The real culprit of India's current crisis - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The real culprit of India's current crisis 

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In this issue:
» Here's one of the greatest economists of the 20th century...
» Why economists fail to see any coming crisis?
» Who is still bullish on India?
» The US housing recovery is nothing but another bubble
» ...and more!

Well, we're sure you've been reading a lot about India's current crisis. The matter that has hogged the maximum limelight over the past few months is India's widening current account deficit (CAD). And the resultant steep fall in the value of the Indian rupee against the US dollar.

What's the cause of this CAD crisis? The government and experts have largely focused on a couple of issues. One, high gold and crude oil import bills. And two, flight of capital from emerging markets owing to the US Fed's likely tapering of QE.

But one very major element of the current crisis has been largely ignored. An article in Business Line by S Gurumurthy throws light on this less-talked-about issue. As per the author, the real culprit of the CAD crisis is unprecedented imports of capital goods during the UPA regime.

Let's go back in time a bit to see how India's balances were when UPA took over office in 2004. Interestingly, India had reported a current account surplus of about US$ 22 bn in the immediately preceding three years. Mind you, that was despite the doubling of average oil prices then.

But since UPA came to power, the CAD kept on widening. Consider these statistics. During the NDA regime, average annual capital goods imports were about US$ 10 bn. But as soon as UPA came to power the imports jumped to US$ 25.5 bn in 2004 itself. And of course, capital goods imports have been burgeoning ever since. Since 2004, India's total capital goods import bill has been US$ 587 bn.

Let us now show you how capital goods imports have had a greater impact on CAD than crude oil or gold. After off-setting oil imports against oil exports, the aggregate net impact on the CAD has been US$ 515 bn since 2004. In case of gold, if you adjust for exports of gems and jewellery, the impact on the CAD has been about US$ 161 bn.

One may argue that unlike gold and oil, capital goods are income generators. And hence, good for economic growth. But the economic data doesn't seem to support this argument. As per the author, India's capital goods imports increased 79% in the last five years. But the growth rate in the index of industrial production declined from 11.5% to 5% level during this period. But it's not just capital goods. India's manufactured goods imports have also shot up 20 times over the last 9 years.

What does all this do? A direct casualty of uninhibited imports has been the domestic manufacturing industry. It simply hasn't been able to hold up against the onslaught of imports.

We very much agree with the author's views. Instead of supporting the manufacturing industry, the government seems to have only sabotaged its growth prospects. And here you have an economy that's in a very weak spot.

What according to you is the real reason for India's currency crisis? Please share your comments or post them on our Facebook page / Google+ page

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01:30  Chart of the day
One of the biggest reasons why value investors such as Warren Buffett avoid technology businesses is that there is very little long term business visibility. With fast changing technology and consumer preferences, a market leader today may lose out to competitors who are able to innovate faster and better. This seems to be the case with Nokia. Hitherto the market leader in the Indian mobile handsets market, the company has lost out to rival firm Samsung during the financial year 2012-13 (FY13). Samsung became the top handset player in India as it sales zoomed up 43.6% YoY to about Rs 113.3 bn in FY13. On the other hand, Nokia's sales dipped 18% YoY to Rs 97.8 bn.

A rich product portfolio that is able to cater to customers across price points has been one of the main reasons for Samsung's rise to the top. Nokia, on the other hand, realised the need for a dual-SIM handset for Indian customers pretty late. As a result, many other players were able to grab market share in this area.

Data source: Business Standard

Have you heard of a gentleman named Ronald Coase? Well, we haven't. But if Bloomberg is to be believed, he will go down as one of the greatest economists of the 20th century. Simply because of the impact the man's idea has had on public policy. Now, what exactly was Coase's contribution? Well, he helped shape the debate between business firms whose actions have harmful effect on others and the people affected by the actions. And what was his solution? Coase opined that the Governments should not interfere in these matters in the form of regulations but let the two affected parties solve the matter between them.

Since he was a believer in free markets, he argued that such decisions should be left to the judgement of the market. It would be an understatement to say that his ideas spread like wildfire. Soon, every decision that involved a dilemma of the kind we just highlighted, Coase's theorem was used and more often than not, the matter was left for the two parties to decide. Little wonder, Coase received wide spread appreciation from big businesses and politicians alike as his theorems reduced Government regulations and helped the former prosper.

But is this the right approach to have from a moral, ethical standpoint? Certainly not we believe. Not everything in this world can be analyzed from a profit and loss point of view and other considerations should also come into the picture. As a matter of fact, even Coase became quite critical of the wrong use his theorems were being put to in his later life.

An article on Bloomberg raises a pertinent question. It asks how many economists are required to see a crisis. The answer unfortunately is none. There is an elaborate reason to support this answer. To understand this lets go back to what triggered the current global crisis. The trigger was of course the use of complicated financial products like derivatives and collateralized debt obligations , etc. the collapse of which wiped out some of the noted financial institutions. The domino effect that followed resulted in the crisis; the vestiges of which are still hurting the global economy.

Interestingly most of the academic world would agree that the use of these complicated products triggered the crisis. But unfortunately, they still feel that these products are necessary to 'complete' the financial markets. Theoretically, these products provide greater flexibility to the markets. This in turn helps in better information, lower transaction costs and eventually better risk sharing.

While theoretically the principles may sound fine; however it is the practical implementation of these principles that failed the global economy. The risks went up multi-fold rather than coming down. The products were in reality so complicated that the information on them didn't help either because the investors didn't really understand them.

Human greed made things worse as most people ended up using these products for speculation and gambling. The result is something we are all painfully aware of. Therefore the paper of MIT's economist, Alp Simsek, comes as a breath of fresh air. He has stated that these products essentially allow people to bet on their views. And taking bets increases the risk rather than reducing it. Hopefully, other academics and economists would listen to people like Mr Simsek and change their views on such products.

Domestic investors in India seem to have bought into the gloom and doom story. However, it seems that those unexposed to the panic mode being created by Indian media are far from being fearful. On the contrary, they are acting on Buffett's motto of 'being greedy when others are fearful'. As per an article in Economic Times, some fund managers of emerging market funds are willing to go against conventional wisdom.

They are unnerved by the volatility in currency rates, spike in interest rates and slump in GDP growth. In fact they believe that although Indian economy is slowing sharply, it is far from collapse. And that the state of the economy masks its compelling long-term potential. One that attracted many foreign investors to India in the first place. Thus, while long term foreign investors continue to repose confidence in Indian stocks, it is time even domestic investors take some cues.

The US housing market has been rallying in recent times. But is this recovery real? Not really as per an article on Moneynews. Consider this data: Nearly half of the US homes sales are cash transactions. This was around 19% in 2005. It seems a bit unrealistic to believe that most of these cash transactions are done by genuine first time or second time homeowners. Hence, the more plausible explanation is that the rally is more investment driven. This means that most likely it will be fickle because these very investments will be withdrawn if expectations are not met. Add to this the fact that supply of newly built homes will increase in the next 12 to 18 months putting further pressure on prices. Hence, it would be prudent to look at the current housing rally with a pinch of salt.

Meanwhile, Indian share markets reversed the morning losses and are now trading in the green. At the time of writing, the BSE Sensex was trading higher by 244 points. Barring consumer durables stocks, all sectoral indices are trading in the green with stocks in the banking and capital goods sector finding maximum favour. Barring Japan and Taiwan, the major Asian stock markets have closed on a positive note.

04:50  Today's investing mantra
"We always look at them as businesses, whether we're buying the whole thing or 100 shares."- Warren Buffett

Editor's note: Please note that there will be no issue of The 5 Minute Wrapup on the 7th and 9th of September 2013.
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30 Responses to "The real culprit of India's current crisis"

prakash bhadkamkar

Sep 18, 2013

1)we must totally stop import of non essential items which are draining the dollar reserves.(2)currency trading must be stopped.whichever industry require dollar it should be routed through RBI and not open market.(3)increase mass transport- railways,make them double people will prefer going by train.this will save lot of oil.(4) put nation before an individual



Sep 18, 2013

In that case it is better for the policy maker to revisit the import policy to suit the given situation to overcome the gap in CAD



Sep 17, 2013

There are stories all over the place that tell of bogus, overpriced exports on the one hand, which are basically round tripping with the benefit of claiming duty drawback. Containers have been checked and found to have scrap but nothing is done. Similarly, local industry has been killed by draconian laws, high taxes and input costs and, as the article says, cheap imports with virtually no taxes. it seems the entire politico - bureaucratic system has got together to make us dependent on imports and destroy Indian manufacturers.Maybe capital goods were in fact idols, rubber bands, paper clips etc etc. If so, the extent of corruption and collusion is unbelievable.

Like (1)

Siva Kumar

Sep 13, 2013

The CAD was a result of high import of Capital Goods. Then where has the manufacturing capacity built by import of such goods gone. The infrastructure sector has a blank, manufacturing has a blank, even toffees are imported, pens, pencils, glue sticks.So were capital goods really imported or are such consumables being imported in the name of capital goods.

Like (1)


Sep 10, 2013

We need to get into further details. We need to classify the imports of capital goods and see which segment is the real culprit. I am sure that our import from china will be the driver as we can see that many day to day usable products are from china.

Like (1)

Sanjay Dharamdas

Sep 10, 2013

India's core fundamentals where the economy is concerned remain strong over the long term.
The current global economic climate is not the only issue, but sound structural reforms and policy issues including corruption need to be addressed too.

Like (5)

rajendra paropkari

Sep 9, 2013

The reason expressed on the page is just a one third ice berg. This Govt has a Scholar Prime Minister but the fact is we need a leader who possess common sense to take the decisions. The impact of dollar 142 per barrel oil was more but historical tumbled value of rupee is now proving impotency of Govt and naturally giving chances to BJP again for 2014.

Like (2)


Sep 9, 2013

I too endorse Yours & Mr.Gurumurthy's view. Further everything is getting imported. I dont understand why all mobiles, Hardwares or even toys!! should be imported? Why govt cant support local industries? Instead of taxing everything, it should give incentives for local goods/services. I think rupee devaluation is a blessing in disguise if govt utilizes this opportunity to boost exports & inhouse production. But govt is busy in politics. I think Modi can be sole hope!!

Like (2)


Sep 8, 2013

Gurumurthy is right to great extent.He should have thrown light why higher imports of capital goods did not result in higher industrial growth.A country of 125 crore people cannot afford to be net importer.Else it will face seious forex crisis.

Like (1)


Sep 8, 2013

even plastic chappals, idols of Hindu Gods, lamps, etc -all items are imported from China -helping Chinese to grow and killing Indian manufacturers. chini chini bai bai? Nehru. Policy of Cong I. Existence of the Govt. is doubtful! Bharat is not in the Indian Hands!! Even Banks are in cahoots with the UPA stifling our manufacturers by not lowering the int rates!!!

Like (1)
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