A Bomb scare of a different kind - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

A Bomb scare of a different kind 

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In this issue:
» Job seekers in China have risen
» Economic slowdown has hit bottom says Krugman
» Asia to pull the world out of the slump
» No more scope for interest rates in India to fall
» ...and more!

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Bomb scares from terrorists have unfortunately become ubiquitous in recent times. But according to Russell Napier, strategist at CLSA Asia-Pacific, mankind is now faced with a bomb scare of a different kind - that of the 'public debt bomb'. He believes that within the timeframe of a decade, the public debt bomb in the US will explode and push the US government into bankruptcy, thus forcing it to impose capital controls to prevent a 'flight of capital' to Asia. This is because Asia will be one of the few places in the world where currencies and asset prices will appreciate even during this time.

By flight of capital, he means that private capital may cease to be willing to finance US government debt, and may even stop wanting to hold currencies of the Western countries, rather preferring to hold currencies of Eastern countries like India and China. To put a check on such a flight of capital, he expects the US government to go to the extent of imposing capital controls. While economic forecasts are usually quite unreliable, what does seem plausible in his argument is the unnerving fact that credit in the US is today bigger than what it was when the recession began. Public debt is thus certainly a hazardous bomb set to explode!

01:03  Chart of the day
India and China are primarily on the watch list of global investors for two reasons. One - they are growing at the fastest rate compared to other large economies in the world. Two - they have what can be called a 'demographic dividend' i.e. a larger population in the working age group. While in the first case China scores over India, it is vice versa in the second. However, what is probably getting neglected is the fact that not this entire demographic dividend is being put to optimum use.

The Asian Development Bank pegged India's and China's unemployment rates at the end of 2008 at 7.2% and 4% respectively, This has reduced from 8.8% in 2002 for India and 10.1% in the same year for China. Thus while unemployment scenario in India has not changed much (as can be seen in the adjacent chart), that in China seems to have improved dramatically over the years. The difference seems to lie in the list of registered job seekers that has shown a consistent rise in China while India seems to maintain a status quo. This situation if not addressed with urgency could be potentially hazardous for India that is betting on consumption-based growth due to its demographic potential.

Data Source: Bureau of Statistics of China, CMIE

While there may be a debate around the world whether the recession has ended or not Nobel laureate Paul Krugman is of the opinion that the global economic downturn has hit the bottom though the recovery will be 'slow and painful'. Further he brushed aside the notion that China was big enough to pull the world economy out of a slump. The rising budget deficits will also be a matter of concern. While they were instrumental in arresting the slide of various economies in the short term, in the longer term they will pose a much bigger problem.

Also, Krugman believes that while the situation is not likely to get any worse, the time is not ripe yet to scale back the stimulus measures unless there are clear signs that the recovery is sustainable. Thus while the debt numbers are important, the governments must not place so much emphasis on it that the recovery process gets compromised meaning that a very delicate balance will have to be struck between the two. And while comparisons with the Great Depression of the 1930s have been inevitable, Krugman believes that history is no guide to a path to recovery. He said, "The Great Depression was ended by a very large spending program known as World War II and we don't really want to repeat that." Indeed, we cannot help but agree with Krugman that while the recovery process has started it will be a while before any significant positive results start flowing in given the depth of the crisis.

There is little doubt left that Asia is going to be the economic engine that is going to drive the world on its way out of the recession. The latest confirmation comes from the Asian Development Bank (ADB), which has strengthened its economic forecast for the region. As per Bloomberg, ADB expects Asia (excluding Japan) to grow by 3.9% in 2009 and 6.4% in 2010. China is expected to grow at 8.2% this year while India will clock in at 6%.

In our opinion, the forecast does not mean that Asia will be able to pull off the growth on its own. Given the export oriented nature of most of the Asian economies, it is crucial that the US and Europe start recovering. Moreover, it must be remembered that Asian policymakers have pumped in huge stimulus packages into their economies and it is vital that they get their exit strategy right. If they wind up the packages too early, GDP growth rates might be hit. If they are too late, we'll be staring at runaway inflation and asset bubbles.

So, while 2009 is not expected to be that great, how is 2010 likely to shape up for the global economy? The head of the World Bank is concerned about economic conditions in 2010 when the effects of the fiscal stimulus fade away. While he does not see a double dip, he believes that the economy is not out of the woods yet as it is unclear whether private demand would be strong enough to build on the stimulus on the path to recovery. He is now looking at the upcoming G20 meeting for direction and believes that the agenda should include global growth, financial stability, climate change, help for the poorest including a new facility to help countries cope with economic shocks not of their own making. This would help sustain the momentum and co-operation achieved during the London conference in April this year.

Interest rates in the past one year had been falling in India in response to the economic slowdown. But Aditya Puri, CEO of HDFC Bank has in an interview in Mint said that he does not think there is any more scope for interest rates to fall. Having said that, whether rates will go up will depend upon the RBI which though it wants to control inflation does not want India's growth to be impacted. Mr. Puri believes that the RBI may be fine with inflation upto a certain level provided India's growth does not get stalled. Therefore, while there may not be movement in interest rates in the short term, at some point of time the bias is certainly upwards.

In the past, the RBI always tended to intervene in the currency markets to stem the appreciation of the rupee so that exporters did not feel the pinch. This time around it may end up allowing the rupee to strengthen in order to reduce the cost of imports and curb inflation without raising borrowing costs. India has already been impacted hard by the deficient monsoons this season just when the economy was showing signs of limping back to normalcy after the slowdown in growth last year. But since poor rainfall has hampered crop production, concerns of rising inflation have been looming large and the RBI may adopt the Indian currency as one of the tools to rein in inflation. Thus, a rise in the value of the rupee would make the import of crude and sugar that much cheaper. In such a scenario, exporters of course could feel the heat as they have already been battered by the recession in the US and Europe and an appreciating rupee will only add on to their cup of woes.

The Indian markets were trading well above the dotted line with the BSE-Sensex trading higher by about 160 points (1%) at the time of writing. Buying activity was being witnessed in stocks across sectors led by IT and auto. However, stocks from the metal space bore the brunt of profit booking. At the time of writing, the Asian markets were trading on a mixed note. Europe began the day on a positive note.

04:56  Today's investing mantra
"A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street - a community in which quality control is not prized - will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest." - Warren Buffett
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4 Responses to "A Bomb scare of a different kind"

prejish nair

Sep 23, 2009

I just removed a few statements from your above article:

- "The Great Depression was ended by a very large
spending program known as World War II”
- Russel Napier believes that within the timeframe of a
decade, the public debt bomb in the US will explode
and push the US government into bankruptcy
- India and China are primarily on the watch list of
global investors
- Asia is going to be the economic engine that is going
to drive the world
- An addition - Which currency is going to lose its
charm in the future - Dollar !!!

I might be wrong but these statements just lead me to one thought - Who would be interested in World War III?
(Oops..I didn't say US, I just thought they may be)
and How would they try to execute it? What indirect approaches would they adopt (as observed in the past)? Would they try to sell more ammunitions to our Asian neighbours? Would they show more intervention in the Asian issues or issues of other developing countries?

I don't know but something might be getting cooked at the background maybe 'A Bomb scare of a different kind". All countries should realize this and be alert of any such bad intentions of the developed nations.
Alert !!! Alert !!! Alert !!!



Sep 23, 2009

I have been following your articles, which are too good for any common man, who has inadequate knowledge about the economy.

Hats off to you, for wonderful work.


Nalam Prasad

Sep 22, 2009

Hi, the quote from Warren Buffett is very good. Can you comment in your next article whether people are considering speculation as the most easiest, now. If not, we need not worry till such time that happens.


Ramkumar R Daga

Sep 22, 2009

Your article are good and thought provoking.
Today's also provides a lot of food for thought. Please keep it up.

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