Borrowing from our children's future

3 JULY 2010

The developed world has been growing, for several decades, by borrowing from the future. Most Governments now have a pile of debt which is several times the GDP. Japan's is at 471% of GDP, followed closely by the UK at 466%, Spain with 366%, and Switzerland with 314%. The US, at 286%, is just a shade better. The debate now is whether the developed world should continue with fiscal and monetary stimuli to sustain economic growth, as they have been doing for the past two years, which will only increase this debt mountain, or whether to start going in for fiscal austerity, as the UK and Germany have started doing.

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In contrast, the BRIC countries have lower levels of debt showing far more fiscal commonsense and prudence, even though these countries have a lot of spending for infrastructure needs and for social welfare needs. Perhaps there are quite a few lessons the developed world could learn from the emerging countries. Not only in the management of economies but also in managing companies! The three headline grabbing global acquisitions of Corus, Jaguar-Land Rover and Novelis, have all turned around and become profitable.

In the US interest rates are just above zero, providing no further room for monetary easing. A continuation of easy money policy to spur consumption basically means borrowing from the children's future to whom you are bequeathing a mountain of debt, incurred to allow you to consume more. Following austerity measures would mean aenemic economic growth, which would not drive investors wild. Following easy monetary policy would mean building up inflationary pressures, with a result that the cure may become worse than the disease.

There is no easy solution. The attempt made to spur economic growth through fiscal and monetary stimuli has been made; it has staved off a complete disaster but has not resulted in private investment taking over from the Government, as desired. So the developed economies, especially the Eurozone and Japan, would have years of poor economic growth; the US, because it is more flexible and because of its technology (such as developing shale oil/gas as a replacement of fossil fuel, or trying to sell technologically superior fighter planes to India in a multi billion $ deal), will do better.

The BRIC countries are doing better, China and India are both growing at over 8% and have much lower debt levels, China with 158% of GDP and India with 129%. Mindful of rising inflation, the RBI raised both repo and reverse repo rates by 25 basis points to 5.25% and 4%, respectively. Rightly so, as it will help avert a future problem.

The philosophy of consumption led growth has other consequences, besides the high debt levels to finance it. The gas guzzling American way of life has resulted in increasingly desperate ways to find the crude oil that supports it. As the easier-to-find fields are depleted, the hunt for crude has taken oilcos deeper into the ocean. The deep sea hunt by BP was done at a depth of 5000 feet or more, and is a hunt fraught with peril. The accident it suffered has enormous and lasting environmental consequences, for the rig, weighing thousands of tons, has collapsed atop the leak. It has first to be pushed, at a depth of 5000 feet, before the leak can be plugged. Till then the oil will spill, destroying phytoplantons, which are responsible for much of the oxygen present in Earth's atmosphere - half of all they oxygen created by plants in fact. Hence the craving for mobility, driving the hunt for oil to riskier terrains, combined with the greed of investors, which blinded the rig manager to the risks of continuing exploration even when warned, is creating an environmental problem of unjustifiable magnitude.

The recent decision to raise prices of petro products by India is thus right, both from a fiscal and an environment point of view. The Government must also introduce, immediately, fuel efficiency norms, specifying the expected mileage from each category of vehicle, according to engine size. These must be tightened every few years. Environment Minister, Jairam Ramesh, is planning to introduce them in 2011, though it ought to have been done much earlier.

Corporate India is, however, abuzz with activity. R Comm merged its telecom tower business with GTL in a deal where it will get cash, which will help reduce debt by Rs 18,000 crores, and its shareholders will get shares in the merged entity. Anil Ambani's holding in the new entity would be 26%. RNRL and Reliance Power are expected to merge, as gas supply can only take place to RNRL if it has a power plant, which it doesn't.

RIL is looking to partner a state owned Mexican company, Pemex, to develop a green field refinery plant. It is also looking to enter the financial services sector, now that there is no non-compete agreement preventing it from doing so, in a likely arrangement with D E Shaw.

Vedanta proposed Rs 12,500 crores aluminium plant in Orissa may finally take off after clearance by the PMO and will provide some 20,000 jobs. Kotak Bank sold a 4.5% stake to Japanese Sumitomo Mitsui Banking Corporation, for Rs 1,366 crores.

Fortis Healthcare has taken up the gauntlet thrown by Malaysian sovereign fund Khazanah, and offered to buy all outstanding shares of Singaporean Parkway, for S $ 3.8, two cents higher than Khazanah, which offered to buy only 51%. The group, after selling its stake in Ranbaxy, is concentrating on healthcare and on financial services, through Religare Securities, which is fast becoming a recognised global player.

The BSE-Sensex fell 113 points over the week, to end at 17460 and the NSE-Nifty dropped 31 to close the week at 5237. Global cues affected sentiment and will continue to do so. Debt levels of developed countries are unsustainably high. They will need to raise interest rates and this would negatively affect economic growth. As interest rates rise, their relative attractiveness to equity increases. Better to await more attractive buying opportunities, although the long term India story remains good.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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