Will the US do a 'Cyprus'? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will the US do a 'Cyprus'? 

A  A  A
In this issue:
» Why US shutdown is reason for India to cheer?
» No longer China support for gold
» The worst impacted companies in economic slowdown
» India now lags Sri Lanka, Bangladesh on this metric
» ...and more!

It was not too long ago when the economy of Cyprus flirted with the danger of going 'bankrupt'! Despite being barely a US$ 23 bn economy, the possibility of sovereign bankruptcy sent shivers down global markets. Imagine if that were to happen with a US$ 15.6 trillion economy! The largest and most powerful in the world! Yes, we are indeed referring to the US and its abysmal state of affairs.

Now consider the statistics. Cyprus had fiscal deficit of 4.9% and bank assets comprised 716% of its GDP in 2012. The US had fiscal deficit of 7% and bank assets comprised nearly 170% of its GDP in 2012 (including off balance sheet items). In fact the top 6 banks in the US alone cornered assets valued at 93% of its GDP. The risk of debt default and collapse of the banking system in the US is therefore hardly worth neglecting.

But that is exactly what the Obama government has been doing so far. Infatuated to the US Fed's money printing policies, the government kept ignoring the warnings of debt ceiling. The debt ceiling limit of US$ 16.699 trillion was breached in May 2013 itself. However, the Treasury chose to adopt extraordinary measures to keep paying its bills. Until the US government finally pulled down the shutters this week, for the first time in 17 years. To get out of this situation, the US government will have to make drastic cut in expenditure or raise taxes or both. In the worst case, it will have to default on debt obligations, which could also lead to a Cyprus-like sovereign crisis. The downside of being the largest economy in the world is that a Cyprus-like bailout will be very difficult for the US to come through.

Thus whether or not the US does a 'Cyprus', the US' debt ceiling is itself an alarm bell for the world economy. Traditionally the US has been able to borrow cheap in the international markets. But a default could damage confidence and drive up the cost of borrowing for Americans. The ripple effect could create a chaotic situation in the international debt market as well.

Investors therefore need to make not just their stocks and gold but also their debt investments with extreme caution. The word 'impossible' can no longer be associated to the risks in global and domestic economy.

Do you think the US will do a Cyprus and ask for a bailout? Let us know your comments or post them on our Facebook page / Google+ page

How will the decisions of the US government affect Indian stock markets? We know it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to broad views on global stock markets, you might also be looking forward to our views on few unexpected movement in stocks. And that is why we are taking steps to make The 5 Minute WrapUp more relevant to you. Watch this space for more details in the coming weeks!

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01:35  Chart of the day
The impact of economic crisis has been felt the most on the scope for youth employment all over the world. As per a recent report by International Labour Organization (ILO), lack of employment opportunities is expected to be the biggest risk for an entire generation of youth. The global youth unemployment level has never been as close to the 2011 high of 13%. At 12.8% of global youth population, the number does look scary. But for countries like China and India that house most of the youth population, the unemployment problem is much bigger than it appears to be.

Global youth unemployment near two decade high
Source: ILO

The US government has shutdown since its leaders were unable to reach an agreement on the broader fiscal policy. This has not really unnerved the Indian investors as evidenced by the Indian share markets which have continued to rally since the shutdown. But if the shutdown persists, there may be reason for Indian investors to cheer more. At least this is what an article in the Wall Street Journal is saying. The reason for this is the Fed's QE policy. If the US shutdown gets prolonged, then the US Fed may find it difficult to taper off its QE plan. In that event, the flood of cheap money that has invaded our markets would continue for the time being. This means that our capital markets as well as our currency may find some sort of a support.

If we recall that when the US Fed had just hinted on a possible taper off, both the markets as well as the Rupee had come crashing down. Therefore any delay or postponement of the actual taper off is something that would provide relief to investors. However, the question is not whether the US government continues its impasse or whether the QE is prolonged or tapered off. The question is, why are our markets addicted to the money flood like to a drug? Why do we need an outside drug to provide stability to our currency and markets? Why is the economy itself unable to provide the same stability? The answer to this lies with the government who seems to be more interested in winning the next elections. Rather than do some actual work to make our economy stronger and thus more stable.

China's gargantuan appetite for commodities is well known. So it is hardly surprising to know that the dragon nation has emerged as the world's biggest importer and consumer of the precious metal. So much so that China's demand for gold has largely been responsible for ensuring that the steep decline in gold prices have not turned into a rout. After a 13 year bull run for gold, prices in recent times had begun to cool off. This was on account of the possibility of the US Fed tapering its QE program. However, China and India's demand for the metal turned out to be a balancing act before curbs on imports imposed by the latter hurt demand. As a result, recently China has been the major driver of gold prices in the international market. But here too, demand has begun to slowdown and premiums on the Gold Exchange have begun to ease. Thus, the perception is that another sell off in the precious metal may not be effectively countered by a surge in Chinese buying. Despite such near term volatility, the long term trend for gold rally still remains intact we believe. It seems unlikely that the US Fed will end its printing program anytime soon given that large chunk of the rally in asset prices has largely been caused by the same. This means that the demand for gold as a store of value will not really wane.

Credit plays a very critical role in the economy. Many businesses depend on credit for working capital and expansion. But what happens when credit dries up in the economy? A lot of businesses get choked. Some may even be pushed into bankruptcy.

As you know, the Indian economy has been going through an extended slowdown. Many businesses have been adversely impacted. But the quantum of the impact has an inverse relationship with the size of the business. As such, the worst impacted companies are the small and medium-sized businesses.

The debt situation in the country is the worst in a decade. Non-performing assets have been rising at an alarming rate. As a result, banks have become very cautious about lending. This in turn has severely affected cash-strapped companies. Eventually, this would propel even more defaults and bankruptcies. It is worth noting that small and medium-sized businesses play a significant role in the economy. They account for 45% of manufacturing and 40% of exports. All in all, the malady in the Indian economy is set to get worse before it goes back on its recovery path.

It is one thing to reach the top, quite another to stay there. This could very well be applied to India. There was a time when the country along with China was considered to be the one of the growth leaders. However, things have taken turn for the worse since quite some time now. While we fared relatively better in the financial crises that brought Western economies to their knees, the internal issues are finally taking a toll on the economy. As against a target growth rate of 8% to 9%, we are stuck with around 5% growth rate. Apart from slow growth and inflation, the country's fiscal health is in a mess thus posing a threat of sovereign rating downgrade.

Forget China. As per Asian Development Bank's forecasts, India's growth projections have been slashed so much that now we are lagging behind economies like Sri Lanka and Bangladesh. Corruption, lack of proper economic policies and reforms and fiscal mismanagement have marred India's growth prospects. Unless these issues are tackled, we are unlikely to get out of this mess.

Buying interest in commodity and auto stocks helped the key indices in Indian equity markets move into the positive after hovering close to the dotted line for most of the session. The BSE Sensex was trading higher by around 26 points at the time of writing. Key indices in Asia closed lower today, while Europe has opened flat to negative.

04:50  Today's investing mantra
"What you're doing when you invest is deferring consumption and laying money out now to get more money back at a later time. And there are really only two questions. One is how much you're going to get back, and the other is when ."- Warren Buffett
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3 Responses to "Will the US do a 'Cyprus'?"

Innovation Research

Oct 10, 2013

The technology research & development (R&D) organization among Netscribes, has been turning technology innovation into business.Technology analysis News provided original news regarding rising technologies.

Like (1)


Oct 6, 2013

US may escape Bankruptcy because of it's Shale-GAS Technology-Invention. BUT India may go BUST after launching SONIA 1,2,3: with huge Deficit, VERY High INflation, Huge Unemolyment,Treasonous Secular Vote-Bank Politics which encourages Indian Mujahideen to Strike at Commercial capitals & ISI Smuggling of PAK-Printed Indian currency into India, Indian economy is doomed.

Like (1)

m s varadhan

Oct 4, 2013

No chance .In such a situation Airforce one carrying US President will land in India and fly back with USD 50000 million or one lakh million as Indian Aid and save USA. Alternatively,US will enter into a nuclear deal with India.Yes, we have to support .They are supporting us one way or other.In turn we have to.

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