Dear Mr Chidambaram, this plan could be dangerous! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Dear Mr Chidambaram, this plan could be dangerous! 

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In this issue:
» A shocking Fed interview you may have not heard
» Marc Faber's views on the markets
» Crisil takes a dim view of India's GDP growth
» Step aside Power. Water gets priority with Planning Commission.
» ...and more!

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The grand east facing room at North Block is where the Finance Minister of India operates from. And the place had a new occupant recently. A gentleman who answers to the name of P Chidambaram. Impressively enough, he wasted no time in announcing that he means business. Out came a couple of positive statements like the review of the infamous retrospective taxation and measures to improve the investment climate in the country. That the stock markets too seemed to have liked the look of the new FM was evident in their buoyancy in the past few trading sessions.

However, amidst all this euphoria, there were a couple of statements that didn't leave a very good taste with us. What rankled us most was the FM's comment on interest rates. Chidambaram is of the view that interest rates hamper the investor and are a burden on every class of borrowers. He further added that sometimes it is necessary to take carefully calibrated risks in order to stimulate investment and to ease the burden on consumers.

Our understanding of these comments suggests that the FM is a supporter of lowering interest rates in order to boost investment. He somehow seems to be getting the impression that the high interest rates are putting the Indian economic growth at risk. He would do well to look westwards to understand why he is grossly misdirected. Bernanke and his counterparts in Europe have been trying to breathe life into their economies through the use of ultra low interest rates for years now. But they have hardly succeeded.

We are not saying that artificially low interest rates do not lead to investments. They do but as soon as the stimulus is taken away, most of these investments turn worthless. Simply because they have been the result of cheap money and not an indicator of real long term demand. This is exactly what happened during the US housing bubble. Here, houses were constructed on hopes that low interest rates would last forever. But they did not and what followed was a huge bust that affected the entire economy. And this is exactly what is happening with China now as it is struggling with massive overcapacity across most sectors.

Thus, what is needed is not cheap money but steps to lower inflation. And Chidambaram could take a big step towards the same by trying to lower the Government's deficits, one of the key reasons behind high inflation we believe. His other plan of inducing RBI to lower rates without a concomitant fall in inflation is dangerous we believe.

What do you think? Do you think Chidambaram is right in asking for lower interest rates? Share your views or you can also comment on our Facebook page / Google+ page.

01:31  Chart of the day
Today's chart of the day is perhaps a shining example of why technology stocks are such an anathema to Warren Buffett. As the chart highlights, even the best know technology companies of their era find it hard to increase or at the least maintain their market value year after year. It was really shocking to know that names like Eastman Kodak, Nokia and Sony, have lost more than 90% of their peak market values in a short span of just few years. If this doesn't convince you to be extremely careful while investing in technology stocks, we don't know what will.

Source: The Economic Times

Instead of sweating your way through a hectic work routine, how about buying a money printing machine? Wouldn't it be the quickest way to unlimited riches? Not at all! Paper money is not wealth. It has no intrinsic value. If everyone started printing money, it would kill the value of the currency. Moreover, you would be put behind bars for printing counterfeit currency.

But all sanity and logic seize to exist when the entity in question changes from you to the central bank. A recent interview of Eric Rosengren, the President of Federal Reserve Bank of Boston proves the point. He has appealed to the US Federal Reserve to start an aggressive open-ended bond buying program until economic growth recovers and unemployment goes down.

To a layperson, this may sound like sophisticated, complicated mumbo-jumbo. So let us explain what he means. What he means is that the US central bank should start a third round of quantitative easing (QE-3) which in simple words means nothing more than reckless money printing. You will recall that in the aftermath of the 2008 financial crisis, the Fed had initiated massive bond buying programs.

In its first QE program, the Fed purchased US$ 1.25 trillion worth of mortgage-backed securities, US$ 300 bn worth of US Treasury securities and US$ 175 bn of debt issued by government-backed mortgage companies. In the second QE program, the Fed bought US$ 600 bn worth of Treasury securities. Mr Rosenbren is pressing for a third round of QE of a similar magnitude but without a fixed amount or end-date. Meaning, just keep printing money till the economy gets back in shape. Only a central banker is legally permitted to nurture such insane and deceitful fancies!

The earlier 9% growth levels may be a thing of the past. But now even reaching 6-7% growth levels is difficult. Rating agency Crisil has recently cut India's GDP growth forecast to 5.5% for FY13 from 6.5% earlier. The deficient monsoon and deteriorating government finances are major reasons for the downgrade. Plus, India is not immune to the situation globally. S&P recently downgraded the Eurozone's 2012 growth outlook to negative 0.6% from 0% earlier.

Crisil expects India's fiscal deficit to deteriorate to 6.2% of GDP, compared to its earlier forecast of 5.8% on lower growth. Plus if the government needs to stimulate the flagging economy, this would put a further strain on finances. Inflation and interest rates also remain high, adding to the stress. The only upsides to growth could be much needed reforms in the mining and power space. Raising fuel prices to reduce subsidies may also provide a push. Sustaining growth, pushing reforms and boosting investor confidence will be the key pressure points for India. But is it up to the task?

For a while now, Planning Commission Deputy Chairman Montek Singh Ahluwalia has been advocating the efficient use of a very much 'taken for granted' natural resource - water. Earlier, he seemed to be in favour of hiking water usage charges for industry, agriculture and consumption usage (barring the below poverty line section of society). However, of late, he views seemed to have changed - given the reluctance of state governments to hike prices for agriculture and consumption - to only doing so for the industry.

At a recent event he stated that "There should not be any reluctance in dealing with water pricing when you are dealing with the industry." Mr. Ahluwalia believes that taking such steps would sustain high growth and also ensure efficient use of water. In addition, he opines that industries will automatically switch to greener methods of water usage such as using recycled water. He indicated that the 12th Five Year Plan (2012-17) would be laying out different ways of using water efficiently.

Off late, the world stock markets have witnessed a huge volatility. Amidst such torrid times, it becomes all the more difficult to find the right entry point. However, investment guru, Marc Faber feels that markets are in a ripe position to stage a rally from here on in the month of August. He is of the opinion that liquidity created by central bankers across the world and negative real interest environment will bring about a rally in stock markets.

However, Faber has also cautioned for a difficult second half. And the reasons are manifold. Growth in Asia is slowing down while US and Europe are engulfed in a crisis. Corporate profits too are on a downhill. Thus, the overall situation does not appear bright. As far as India's prospects are concerned, he is not too optimistic either. Other emerging markets seem to be topping his wish list at the moment. If his predictions turn out to be correct, Indian stock markets are likely to face difficult times ahead.

Meanwhile, indices in the equity market in India were seen having yet another positive session what with the Sensex trading around 40 points higher at the time of writing. Metal and auto stocks were in the midst of some strong buying interest. While most Asian indices closed firm today, European stocks have opened in the red.

04:53  Today's investing mantra
"An investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace" - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Dear Mr Chidambaram, this plan could be dangerous!". Click here!

    20 Responses to "Dear Mr Chidambaram, this plan could be dangerous!"

    Ramana Kumar

    Aug 19, 2012

    i think his approach is completely wrong. trying to reduce interest rates and boost the demand for consumer durables is a very short term measure. nobody is going to invest in capex becos of this temporary boost. and he is doing this by interfering in the play of natural market forces in banking industry. its like increasing subsidies further thru banking channel this time. there is no fresh approach here, its a disappointment.

    Like (2)


    Aug 12, 2012

    Its indeed a dangerous idea to toy with Interest rates. With all (so called)learned men viz. P.C., M.S. Ahluwalia, & The PM,at the helm of the finances of our country, it's not coincidence that we're facing a situation precedented in 1991. They are all up to quick-fix solutions, rather than the long term sustenance.

    At a time when inflation has been soaring, how else would a common man fund his daily cost of living, if he can't even earn reasonably on his meager savings.

    So, what you bought yesterday for Rs.10, costs Rs.13 tomorrow (courtesy INflation), but what you saved yesterday becomes only Rs.11 (courtesy PC)by then. What on idea Sirji !

    And what could the sectors of the Economy which have been pampered by the low interest rates in the past, achieve? Moreover, it may also encourage people to adopt the American style of life - to finance a unaffordable lifestyle by borrowing. So, the common public should lead life on debt to stimulate "growth" of the Economy & our much pampered Industrial sector.

    Like (2)


    Aug 11, 2012

    Dear Respected FM,
    Pl avoid the mistakes that u & your Govt did in 2009 budget. 1) Blanket farmers loan waiver scheme
    2)6th pay commision. These are measures of cheqp popularity to gain the vote bank but forver it will be
    drain on the economy and ultimately on common man. Pl do not resort to such other measures, otherwise the deificit will increase and again there will be situtation like 1991

    Like (1)


    Aug 9, 2012

    i agree with you, providing stimolus by way of reducing interest rate will not be correct given the over heated realty sector,availability of chap money may furter give boost to speculative reaty trading and incresed realty prices which are not supported by other sectorial growth of economy, lowering infation to boost demand in other sectors will try to support already heated realty prices is more logical solution

    Like (1)


    Aug 9, 2012

    I think we need to have a balanced attitude.Lowering the interest rates a little bit will boost the production area. At the moment, high interest rates dissuades activity & investments in manufacturing sector. People turn invest in non productive assets. If it is possible, selective sectors can be given interest discount to boost production; this coupled with removal of other bottlenecks like poor infrastructure,(Particularly Power cuts)will increase production helping to bring down prices.
    Most of the west has much less manufacturing areas and they are service oriented economy.So the comparision is not absolutely correct.

    Like (1)


    Aug 9, 2012

    In your sustained efforts to glorify Warren Buffet, you have selected the tech stocks which did not do well. But there is always other sider to the story. There are tech companies which have been successful and have given fabulous returns to their shareholders. Why are you no talking about tech companies such as MS, Dell, Google, Apple, Intel, Oracle etc.? The fact of matter is Mr. Buffet has missed out on tech boom and no efforts to rationalize this fact will mask the truth.

    Like (1)


    Aug 8, 2012

    as correctly argued in the article there is but little co-relation between lower interest rates and investment and marginal downward adjustment is unlikely to boost investment. the real problems plaguing the economy - which are well known - are difficult for this government to address so it finds it convenient to try and create conditions for a buoyant sensex which gives an illusion that the economy is doing well and to that extent lowering interest rates may'll also help FIIs make money and with the distinction between FII & FDI having been deliberately heavily blurred it can be argued that investment is picking up!the approach however is myopic and not in the best interests of the country's economy and the government would do well to tone up governance and get its house in order rather than batter the central bank for its independence.

    Like (1)


    Aug 8, 2012

    Yeah Palianappan, listen to Mr. Equitymaster. They make sense more times than not. Bring inflation down. That will help everyone... not just borrowers. But do you have the skill or the gumption to do this? I seriously doubt it... In the end we'll end up with high inflation and lower interest rates, impacting retirees who survive on interest income. So what's new? Maybe Mr. Advani is right after all about UPA-2.

    Like (1)


    Aug 8, 2012

    If some intelligent unbiased person interprets new FM's proposals, will realize that all his efforts are directed towards creating a short-term illusion of euphoria but in the long-term it will do damage to this country. He is trying to engineer a boom in the stock market and help foreigners to make money in India at the cost of Indians. He is also trying to prove that he is a better FM and as politician he has 2014 election in mind. He will try to interfere in the independence of RBI by forcing it to reduce interest to satisfy the vested interests. Future will judge how far this man is working in the best interest of this country.

    Like (1)


    Aug 8, 2012

    It will be dangerous to lower interest rates and sure he will put tremendous pressure on RBI to the extent he may ask for the head of the RBI Governor for not toeing his line, which appears to be the likely battle royale and get his guy to come and sit there. Well all in the name of investments. Good luck India we have new things coming up our sleeve...there is never a dull moment in life!!

    Like (1)
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