»5 Minute Wrap Up by Equitymaster

On This Day - 25 NOVEMBER 2014
Our 'US$ 10 trillion' dream will not come true unless...

In this issue:
» Surprising revelations about China's labour laws
» India's low R&D spend a huge drawback
» A currency war in the making?
» Roundup on markets
» ...and more!

 Chart of the day
When it comes to generous doses of optimism, India has had more of it in the past 6 months than in the past 7 years. Every analyst, economist, fund manager and consultant seems to be finding consensus in the opinion about India's brilliant economic prospects. So much so that some of the assumptions behind their sugar coated predictions make up for our daily dose of humour! Now, don't get us wrong! We are certainly not trying to play the devil's advocate by undermining India's economic road map. Nor are we naysayers to the possibility of India emerging as a much stronger economy over the next few decades. In fact we have identified seven very visible signs of India entering a Golden Decade Megatrend. But the attempt of the business media to glamorize India's ascent makes it ridiculous. Most of the predictions that we have read over the past few months make the India revival story sound like a fairytale. And that according to us is intended to build in greed amongst investors, rather than rational thinking.

Take the PwC report on India becoming a US$ 10 trillion economy for instance. Now the size of India's economy at the end of 2013 was about US$ 1.87 trillion. Expecting it to reach US$ 10 trillion (grow 5 times) is certainly not an impossible dream. However, hoping that the dream will be realized with over ambitious targets can lead to varied misconceptions.

The report expects India's GDP to cross the US$ 10 trillion mark by 2034. Two decades is a long time you would say. However the base assumption for this prediction is that the economy will grow at an average rate of over 9% per annum. The argument that if China could do this, why not India, also does not work here. For China's government enforced infrastructure spending and export driven model had a huge role to play in its growth. China managed to piggy back on the growth in the US and Europe during their heydays. India's growth, however, will be contrasted by a slowing global economy for a long time to come.

Most importantly, the 9% GDP growth estimate relies heavily on job creation. It expects the economy to create 10 to 12 million jobs every year. Given that the country currently produces 5 million graduates every year, 50% of which are found unemployable, the target seems ridiculously steep! The fact that the share of unemployment is highest amongst the more qualified population in India is most worrisome. And without enough efforts to adequately skill India's educated youth and make it employable, the higher GDP growth is never going to come.

Share of unemployment amongst educated populace

Plus in its hurry to accelerate growth, the Indian economy will have to confront some herculean challenges. As Vivek Kaul has aptly put it in the Daily Reckoning, the quality of assets in PSU banks in India is itself a ticking time bomb!

Thus investors should read these predictions about the Indian economy while remaining aware about the challenges ahead. Buying stocks based on feel good assumptions could be fraught with risks. And giving in to the greed of participating in India's 10 trillion dollar growth story without paying heed to valuations, could do irreversible damage to your portfolio.

Do you find the prediction about India's GDP touching US$ 10 trillion by 2034 realistic? Let us know your comments or share your views in the Equitymaster Club.

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Interestingly, however, a recent OECD survey about the factors that make China relatively more attractive investment destination compared to India threw up some unknown facts. China's business friendly policies are known to be the key reason for its ability to attract investments. Most of the investments that come into the country by way of FDI are into manufacturing sector. Moreover, India's manufacturing sector is understandably in a mess thanks to the country's archaic labour laws. However, as per the data shown in OECD's survey, China's employment protection legislation and product market regulation are almost as restrictive as India's. Further, China fares worse than India in the Barriers to FDI indicator. This is because the dragon economy is far more restrictive in FDI in select sectors than India.

Thus, the India versus China Megatrend, going forward will depend on how each of the economies bring in reforms to correct their respective drawbacks. Putting in place policies to make India's manufacturing sector more attractive than China's can be the easiest way to tilt the balance in India's favour. And the 'Make in India' drive is indeed a good start.

Having said this, the fact is that economically speaking, China is well and truly ahead of India. A lot has been said about China's infrastructure, policy making and manufacturing strength. These factors are often blamed for India's slow economic progress. While these are certainly important, let us acknowledge the elephant in the room: innovation. Is it really surprising that every advanced economy in the world has been driven by innovation? How does India fare on this front? Unfortunately; we don't do so well. In the latest Global Innovation Index 2014, India has dropped by 10 places to the 76th position.

For a country that prides itself on its engineering and scientific talent, it is shameful that India spends just one fifth of the amount spent by China on R&D. In the 21st century, economic growth will be largely driven by intellectual assets. Research has shown that countries with strong IP laws attract more FDI & produce more patents than ones which do not. India has a long way to go when it comes to encouraging and protecting intellectual property. Although we have taken some steps in the right direction, a lot more work needs to be done. Without enforcing strong laws which promote and protect IP rights, the government's 'Make in India' campaign is unlikely to be a big success we believe.

No discussion about China's economy is complete without the mention of its currency. It is well known that the dragon nation has kept its currency artificially low in the past. This was done to provide a boost to the export sector which was the main driver of the economy. As China slows down, this trick will be tried again. Only this time, it may not work.

The economies of Europe and Japan, China's large trading partners, are in dire straits. Japan is already in recession and Europe is barely registering positive growth. Thus, their central banks have responded with heavy doses of money printing. This flood of money has had the effect of suppressing the Euro and the Yen. To understand just how much these currencies have fallen recently; consider this. Against the US dollar, the Yen is trading at a seven year low and the Euro is trading at a 2 year low. In such a scenario, it will be extremely difficult for China to devalue its currency.

If it does so, it will effectively be declaring a currency war. This would be a zero-sum game. There are no winners in such battles. We believe if China goes down this road to boost GDP growth, it will be playing with fire.

After opening flat, the benchmark Indian indices slipped into the red as the session progressed today. The BSE Sensex was trading lower by 200 points (-0.7%) at the time of writing. In the midst of broad based selling, stocks from the energy and pharma space were the only gainers. Asian markets were mixed with Chinese markets leading the gains and the Hong Kong markets leading the loses. Most European markets were trading firmly in the green at the time of writing.

 Today's investing mantra
"The individual investor should act consistently as an investor and not as a speculator. This means that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money's worth for his purchase" . - Benjamin Graham

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