»5 Minute Wrap Up by Equitymaster

On This Day - 24 JULY 2012
Is India a bubble waiting to burst?

In this issue:
» India's labour reforms need a change
» Policy paralysis, the sole reason for India Inc's woes?
» Global economy in worst shape since 2009
» India stares at the possibility of a drought
» ...and more!

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When noted Morgan Stanley economist Andy Xie labeled India a 'black swan' we had to sit up and take notice. But to the basics first. What is a black swan This concept was first introduced by Nassim Nicholas Taleb. It is essentially a metaphor for rare and random events that are a surprise to the observer, have a major impact, but subsequently are rationalized with the benefit of hindsight.

Put this in India's context. It goes without saying the economy has slowed down in the past one year. But the stupendous rate at which India has grown in the years prior would leave no doubt in many minds that the country will not meet the fate that has befallen its developed peers. But Andy Xie thinks different. He believes India is a bubble waiting to burst. The prime reason he cites is that a lot of hot money has flowed into the country and has created a bubble. The problem is also that the money has not been used to build infrastructure, which can sustain the economy. He also believes that one should not be deceived by the high returns and capital in the nation because they will vanish without strong support from the industrial sector.

Indeed, if the bubble in India bursts, the shock will be immense and so will the impact. Though on hindsight, none of the factors that propel this crisis will be surprising. Indeed, lack of adequate infrastructure has been plaguing India for a long time now. And we all know that its current problems are on account of a bloated deficit and lack of reforms.

It all depends on how the government chooses to tackle these problems. Growth is yet not an issue because the country is still doing better than its developed peers. But if the government swings into action and takes important measures to bring debt down and ramp up infrastructure, not only will a crisis not take place, but the possibility of an 8% GDP growth on a sustained basis could be well within reach.

Do you think that India's growth is a bubble waiting to burst? You can also share your comments with us or post your views on our Facebook page / Google+ page.

 Chart of the day
With the rupee falling so rapidly, exporters in India would largely stand to benefit in the form of higher earnings. And to some extent, higher volume of exports would also help ease some of the pressure off the government deficit. However, today's chart of the day shows that compared to other countries, India's exports in value terms in 2011 were quite lower. There is an upside to this as well. India is an economy driven by domestic consumption. One of the reasons why that made it resilient to the 2008 global crisis was that unlike China which was heavily dependent on exports, India could bank on consumption back home.

Data Source: The Economist

'We are facing this situation due to the conditions in the western world'. How often have you heard this lament from policymakers of emerging markets? All the time, isn't it? Even India's policymakers cannot be absolved of such blame. However, if The Economist is to be believed, external factors explain only a small portion of the volatility in GDP growth of emerging nations. As per the magazine, curbing domestic credit and keeping currencies flexible can prove to be of big help in tiding over the crisis.

India certainly cannot be faulted for the latter. Its currency isn't as rigid as say like China. But it could certainly do its economy a world of good if it keeps debt under control. Its fiscal deficit condition is nothing to write home about, causing inflation and slowing down growth due to crowding out of private investments. Thus, unless it brings the deficit under control, the long term sustainable growth isn't 8%-9% as we have come to expect. It is more in the region of 6%-7% we believe. And this seems to be true for all the BRIC nations.

When it comes to unemployment, states in India are more diverse than their cultural lineage. The likes of Bihar, West Bengal, Tripura and Kerala have unemployment rates that are nearly triple the national average of 3.8%. Haryana, Himachal Pradesh and Gujarat on the other hand have covered themselves in glory when it comes to job creation. However, the latest instance of labour unrest in Manesar shows that all is not well. Not even in states that claim steep employment numbers. A change in the country's labour law is therefore paramount.

A recent survey of job trends across states has challenged the conventional wisdom. That pro-worker policies protect jobs and ensure higher employment has been proven to be false assumptions. None of the communism inclined states like Kerala or West Bengal have achieved much in job creation. On the other hand, the more reformist states like Gujarat have sprinted ahead. However, labour reforms cannot just suit the need of workers. They must meet the requirements of companies and investors as well. The overall ease of doing business needs to be conducive for entrepreneurs and investors.

Policy Paralysis! These days, any reference to the Indian economy seems to be incomplete without this term. For starters, the term refers mainly to government inaction on reforms and initiatives that are vital for the health of the Indian economy. On one hand, policymakers shift the blame on the sorry state of the global economy, especially the crisis in the Eurozone. Of course, in part, India's growth has been affected by the slowdown in the global economy. But the other reason is the government's failure to initiate some tough reforms. For instance, the high fiscal and current account deficits are nothing but the government's own doings. There is no foreign hand involved here. Ditto could be said about the corporates. To what extent would it be appropriate for them to blame the government? If all their future prospects are dependent purely on the government action, then they are certainly bad businesses. Investors should certainly steer away from stocks that are too heavily dependent on government policies.

During the dark days of 2008-2009, companies were on the brink of bankruptcy. But this time around, entire countries are on the edge of disaster. Six of the 17 nations that use the Euro are in recession. The American economy is still struggling. And the developing world countries - China, India and Brazil - are in no position to pull the world safely back to shore. Growth is very evidently slowing in the emerging markets. In consequence, the International Monetary Fund has reduced its forecast for world growth this year to 3.5%, the slowest since a 0.6% drop in 2009. All in all, the global economy is in the worst shape since the dark days of 2009. This is one of the negative fall outs of globalization. No nation is fully decoupled and there is literally nowhere to hide.

Although monsoon rains have now covered all of the country, India is still staring at the possibility of a drought in some regions with rains 22% below a 50-year average so far. It is most likely that the government will have to announce a drought within a fortnight. The center and the states are now gearing up for contingency plans. The lower rainfall could result in output of summer-sown crops such as oilseeds, sugar and pulses to fall. As a result the government is making available enough seeds for all crops, including coarse cereals and pulse. The government will increase the availability of electricity and diesel to the grain-bowl northern region. This will help farmers draw ground water so that the yield of rice is not affected. It will also increase the subsidy for the supply of pulses through the government's welfare program to poor families to meet any shortage. If these measures are not properly implemented, the drought could further hurt India's already slowing economic growth.

In the meanwhile, the Indian equity markets shed initial gains and were trading weak. At the time of writing, BSE Sensex was down by 10 points (0.1%). FMCG stocks along with consumer durables and oil & gas stocks managed to stay in the green. All other sectoral indices were trading weak. Asian stock markets displayed mixed sentiments.

 Today's investing mantra
"Many investors seem to have forgotten the hard reality. There are frequent periods when the stock markets don't do much." - Jim Rogers

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