»5 Minute Wrap Up by Equitymaster

On This Day - 26 FEBRUARY 2013
Is democracy failing?

In this issue:
» India abandons idea of a sovereign wealth fund
» India seeks more taxes from MNCs
» Govt. faces another failure in spectrum auction
» HR challenges for new bank license holders
» ...and more!

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If history has taught us one thing it is that democratically elected governments have ultimately led to economic progress over a longer period of time. The Western countries of the US and Europe are testimonial to this fact. After all, they have not developed the 'rich world' status for nothing. These countries became rich because their citizens overthrew the elites who had more power. This to create a society where political rights were more equally divided. What is more, over the years other style of governments did not really work. The Arab states are a prime example of this. Years of autocratic rule or dictatorships have led to the series of uprisings in these nations in recent times. Most of the countries in Africa are mired in poverty and civil wars largely due to the lack of meaningful democracy.

But this western style democracy is facing challenges like never before. In the West atleast, politics are increasingly becoming more focused on promises and ideals rather than pragmatic solutions. So you have a situation in the US where the recent governments have made big spending promises to citizens. But they have no resources to fulfill them as debt has kept piling up. Similarly, the Euro is also being severely tested as the formation of the single currency was probably based on the European ideal. But practically speaking this was always going to be a challenge given the different rates of growth and development in each of those countries. Thus, today, in the aftermath of the global financial crisis it seems more and more likely that the Euro could break up if certain countries forming part of it do not recover.

Politics in India is no different. Promises are made for the uplifting of the poor, or on the basis of religious ideals. But there is not much focus on practical solutions to the problem at hand. That is why we have seen disruptions in the Parliament in recent times. The ruling and opposing parties have not been able to come to an understanding on virtually most of the important issues. While development is considered important, most are quite clueless or do not have the willingness in its execution.

Of course this is not to say that democracy has failed. Despite challenges, in the longer term it is still the best form of political system that can ensure the economic well being of any country. But governments need to take more efforts to understand the underlying problems of their respective nations. They need to focus more on practical solutions to these issues if the countries have to prosper in the future.

Do you think that the current form of democracy is not helping much in economic development? Please share your comments or post them on our Facebook page / Google+ page

 Chart of the day
The global financial crisis had many repercussions on the developed world. One such was the rise in unemployment. It was hoped that monetary measures adopted by government would propel growth and bring down this number. But unsurprisingly, this has not happened. Most of the countries are still down in the dumps. And the unemployment rates remain bleak as well. Because of the lack of recovery most of the workers unemployed during the 2008-09 global crisis have been losing touch with the world of work. That is why as more time passes it has become difficult for them to find work. And this shows in the statistics as well. As today's chart of the day shows, barring Germany, long term unemployment rates have increased across most countries. And the situation is not likely to improve anytime soon especially if governments continue to interfere in the economy. Indeed, we believe that money printing is not the answer to job creation or GDP growth. Instead governments should focus on industries and infrastructure.

*or more
Data Source: The Economist

Have you ever tried using the borrowing limit on your credit card to buy stocks? This under the presumption that the money you make in stocks could ultimately be used to repay the credit card debt. The idea seems quite risky, isn't it? In fact as per us, it almost borders on stupidity. Still, for long now, financial advisors to the Indian Government have been toying with an idea along similar lines. And this idea is known as the sovereign wealth fund. Essentially, the idea of a sovereign fund was floated with an aim to counter a similar fund by Chinese who were buying up global resources left, right and centre.

But what was not taken into account is one crucial difference we believe. China is a current account surplus nation. In other words, it exports way more than it imports and thus generates huge amount of surplus capital. India on the other hand has mostly been a current account deficit nation. It consistently borrows from abroad so that its imports needs are met. And such a position does not give us the luxury of creating a sovereign wealth fund. Simply because the money that will be contributed towards the fund will not be ours in the first place. Thankfully, good sense has prevailed and the idea has now been shelved by the Finance ministry. Let's just focus on getting our house in order in the first place. Concepts like sovereign funds can be taken up later.

Multinational companies (MNCs) may boast of big brands and solid balance sheets. Given their healthy cash flows, many also sport the highest return on capital employed. However, few are known to cater to the interests of minority shareholders. In fact, more often than not, they prefer to delist the venture. Particularly if parent entity comes under regulatory scanner and is uncomfortable sharing capital allocation and growth plans. Indian tax authorizes, however, have been keeping a close watch on the activities of MNCs. And it goes without saying that the latter's tax evasive policies have not gone down too well with the authorities.

As a result, India is seeking billions of dollars in taxes from some of the world's biggest MNCs like Royal Dutch Shell and Vodafone. The demand is on the inter subsidiary transfer of funds that according to IT department are improperly valued. Readers may note that MNCs frequently buy shares of overseas units as a way to inject cash into the overseas units. This is one of the many ways of tax evasion. Now, levying higher taxes may be seen as a dampener to foreign investments. However, we think the IT department must do its duty in demanding what is rightfully due.

Any entrepreneur would agree when we say that pricing is one of the most important thing when it comes to goods and services. This is true not just for the goods and services offered by companies but also true for resources. If the price is too high, there would be no takers for the resource. Of course there are other factors that influence demand but price is a key thing. So it was not really a surprise when telecom operators cold shouldered the spectrum auction in November last year. The price was just too high for any of them to participate in a meaningful manner. This was a slap on the face for the government which was quite confident that the auction would be as successful as the 3G auction had been. The lackluster response led it to reconsider the price.

Yesterday, it offered spectrum in 4 key circles at a price which was nearly 30% lower than the November's reserve price. But yet again, the operators shunned the auction. The only bidder was Sistema Shyama who is desperate for spectrum post the Supreme Court's order to shut down operations in circles where its licenses were cancelled. The operators have been crying hoarse that the government has to price the spectrum in a conducive manner. The sector is already facing the hardships of intense competition and high costs. And during such times if the government decides to squeeze more cash out of it for meeting its own deficit targets; then obviously the operators would put up a fight. Maybe the government should sit down with the operators and discuss things with an open mind. That would help them with more successful auctions. No point in coming up with one auction after the other if they are all going to fail.

New banking licenses contenders have a tall task ahead of them. The banking industry is anyway facing a human resource challenge as a number of employees are retiring every year. New banking license holders will have to compulsorily have 25% of their branches in unbanked rural areas. These new banks will have their task cut out in finding skilled employees to work in such branches. PSU banks, especially State Bank of India, Bank of Baroda and Punjab National Bank will be a major hunting ground for talent. These banks will consequently face attrition issues. Better compensation and more recognition will drive mid-level associates to these new banks. For lower level employees, hiring can happen from Tier 2 and 3 cities. We believe that setting up new branches and paying exorbitant salaries to employees will raise the cost to income ratio of these new banks significantly. It will also take a lot longer for these new branches to break even. Speculators have been piling on the stocks of the banking license hopefuls. But, long-term investors should consider the various operational issues and competition that these new banks will face.

In the meanwhile, the Indian equity markets extended their losses during the post noon trading session. At the time of writing, the BSE-Sensex was down by nearly 200 points or 1.1%. Barring stocks from the information technology and FMCG spaces, selling pressure was seen across the board. Asian markets ended the day on a weak note with China, Hong Kong and Japan down by 1.4%, 1.3% and 2.3% respectively.

 Today's investing mantra
"Stock speculation is largely a matter of A trying to decide what B, C and D are likely to think-with B, C and D trying to do the same." - Benjamin Graham

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