What should Mr P Chidambaram not learn from China? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

What should Mr P Chidambaram not learn from China? 

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In this issue:
» Important investment advice from Vanguard
» Gold jewellers will refrain from selling gold coins and bars
» Nearly 40% of US$ 200 bn loan of India Inc unhedged
» US Fed Chairman does an about turn on monetary policy
» ...and more!

That China is in some sort of trouble seems to be becoming more and more obvious with each passing day. And majority of the experts are putting blame at the doors of the country's shadow banking or the unofficial financing system.

However, sometimes what is obvious isn't necessarily so. As per an article in Bloomberg, China's shadow banking practices are not the real culprits they are being made out to be. As per an influential banker in the country, who himself is a shadow banker and provides loans to small Chinese entrepreneurs, there is definitely some stress in the Chinese shadow banking system. But its levels have reached nowhere close to what can be constituted a catastrophe in waiting.

Does this mean the Chinese economy is safe for now? Certainly not opines the same banker. However, the real threat is right out there in the open and not lurking in the shadows as per him. In essence, he believes that Chinese policymakers should raise interest rates on loans that flow through the formal banking sector. Because it is here that projects that look unfeasible at 9% interest rates are suddenly made to look feasible by lowering interest rates to 6%.

Now, please pay careful attention to the last sentence in the above paragraph. Isn't this exactly what our policymakers, our finance minister in particular, up to? Despite inflation being high and our currency being weak, our FM wants banks to lower rates. But this is nothing short of turning economic logic on its head we believe. Our FM believes that doing so would raise investment opportunities and thus create more jobs and help grow our economy. But the reality is something else. When we lower rates even when inflation is high, we make projects that are unprofitable at higher interest rates look artificially profitable. Mind you, their profitability hasn't come from higher productivity. But is merely a result of lower interest rates in the system. They in turn compete for resources with other naturally profitable projects. And thus rather than lowering inflation, they end up taking it even higher.

Now compare this with the act of raising interest rates. As we raise rates, uncompetitive projects have no other option but to shut down and in the process, release more resources in the economy. These resources then lower inflation and are diverted towards more productive activities. This then leads to a structural fall in inflation as well as interest rates. Now you figure out which of the options is better from a long term perspective. It is indeed the second one, isn't it?

Thus, there are indeed a lot of things our policymakers can learn from China. However, the policy of keeping interest rates artificially lower is one thing they would do well to not learn.

Do you think we should not follow the Chinese lead and hence, not raise interest rates until concrete steps are taken by Government? Please share your comments or post them on our Facebook page / Google+ page

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01:32  Chart of the day
Political parties. Police. Parliament. Are these Indian institutions really corrupt? Well, it will be hard to give out reasons on why they aren't? Thus, the question remains not of whether they are corrupt but to what extent. Well, around 71% percent of people polled by Transparency international believe that not only is corruption alive and kicking in India but has actually increased in the last two years. And no prizes for guessing who they feel is the most corrupt. Around 86% of respondents believe that political parties are indeed corrupt with police coming in as close second where 75% replied in the affirmative. Clearly, corruption is easily one of India's biggest scourges and current rules and systems are proving to be hopelessly inadequate in curbing the same.

Source: Live mint

One of the companies that we really admire and draw inspiration from is the US-based Vanguard Group, the world's largest mutual fund company. So whenever we come across anything insightful from Vanguard, we're always keen to share it with our readers. In a recent commentary, Vanguard shares some of the same lessons that we have been emphasizing investors to keep in mind. Here are some key takeaways...

Make sure your investment decisions are not knee-jerk reactions to news headlines. For instance, just some time ago US central banker Ben Bernanke had hinted about a prospective pullback in the QE program. This had caused sell-offs in global equity markets. And in his latest comments, he seems to have changed his stance. And the markets have soared.

The other thing to keep in mind is that your investment allocation should be based on your requirement and not your desires. For instance, in the quest for high returns, one may get tempted to take unwarranted risk. Moreover, timing markets could result in hefty gains at times. But equally, there is the risk of big losses. And this could wipe out all your previous gains. Overall, investors should keep in mind their long term goals and have a well-diversified pool of assets that suits their risk appetite.

The sins of the past were to come haunting sooner than later. But for India Inc, the rapid depreciation of the rupee has made the eventual perils look overwhelming. Several large and small companies took advantage of the lower interest rates overseas over past few years. The big ticket borrowings then came very handy for ambitious expansion plans. However, many companies did not bother hedging themselves against forex risks. As a result, they are now to face a double whammy. One the depreciation of the rupee is biting them hard. Two, the possibility of rollover of the loans seems bleak. The companies will have to bear the burden of higher interest rates and marked-to-market losses for rollover of hedged positions. As reported by Business Standard, rating agency CRISIL estimates that nearly 40% of US$ 200 bn of India Inc's foreign currency debt is unhedged. In the absence of foreign currency earnings, the smaller companies in particular could see their profits getting wiped out.

Ben Bernanke had sent shivers down the spine of global markets when he announced plans to taper off the QE program. His underlying reason for that announcement was that the US economy was showing signs of improvement. His announcement was followed by a steep fall in all asset classes as there were fears that the taper off would be followed by a phase of monetary tightening which would lead to higher interest rates in the US. But interestingly that is not what Mr Bernanke wants. At least not right now.

In a statement yesterday, he has stated that the Fed would continue with a more accommodative policy till such time as unemployment rates in the US dip to below 6.5%. In fact he plans to continue with the sustained stimulus program in the foreseeable future. This means that interest rates in the US would be maintained at near zero levels. This makes emerging market assets including that of India's more attractive in comparison as they offer higher rates of returns. But the point is that eventually there would be a taper off of the QE program. It may not happen today and it may not happen tomorrow. But it will happen eventually. If India does not wish to be caught on the wrong foot at that time, it has to take steps to improve its fundamental strengths. So that even when the QE program comes to an end, Indian assets would still be attractive to foreign investors.

An ever bloating current account deficit has been the bane of the government for quite some time now. Besides the slowdown in the economy, it has been the other reason why the rupee has plunged the way it has against the dollar. The weakened rupee has put further pressure on the deficit thereby creating a vicious circle. India's appetite for gold is well known especially during festive and marriage seasons. But the weak global macroeconomic factors have also led to Indians buying gold as a store of value. This has then led to a surge in gold imports. This along with oil has been the primary reasons for overall imports rising. The government had put in place measures to curb gold imports. But this did not really have the desired effect. And so the All India Gems and Jewellery Trade Federation (GJF) has decided to support the government in bringing down the current account deficit.

It includes stopping the sale of bullion and coins to consumers and corporate bodies. This could be for the next 6 months or so. Whether it actually helps in reducing deficit remains to be seen. But it goes without saying that an understanding of this sort cannot be a one sided affair. The government, on its part, will have to ensure that manufacturing and productivity improves. It will also need to come with ways of bolstering exports. So that deficit gap starts narrowing down.

Meanwhile, with fears of any tapering off of the quantitative easing being allayed, indices in Indian stock market sprang back to life today with the BSE-Sensex higher by 360 points at the time of writing. Stocks from the banking and metals space were seen attracting the maximum interest. While other Asian stock markets closed strong today, Europe too has opened on a positive note.

04:55  Today's investing mantra
"Our acquisition preferences run toward businesses that generate cash, not those that consume it."- Warren Buffett
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5 Responses to "What should Mr P Chidambaram not learn from China?"

rajesh seth

Jul 15, 2013

sir,i dont understand that y dont we take some long term steps to boost our economy instead of dependeing upon FDI,because i believe when it comes it does not impact our economy much but when it goes out it destroys us.on one hand we r making our working manforce lazy by providing soaps to them making them vote banks for political parties, on the other hand we have not been able to provide proper infrastructure to our dedicated hardworking man force,so that they can face international chalanges,in last 65 years we have not been able to fulfil our defense requirements for which we have to shell out precious dwindling foreign currency,oil imports is our majboori but why we have to import petty things like furniture,lights or other small things which dont require high tecnology


k.siva prasad

Jul 12, 2013

If logic hold good China not hold good for INDIA.Keeping interest rate lower will helpful to some Business Houses who funding the Poltical parties for coming Elections only.


Arun Draviam

Jul 11, 2013

If your logic holds good, then the USA, followed by the EU and now by Japan should not have resorted to quantitative easing and virtually zero interest rates. It is not just, therefore, one of policy rates but one of political game - who out beats the rest. If India had followed suit the USA soon after the former resorted to QE, perhaps India might have been rejoicing now, barring one area viz. oil and gas. But then in 2008, India felt comfortable that the financial meltdown in the USA did not affect India as it had a sound banking system and the SEBI had not allowed investment banking in India; albeit, being a different matter with the B-Schools in India that talk about investment banking all the way!


Rajagopalan Ramesh

Jul 11, 2013

More than the economy and growth of the Nation, FM seems to interested in keeping the Stock Markets up, at any cost. Let him leave this job to Mr Subba Rao, RBI Governor and give him a free hand. Inflation would be quickly kept under rein and gradually other measures can be taken to revive the growth. Mr Subba Rao, given enough freedom and leeway, is capable of reducing the Current Account Deficit as well. Politicians and Congress Party seniors should be throughly and mercilessly kept away from meddling with economy and economics as well.

Like (1)


Jul 11, 2013

how not to be deficit nation?Deficits are due to bad management. China has surplus, to prevent overvaluation, it creates small news that make Rcurrency low for decades. PC can not learn anything.There is speculative financing, eternal trade deficit, no local manufacturing & unprofitable high interest rates.RBi does hear him. He runs , but none invests.He must depute NAMo for $ and see effect.India is broke for next 2 years @ current trade deficit,nothing can stop Rs fall to 70-75.How do we manufacture teach him.

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