Are Indian investors running up a down escalator? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Are Indian investors running up a down escalator? 

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In this issue:
» China no longer the biggest lender to the US
» Indonesia be the next member in the BRICS?
» China Inc. results show proof of slowdown
» Unhappy birthday for Dodd-Frank Act
» ...and more!

------------------------------------ Is the next Global Crisis closer than we think? ------------------------------------

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Some of you may even ignore this without reading further...

But it's our duty to bring you the facts.

You see, many renowned financial experts around the world strongly believe that we are on the brink of the next Global Crisis.

And if that happens, even India may not be spared this time for reasons we both know.

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It is the law of nature that most of the time our needs outstrip our resources. Hence most of us save up today so as to have enough resources for our future needs. But those savings do not guarantee adequacy of future resources. This example cited by Warren Buffett in 1981 Annual Report of Berkshire Hathaway explains why.

"If you (a) forego ten hamburgers to purchase an investment; (b) receive dividends which, after tax, buy two hamburgers; and (c) receive, upon sale of your holdings, after-tax proceeds that will buy eight hamburgers, then (d) you have had no real income from your investment, no matter how much it appreciated in dollars. You may feel richer, but you won't eat richer."

Buffett's take on the plight of high inflation- high taxes afflicted investor has hardly ever been more relevant for Indian investors. On one hand, India's wholesale price-based inflation continues to remain sticky and high. Though grossly archaic in calculation inputs, the inflation number has to a good extent captured rise in food and fuel prices. What this means is that the real return for an average investor is getting further squeezed. Neither stocks nor fixed income papers are currently offering stupendous near term returns. In such a scenario, investors can only hope for lesser impact of inflation on nominal returns. But that is not to be.

Add to that the prospect of higher tax payouts, both directly and indirectly. The inflation-adjusted post- tax returns could effectively leave you with a fraction of what you had invested. According to Buffett, investors suffering from such plight are "running up a down escalator whose pace has accelerated to the point where the upward progress is nil."

However, both inflation and taxes may continue to cannibalize net real returns in the medium term. Investment in high return tax efficient instruments is therefore the ideal solution. Long term investment in safe stocks fits this requirement well. But investors need to be very careful about whether their stock portfolio adds to their wealth over time. Companies that grow earnings without sustaining or growing return ratios destroy shareholder value rather than create it. Investors putting money in such high growth low return stocks would therefore do better keeping the money under their carpet. It is a cautious and well researched approach to investing that one needs to take.

Do you think high inflation and high taxes have a lethal effect on investor portfolio? Let us know your comments or post them on our Facebook page / Google+ page

01:30  Chart of the day
Economic slowdown, bad lending and high interest rates have brought back a much feared ailment to Indian banking system. It answers to the name of 'restructured loans'. Essentially irrecoverable and unserviceable as per schedule, these loans are but a makeover for banks' books. The rules allow banks to modify terms of repayment and interest to ensure a more liberal deal for the borrower. Meanwhile, the bank gets to classify the loan as 'standard' for a prolonged period. Nevertheless statistics show that most of these loans go on to be written off. At 4.6% of Indian banks' overall lending, the restructured loans are a key threat for the sector in FY13.

Source: Economic Times

The umbilical cord that connects the economic fortune of US with that of China's is on the verge of loosening up a bit. In fact, its place is likely to be taken by another similar relationship. The one between the US and Japan that is. As reported by Bloomberg, China may no longer remain the biggest holder of US Government treasuries. And it will be replaced by none other than its oriental rival, Japan. This is certainly good news for US policymakers, who for quite some time now, have been finding it difficult to calm down the anti-China rhetoric. Sadly though, given the economic strengths of both Japan as well as China, we won't be surprised if China reclaims its top spot.

Truth be told though, it is not a race that both China and Japan could be particularly proud of. US treasuries are perhaps the biggest enigma of our times. Despite being issued by an economy that is not in the best of shapes, it continues to find takers year after year. Thus, both China and Japan would be better off putting their hard earned money in other more attractive asset classes.

The BRICS (Brazil, Russia, India, China and South Africa) countries were until some time ago, the apple of the investors' eye. However, these economies are facing challenges in the form of slowing growth and high inflation. As such, many a global investors have been shying away from investing in these countries.

There is another emerging economy that appears to be a lucrative investment opportunity for investors. The name is Indonesia. Currently ranked 16th, the country is expected to become the 7th largest economy by 2030. Owing to factors such as robust domestic consumption and a rising middle class, Indonesia features among the fastest growing economies in the world today. It must be noted that the country was severely affected during the Asian financial crisis of 1997. However, it has shown great resilience in the recent global crisis. The economy has been growing at a healthy rate of about 6%. And the same is expected to continue going forward. Will Indonesia be the next member in the BRICS? Seems quite likely.

We have always vouched for a one stop shop solution for all the problems relating to execution in the infrastructure sector. Having a single autonomous body that deals with all the project related matters keeps the process simple and tidy. That's because the client has to deal with only one government institution. This speeds up the execution as there are minimum delays in getting approvals and sorting out the paper work. In that regards, the government is all set to create National Investment Board (NIB). However, its effectiveness is far from certain. True, that NIB will provide a single window mechanism for all project clearances. But its effectiveness is limited to the projects related to the Centre. That's because the committee comprises of representatives only from the central ministries. But in order to speed up the project cycle we need some solution at the state level as well. So, a combined effort is required from both centre and state to eliminate execution issues.

If the third quarter results of Chinese corporates are anything to go by, then the dragon nation is surely witnessing a slowdown. However, this has not been something new. Even in 2011 China had to contend with issues such as slowing sales, swelling inventories and sluggish bill payments. All of which pointed to declining demand and deteriorating cash flow. Most are of the view that this quarter is probably a trough and that things should improve from thereon. But in matters such as these as is the case with stockmarkets, predicting a 'bottom' is a futile exercise we believe. China's growth so far has largely been fuelled by exports. Thus, as long as the US and Europe continue to languish in a slump, this is bound to rub off on Chinese growth as well. A few more quarters will probably give a better indication of where the country's growth is headed.

2008 marks an important milestone in US history. It was a year where complicated financial products nearly brought the US economy to its knees. In the wake of the crisis, the regulators introduced the Dodd Frank Act. The Act increased the government oversight of trading in complicated financial products. The idea was to make the financial system safer. Four years down the line a small bank in US has contested that the Act is not really market friendly. A little bank in Texas provides loans to customers who are typically farmers in that area. Unlike the larger banks it does not syndicate its loans with Freddie Mac and Fannie Mae, the US housing finance giants. Instead it keeps the loans on its own books. And charges a higher level of interest rate on the loan as these are typically small loans. In case the payee is unable to pay the loan in any year, the amount as well as the interest component is ballooned and rolled over. When the payee has the capacity, he has to repay the ballooned amount of accrued principal and interest thereon. This is again unlike the larger banks which take the option of repossession of property.

Now the practice followed by the Texas bank is prohibited under Dodd-Frank. As a result the Texas bank has to discontinue the same. The result being that the farmers either go to the large government banks for loans. Or the smaller guys do not get any credit facility. Therefore the bank has argued that the Act is actually killing credit for the smaller farmers rather than making banking safe for them. If they win, the Act would have to be rewritten accordingly. If not, the banking system in US would continue getting more skewed. Considering that the regulators want to increase credit growth in the country, the latter option would not be a viable one.

Profit booking in key heavyweights from auto and commodity sectors led the benchmark indices in Indian equity markets to shed early gains and move into the negative territory post noon. The BSE Sensex was trading lower by around 49 points at the time of writing. Other Asian markets closed higher today while Europe also opened on a positive note.

04:50  Today's Investing Mantra
"The chief losses to investors come from the purchase of low-quality securities at times of favourable business conditions" - Benjamin Graham
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3 Responses to "Are Indian investors running up a down escalator?"

sunilkumar tejwani

Oct 16, 2012

Warren Buffet is a speculator par excellence. (a long term speculator with vested interest in the stocks he is invested) therefore, any of his quote/ unquote is to be taken with not a pinch but tons of salt.
Therefore, any of his comments are best ignored.


Gangadharan Nair

Oct 16, 2012

In Indian market the inflation was equivalent to 15% compound for the last 50 years. If you see, the value of currency in terms of cost of gold, the currency was loosing its value @ 15% per year. The value of currency has come down to 1/677 in 48 years. So any investment which has brought less than 15% return is a loss. Instead of investing on share one should have invested in GOLD.

Like (2)

Ganapathy Sastri

Oct 16, 2012

Thirty years back you could buy property for one lac. Thirty years from now you can have proper tea for one lac. That is the kind of inflation our politicians and central bank have been maintaining during the last forty years. We have had massive inflation year after year since early seventies. During the last 3 years prices have doubled meaning a CAGR of 24%. There is no way one can earn more than the inflation rate with his money. If he pays taxes on his nominal interest, it makes the situation worse.
Just imagine thirty years back one could have lived off a corpus of Rs. 10 lacs very comfortably. How much of that will be left today? Every paisa of that would have wiped off. Today every one talks of accumulating 1 cr or more.

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