The problem the rich world cannot escape from - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The problem the rich world cannot escape from 

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In this issue:
» The man who coined BRIC predicts a stock market rally
» IIP numbers disappoint
» Banks say no to savings rate deregulation
» Corporate deals bring tax booty for Government
» ...and more!

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Here's a small puzzle to start with. Can you tell us what are we referring to? This thing has made some people very rich. But this has also led to abject poverty. Thus, when this works it magnifies your gains. Your wife thinks you are a genius and all your neighbours get envious. However, if history is any indication, this particular tool often produces disastrous results even when employed by very smart people. This description, borrowed from Berkshire Hathaway's most recent shareholder letter, refers to nothing else but leverage.

Certainly, there isn't anything in finance that seems more addictive than leverage. Most people who use it go back to conservative practices only when forced by circumstances. The developed world seems to be a perfect example of the same. The US, for instance, went on a credit binge that lasted for nearly three decades. And had it not been for one of the biggest asset busts in the form of sub-prime crisis, it would have perhaps gone on for even longer. Same is the case with other countries like Britain and Spain. Thus, these nations have now reached a point where their ability to repay their respective debt burden has come under immense scrutiny. Debt reduction or what is also known as deleveraging, is the only option that is now available to them.

Fortunately, there are some positive signs on this front. As per the Economist, total debt levels, measured relative to GDP, have stabilised and has started to even inch down in some countries. However, if the past is any guide, there seems a long way to go. You see, broadly there are only two ways to take care of the debt situation. You either repay it or default. The latter approach will certainly yield quick results. But it could also lead to disastrous consequences if confidence in the system sinks. As far as repayment is concerned, the same requires strong GDP growth rates. However, at a time when the private sector is not spending and the Government spending is constrained on account of deficits, it becomes quite tough for GDP to grow at above average rates. Clearly, the escape from this problem is looking very difficult for the rich world. It is likely to haunt them for quite some time to come.

How do you think will the rich world solve its problem of excess debt? Share your comments with us or you can also post your views on our Facebook page.

01:10  Chart of the day
While GDP growth may be an issue in the developed world, there seems to be quite a bit of it coming in the way of developing regions like India. What else could explain the double digit salary rise expectations in nearly every sector of the Indian economy? As today's chart of the day highlights, overall salary expectations for the year 2011 is on a strong upward trend indeed. Auto and auto ancillaries are expected to dole out its employees the maximum increase in wages. However, the new age sectors of IT and telecom are likely to fare worse than even the overall outlook on a relative basis.

Source: LiveMint

What started with Greece has already engulfed Ireland and is on its way to victimize Italy. While Eurozone debt crisis is expected to turn worse, it's no different in U.S which will run out of funds if debt ceiling is not raised. On the dark clouds hovering over global economy, there is one man who sees a silver lining. Mr. O'Neill of Goldman Sachs, who coined the term BRIC, is quite optimistic about the global stock markets. Besides a high unemployment rate in U.S which will bode a loose monetary policy, he sources his optimism from the assumption that inflation rates in China are peaking which could send global stock markets on a bull run and overshadow the Eurozone concerns.

We agree that a combination of the BRIC consumer and an accommodative monetary policy is a powerful recipe for bull market in equities. While it sounds all good, we believe that predicting prices is a tricky affair, especially for an economy as big as China. Hence, we would take the forecasts regarding inflation peaking in China and bull run in the stock markets with a pinch of salt. Especially from investment banks that are known to have huge vested interests.

India Inc has witnessed a spate of large corporate deals in the recent past. These are expected to add value to the companies involved in the deals. The deals also signify the expanding global footprint of Indian companies. But these deals also bode well for the Indian government. They have helped fill up the government's tax chest. The deals of Vodafone-Essar, Vedanta- Cairn and Hero Honda alone would help the government with Rs 70 bn in tax collection. Interestingly, some of these deals were opposed by the government on some ground or the other. Furthermore, companies like Vodafone feel that they do not have any tax liability as the transfer of cash took place between two non-Indian parties. Such companies have gone on to state that Indian tax laws are not conducive to foreign investments. Nonetheless, if the government wins the cases, they are sure to see their cash reserves swelling this year.

The Reserve Bank of India (RBI) had a noble plan to protect the interests of depositors. It put out a proposal to deregulate interest rates on savings bank accounts. However, bankers responded to this proposal with a resounding 'No'. The Indian Banks' Association, the representative body for banks, has vouched for status quo to be maintained on the subject of deregulation of savings account rate for the time being. The volatile interest rate environment and the upward trajectory of inflation are the major concerns. A rate war would severely damage banks' margins.

But the RBI has not been lacking in looking out for the interests of depositors. It has made a few changes recently. The interest rate on savings bank accounts stood at 3.5% since March 2003. The central bank hiked this rate to 4% a few months back. Also, since 2010, interest rates are calculated on a daily basis, effectively increasing the amounts due to depositors.

Index of Industrial Production (IIP) data is considered to be a good indicator of future economic growth. And when recently Central Statistical Organization (CSO) announced the IIP data for the month of May, it clearly offered evidence of weakness amongst the key sectors. The industrial output grew 5.6% in May which is lowest of what India reported in the last 9 months.

Higher interest rate regime slowed the industrial capex cycle, impacting the overall output. Policy inaction, delays in environmental clearance and land acquisition problems were also the key bottlenecks that restricted industrial growth. Sectors like mining and intermediate goods were the worst impacted. It is difficult to say for how long the situation is likely to persist. With inflation remaining above the comfort zone, RBI is likely to maintain its hawkish stance. This would mean that cost of capital will remain high thereby further delaying the capex plans of corporates'. However, with the recent cabinet reshuffle it would be interesting to see the stance of our new environment minister on ecologically sensitive projects. A soft stand and we could see growth reviving at least in the mining sector. In such a scenario, we believe that policy initiative is one of the key factors that could bring industrial growth back on track. And only time can tell when this would really happen.

Meanwhile, indices in the Indian stock market looked all set to halt their three day losing streak as the Sensex was trading higher by about 110 points at the time of writing. Heavyweights like RIL and HDFC Bank were seen driving most of the gains. While most indices in Asia closed in the green today, Europe is also trading in the positive currently.

04:50  Today's investing mantra
"You can be highly successful as an investor without having the slightest ability to value an option. What students should be learning is how to value a business. That's what investing is all about." - Warren Buffett
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4 Responses to "The problem the rich world cannot escape from"

Ketan B.Kapadia

Jul 16, 2011

If the US defaults on its debts, who has the balls to recover their dues from it? But it may not do so, to keep up it's image.
The way to clean up their debts is to sell part of their Gold Reserves.
They should push Gold up to $ 2700 - $2900 / T.Oz. At those prices, every speculator-investor will be desperate to buy it, expecting it to reach $4000. Then start to sell off 35% to 40% of their stocks, slowly. They will have enough to reduce their debts to a more comfortable level.
Later Gold will crash down, since it's industrial applications are very little.
By then, their currencies (Dollar & Euro), would have been devalued enough to sustain new manufacturing factories.They would put enough tax barriers on imports.

It is possible that the US would militarily control Saudi-Arabia & some more Oil producers, to ensure it's survival, since it depends heavily on oil.
For raw materials, Africa is always there.
To the suggestion that a war would be waged, you need money to create weapons & ammo. Where is the money ? The rich nations have lost money fighting wars. The poor nations are smarter than before. They will not waste money.
New invention will benefit only if the world has enough money, need & desire to buy it. Also, real money is needed to fund research.Where is it?


A john

Jul 15, 2011

Well as always the answer is in our history books. When ever one nation faces economic crisis, specially a strong nation it will go to War to fill its coffers.
So sooner or later the equalizing factor of War will happen.


Rajesh Jain

Jul 13, 2011

The problem of Debt cannot be solved with more Debt. Repaying the debt will take a lot of things to fall in place & a very long time the only other option left is DEFAULT. AT SOME POINT IN TIME IT HAS TO DEFAULT



Jul 13, 2011

Debt is a beast that behaves the same way regardless who is holding the beast. The beast starts getting aggresive if it smells a sense of fear in the holder. Having said that the old saying goes that WEALTH IS CREATED BY EITHER THE APPRECIATION OF ASSETS OR BY HOLDING A MONOPOLY. the coutries suffering under the debt burden must come up with a monopoly like CLEAN ENERGY TECHNOLOGY, CURE FOR SOME ILLNESS NOT CURABLETO DATE ETC. Why should one believe that countries like USA, UK, Spain & Germany can or will not come up with some new invention or discovery and leverage that to wipe out the current debt. This has happened before through OIL, COMPUTERS, AUTOMOBILES, the list is endless.Probable there is more intelectual capital deployed in research/ R&D than ever before. The results of all this R&D shall be positive and the leaders shall once again come on top, be DEBT FREE or almost.
THE ANSWER TO TODAYS PROBLEM LIES IN INNOVATION AND DISCOVERY that will help mankind.Be optimistic about the ingenuity of the human mind. Financial problems faced by some of the developed coutries is only a hiccup, will blow away. QED

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