Will India come out of its biggest crisis? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will India come out of its biggest crisis? 

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In this issue:
» Is this the best way to account for business cyclicality?
» A credit crisis could be developing across Asia
» Home buyers stay away this Diwali
» India needs flexible labour laws, feels Basu
» ...and more!

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The Finance Minister seems to have finally given up. For he has made an admission in a recent interview that India's economic growth could slow to as little as 5.5% this financial year. Well, the last time India's growth came in at less than 6% was way back in 2002-03. Thus, it can be safely assumed that India's growth this year could well be its lowest in almost 10 years.

To be fair, India's problems this year were not entirely of its own making. There was global slowdown to deal with plus monsoons weren't fully obliging either. But this in no way should tone down our angst against the Government that perhaps failed on most fronts. Consequently, policy-making and reforms suffered a great deal and further compounded our woes.

If asked, our FM does point out that India has the wherewithal to again reach its economic potential. And he harks us back to the period of 2004-08 where we supposedly had 9% plus growth. He thus argues that we have done it before and hence, there's no reason why can't do it again.

Herein lies our biggest problem we believe. In order to achieve a certain result, one needs to follow the right strategy. And the FM, by arguing that we have grown at a much higher rate in the past, believes that we indeed have the right strategy.

Very little can be further from the truth though. We are of the view that the reason we had those 4-5 years of very high growth was because of supply of cheap, excess liquidity from the west. And there wasn't any major structural change that had taken place in the Indian economy. For if there had been, we wouldn't have been doing as poorly as we are doing now.

Thus, for us to go back to the growth rates of 8%-9%, our policy makers need to realise this fact and not just blindly take credit for something they had little hand in. We will be much better off assuming that we never had the environment in place to achieve high growth rates and thus work from that vantage point. This way, we would be forced to undertake some big bang reforms and not just minor tweaking here and there. Don't get us wrong. We do believe that India has the potential to grow at a fast pace for many more years to come. But we need a polity who is able to determine the right causes to be able to bring about the right effect instead of just botching it all up.

Do you think we would be able to revert to the high growth rate of 8%-9%? Share your views or you can also comment on our Facebook page / Google+ page

01:25  Chart of the day
India's demographic dividend will hold it in good stead not only in terms of growth but also in terms of limiting its public service expenditure. As today's chart shows, India will have to spend an extra US$ 70 bn towards primarily taking care of its elderly, way lower than what the US will spend. However, it is believed that even a small effort towards increasing the efficiency of public-sector could go a long way in bridging this gap. One of the reasons behind this increase is also the increased spending per person that the Government does once nations become richer.

Source: Financial Express

What valuation technique should one follow to eliminate the risk of business cyclicality? Though we believe there cannot be one absolute right answer, we believe the P/E (price to earnings) technique practiced by renowned American economist Robert Shiller is a good place to start. It must be noted that this gentleman is credited with rightly identifying the dotcom and housing bubbles. His version of the P/E technique tries to eliminate the effect of business cycles on valuations. He doesn't look at TTM (trailing twelve month) P/E or one year forward P/E. He calculates the P/E based on the average earnings of the last 10 years and adjusts them for inflation.

This, we believe, is a fairly appropriate indicator of the long term trend. Of course, you may not be able to time markets using this technique. You may even lose out of several speculative bull runs. But what this technique will really do it keep you in good stead over the long term. And most importantly, prevent you from losing your capital. Several investors who rode the dotcom bubble made manifold gains during the 1990s. But when the bubble burst, the tech stocks tanked so heavily that all those fancy profits were wiped off.

Steep rise in property prices. High interest rates. Disproportionate lending to real estate sector and towards home loans by banks. Do these read very similar to headlines of business dailies that you have read in the past few months? Well, it seems the story is not very different in other Asian economies. As reported by CNBC, a research report by Capital Economics has pointed at the similarities in credit boom across Asian countries. One that has fuelled a credit bubble in real estate over the past year. So much so that with property prices falling, NPA problems have surfaced in banks across the region. Of course that has been accompanied by slump in credit growth and lower GDP growth.

In fact the report cites that the situation is most worrying in Hong Kong, Vietnam and China. It even compares the situation in Hong Kong to that in Ireland prior to the financial crisis. Prior to the credit bust, the Irish economy expanded rapidly due to a low corporate tax rates and near zero bank interest rates. Needless to say the credit boom culminated in the whole economy going bankrupt! If that situation is to be played out throughout Asia, it is indeed worrying. The RBI has already warned banks to be careful about their NPA problems. But unless it enforces proactive provisioning, the situation in India may not be very different from that in rest of Asia.

A few months ago, Maruti Suzuki was in the news pretty much every single day. The reason for this was the labour unrest at the company's premises. The outbreak and strikes had severely hurt the company's manufacturing facilities leading to delays in production. The resultant loss of property, finances and life was written about in every single news daily. One thing that was highlighted in this event was the rigidity of Indian labour laws. Had they been more flexible, the company would have found a way out of its troubles much sooner.

This is exactly what the World Bank chief economist, Mr Kaushik Basu has suggested. In his recent visit he has stated that labour laws in our country need to be made more flexible. This would boost not just labour productivity but also the country's employment ratio. The thing is that flexible labour laws can give the companies the flexibility to change with changes in the demand pattern. Though a completely free market where the force of demand and supply flow uninhibitedly, is not recommended either. That would be disastrous as it could lead to exploitation of the labour force. But some amount of flexibility is required. The Indian government has since long been debating the changes to the labour laws. However fearing the trade unions these have usually been shelved at some pretext or the other. Hopefully now the government would make the necessary changes given their reformed outlook towards reforms in general.

No lure of the festive season is inducing buyers to make home purchases. The 24% surge in home prices over the last one year had made housing unaffordable for many. This has stunted growth in home loans, which slumped to a five-month low in September 2012. And no amount of attractive discount schemes or cut in home loan rates has really helped. According to the Reserve Bank's latest housing price index, house prices remained on an uptrend, up 24.1% in the first quarter (April-June), compared to an average of 20% over the last two years. Meanwhile banks have slashed home loan rates to no avail.

But nobody seems to understand the crux of the problem. Most builders and developers are focusing on building luxury homes for high net worth individuals. When the reality is that large part of the housing demand is from people looking for low cost and affordable homes. Developers, in the meanwhile, are not ready to lower prices despite unsold inventory. This should then translate into cash flow problems for them compelling them to lower prices and bolster volumes. But the ready availability of cash from banks and private equity has skewed the picture. Indeed, there are some structural issues that need to be addressed in real estate to solve the supply demand mismatch. Short term measures such as discounts and interest rate cuts can only help so much.

Meanwhile, Indian equity markets have been trading lacklustre right since morning with the Sensex nearly flat at the time of writing. Auto and oil & gas stocks are facing the maximum pressure. While majority of the Asian indices closed in the red today, Europe is showing a positive trend currently.

04:54  Today's Investing Mantra
"Even the best-trained investors would make the same mistakes that investors have been making forever, and for the same immutable reason - that they cannot help it" - Seth Klarman
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5 Responses to "Will India come out of its biggest crisis?"


Nov 7, 2012

I agree - the problem is bigger - we Indians hallucinate a lot. As net importer and a large market, India could have boomed post the US financial crisis exported globally, but India chose to continue navel gazing, and I believe there is a slim chance it will come out of it's present crisis.

Historically, in 1950's, US chose it's strategic ally as Pakistan over India, as it believed that India, with it's contradictions and mal-governance, would break apart in ~ 50 yrs. Since 1980's, economists talk in hushed tones of India trending towards the missed opportunity of the century, and I sincerely hope we do not end up joining the group of failed states. It could happen as the ship is rudderless.

While chances are slim, if we Indians are able to pluck our heads out of the sand collectively, vote in a decisive agenda of change, and actively participate in public and policy matters, we might hobble back by 2025.



Nov 7, 2012



kantilal b gorasia

Nov 7, 2012

In the existing atmosphere it may no be possible to achive high growth rate because we do not have trust worthy leaders to lead nation as it of our making.In fact we have created scams everywhere.People in government must think and take appropriate measure to correct the situation.



Nov 6, 2012

Fundamental structural issue is that the hardworking and law abiding are not rewarded but punished in our society, and the crooks, lazy and connected are rewarded. The real way to get the reforms done is by effective law enforcement, control on corruption, proper utilization of deployed resources, control subsidies, control black money in the system, stop the accounted money in the name of FDI, most importantly let the people have trust that if one works hard he/she will be rewarded in our system.


sharad sharda

Nov 6, 2012

In the present environment, one can not expect such a good growth rate of 8-9%. There is lack of political synergy, tactics of delaying decision for vested interests, lack of clarity on policy, mind boggling new incident of corruption coming on surface every morning and decreasing morale, will never allow the growth to reach to that level.

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