Will India learn from Detroit's debacle? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will India learn from Detroit's debacle? 

A  A  A
In this issue:
» Banking lessons from the Euro zone?
» The problems with the Food Security Bill
» In pursuit of management excellence...
» Mis-selling of insurance policies rampant in India
» ...and more!

Detroit. This city once symbolized the manufacturing supremacy of the United States. This was the place where Henry Ford pioneered the automobile assembly line. Detroit represented America's industrial might and innovation. Back in the 1950s Detroit was the fourth-largest city in the US with a peak population of 1.8 million. At that time, it boasted of one of the highest per capital incomes in the US.

But that's all past glory now. The city's fortunes have been plunging over the last few decades. And it just hit an all-time low. Yesterday Detroit filed the largest ever municipal bankruptcy in the history of the US.

Detroit lost out to emerging market manufacturing hubs such as China. Employment and revenues have been going downhill. Consequently, the population has been on a terminal decline with just about 7 lakh inhabitants now. The city is now known for very high crime rates and government corruption.

Excessive fiscal mismanagement is one of the major reasons for Detroit's bankruptcy. As per Reuters, the city's long term debt has shot up to an estimated US$ 18.5 bn.

Detroit's decline raises a lot of questions about our own country. A country that frequently resorts to populist policies and where large-scale corruption scams are a regular feature! Add to this the sheer number of loss-making public sector undertakings (PSU). The government keeps borrowing and pumping money into loss-making enterprises. The condition of state government finances is just as bad. To name a few, state governments such as Bihar, Uttar Pradesh, West Bengal, Odisha and Punjab have high debt to gross state domestic product (GSDP) ratios of 30-50%. In addition, their interest burden as a percentage of revenue receipts is also close to unsustainable levels. State governments often tend to take recourse to central government aid to fix their finances. But how long can this go on?

With India's growth story already under the cloud of doubt, keeping government finances within sustainable levels will be a big challenge. It is high time policy makers take lessons from the fiscal turmoil in the West.

Do you think the Indian government could be heading towards a major financial disaster? Please share your comments or post them on our Facebook page / Google+ page

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01:15  Chart of the day
The Reserve Bank of India recently received 26 applications for new banking licenses. The entry of new players will raise competition in the banking sector. Apart from competition for customers, the competition for human talent is also set to intensify. The public sector banks are likely to witness flight of quality human capital to new private banks owing to prospects of higher remuneration and better career prospects therein.

As per an article in Business Standard, all private and public sector banks together employee a little over a million employees. PSU banks are already facing a talent crunch at all levels. The chart of the day shows that the profit per employee is the lowest at public sector banks at Rs 0.64 million per employee. Private sector banks and foreign banks enjoy much higher profits per employee. It must be noted that within the private banks, the profitability of old private banks stands at Rs 0.62 million per employee, almost at par with that of PSU banks. The new private banks enjoy much higher profitability of Rs 1.24 million per employee. At Rs 3.4 million per employee, the foreign banks enjoy the highest profitability.

Data source: Business Standard

Banks in the Euro zone banks continue to stagger under their debt overloads. At last count, their debt inched closer to 250% of Euro zone's GDP. Little wonder then, that investors would rather prefer the banks dead than alive. The fact that their average price to book value had remained below 1 time for a prolonged period it is quite a hint. The investors in US based banks fear a similar situation.

Indian PSU banks with truckloads of restructured assets cannot be hailed very differently. Here too, a valuation below book value is the norm. With several large projects getting stalled, higher accretion to banks' NPAs will be no surprise in the coming quarters. The RBI, meanwhile, wants banks to meet the capital adequacy guidelines as per Basel III. It is estimated that the central government would have to provide about Rs 910 bn for the capital requirements to be met. With PSU banks in India showing no remorse for their poor quality of lending, it is 'head-banks-win-tail-taxpayers-lose' kind of situation. Can the government take some learning from the Euro zone?

The state of affairs in our country is sad. In under developed countries, children die because of lack of food. The sadder part is that in our country children also die because of food. This was highlighted in the recent tragedy in Bihar where nearly 23 innocent lives were lost due to consuming the government sponsored mid-day meal. This tragedy has again brought into question the Food Security Bill that was recently passed by the government.

A pet project of the ruling government, the Bill aims at giving 5 kg of cheap grains to 800 m people every month. Though the thought behind it is noble but the execution of this project is questionable. The government has not put into place any system to monitor the distribution. This means that even rotten grain can find its way into the system and be distributed to the poor. Let us not forget that due to lack of storage and infrastructure, grains rot away in several parts of the country. This grain is only good to be thrown away but it ends up on the plates of the people. In addition to the problem of rotting grains is the problem of rampant corruption. As a result, much of the promised grain never really reaches the hands of the poor. If the government is actually interested in the food security of the poor and is not just using the Bill as a means of gathering votes, then it needs to put in some thought into the execution as well. But is the government actually thinking beyond the 2014 elections?

'Excellence' is a trait most businesses or companies strive towards. And yet, it is well known that there are some companies that do this much better than the others. Naturally, the secret of these successes has been the subject matter of various business books for quite some time now. What immediately comes to mind is Jim Collins' popular books Good to Great' and 'Great by Choice' discussing this concept quite well. Of course, no study on success is completely foolproof.

As reported in an article in the Economist, over the years most success studies have thrown up 2 faults. One is the 'halo effect'. Here if a company displays good performance, then everything that it does is linked to success. So that when the company falters, these virtues turn into faults. The other is the assumption that behavioral difference visible between two companies explains the difference in performance.

Now there is another book that has hit the stands which strives to explain how successful companies think. Authors Michael Raynor and Mumtaz Ahmed working for Deloitte have adopted a more data focused approach and have gone through reams of data to come up with their theory. The first is 'Better than cheaper'. This obviously means that a successful company focuses more on the quality of its products and does not just compete on price. The second is 'Revenue before cost'. This means that a company needs to build up volumes by expanding reach and improve realisations before it can think of pruning costs. The third rule is 'there are no other rules'. But what are the strategies that the management needs to adopt if these rules have to be consistently adhered to? That is the million dollar question.

We have always been vocal about rampant mis-selling of financial products that happen in the Indian markets. And it is disheartening to see that nothing has been done to stop it and mis-selling still prevails. Take the case of insurance policies. As per a news article in Economic Times, almost 20-35% of the policies sold lapse in the second year itself! Obviously abandoning a policy in the very next year itself means that you were mis-sold. Over time you realized of that mistake and hence you decided to discontinue.

Off course, sometimes poor return in year one could also be the reason to abandon a policy. But one must note that insurance is not bought for returns. It is bought for life protection. Investors should understand that investment and insurance are two different needs. Hence, two different avenues are needed to satisfy these needs. You cannot expect insurance to satisfy your return needs. Apart from investors, it is agents who are more responsible for creating this situation. It is the duty of the agent to appraise any investor before selling him any financial product. But in this financial age where commission determines the kind of product you choose to sell expecting your advisor to appraise you is kind of asking too much from him. After all it is your money that is being invested. Hence, investors should thoroughly do their home work before buying any financial products. They should consider their risk profile and return considerations before committing their money. If not, agents will continue their mis-selling drive at your expense.

In the meanwhile, Indian stock markets were trading flat. At the time of writing, the benchmark BSE-Sensex was up marginally by 12 points (0.06%). Metal and consumer durables stocks are trading in the green. On the other hand, healthcare stocks are leading the losses. Asian stock markets were trading mixed with Malaysia and Hong Kong trading firm, while Taiwan, China and Japan traded in the red.

04:50  Today's investing mantra
"No formula in finance tells you that the moat is 28 feet wide and 16 feet deep. That's what drives the academics crazy. They can compute standard deviations and betas, but they can't understand moats."- Warren Buffett
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8 Responses to "Will India learn from Detroit's debacle?"


Jul 22, 2013

India is a wonderful old country. But whats ailing it is we are trying to copy western model while forsaking our own. We must not forget the Mahatma and try to model our country in his ways.

From the article, it seems that mostly it is the opposition ruled states who have such high debt to GSDP ratio. Do they think that its free and the blame can always be put on the Centre for everything. Who can dare states like Punjab to curb and spend responsibly.



Jul 22, 2013

I just wonder why many opposition ruled states have such high debt to gross state domestic product ratio. Is it coz they think its free without any responsibility and indulge in more populist measures, while putting all the blame on the Centre.

Also, the States like Punjab can generally get away with anything with their aggressive instincts.

We need to correct this imbalance.


Subhash Vashi

Jul 20, 2013

Indian Government is not India. It does not represent the country or the people. It is simply a group of people who created a giant business empire called "Government of India". So, in answer to your question, No, "Indian Government" is not heading for a financial disaster. India and its people are.


Norbert Crasto

Jul 20, 2013

Without a doubt! The scenario is so bad in all fronts including the current account deficit. I will not be surprised with the INR will hit a low of Rs.70 to the $ in 2014. We are living in a fantasy world with the corruption as our motto and lots of hype. It is too late for any turnaround.


Rameshwar Gagrani

Jul 20, 2013

Reg: mis-selling of insurance products.

Many a time views are expressed that insurance and investment should not be mixed, then why government allows
insurance companies to sell such products. Why not the insurance companies be allowed only for insurance needs
of the countrymen? the fault lies with the policy, which government does not want to correct.



Jul 19, 2013

I am sorry to say what the Chinese in Singapore say about Indians. When they see any Indian they will say kill the Indian first before killing the snake. According to them the Indians are more poisonous than snake. Only after coming to this country I discovered this fact that it is very much correct. From all the happenings in India we will have to come to an conclusion that India will not improve in any way in any field.I do not like to go in very detail about all this. I hope every one will understand this.



Jul 19, 2013

I'm afraid India will never learn. India is not a learning culture as a whole, although parts of the population are very smart. The people in power are die hard populist, and will lead the country through crisis after crisis. This has been their track record. And each crisis forces India to surrender something of value to those entities who bail India out.


Rajagopalan Ramesh

Jul 19, 2013

Yes. It appears so as Central Government is already on the brink of major economic disaster. Their hope lise only in Private Sector taking extra efforts for their growth and profitability and this might result in bailing out Government from any possible disaster or de-growth in GDP. I doubt whether the Central Government takes into account the budgetary deficit of State Governments in their overall central budget. The CAG should also carry out an audit of budgets, their implementation and shortcomings or failures. They can also sufficiently warn the Government of their future problems in varous facets of economy. There should be a system to penalize the State Governments severely if they mishandle the fiances of their Governments.

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