannot succeed or even do much for the country, unless IBC change their mindset, for the benefit of India, whose integral part is IBC.
Written by: BM Shah (12/5/2014)

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