Will the floor fall out if ceiling is not raised? - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
Will the floor fall out if ceiling is not raised? A  A  A

PRINTER FRIENDLY | ARCHIVES
30 JULY 2011


We are coming to a crunch time. The US hits a ceiling of $ 14.3 trillion of debt on August 2. If the two political parties do not reach an agreement on how to reduce future Government deficits before August 2, and Congress does not raise the ceiling, the floor may fall out of markets. For, it would lead to a downgrade of USA's AAA rating, thus making future borrowings more difficult and more expensive. The Government would default on some of its obligations, either external (to creditors, making it more difficult to borrow) or internal (for entitlement programmes, making it more difficult to govern).

----------------------------- Mark Your Calendar. Global Crisis Starts August 2nd. -----------------------------

The global economy is in a crisis... And things are only going to get worse.

In fact, this crisis could get really bad on August 2nd and thereafter...

That's the day the US government could run out of money i.e. it will no longer be able to pay its bills.

You can well imagine the fall out of this on the global economy... there will be utter chaos, and stock markets could reflect this sentiment as well.

But how does that affect you?

Well, the chaos that this will trigger in the global economy will not leave India untouched.

And that's why you need to be really sure that your portfolio of stocks is Crash Proof.

How can you do that right away? Just read on to get access to a proven solution to crash proof your portfolio...

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The reason the two parties are unable to agree is because the ruling Democrats are unwilling to cut entitlements (as they go to the poor) whilst the Republicans are unwilling to raise taxes (which are paid by the rich) but insist on spending cuts and balanced budgets. This will have not only financial consequences but also geopolitical ones; China, e.g., recently flexed its muscles, intercepting a US spy plane over Korea and chasing it away.

A downgrade of USA's AAA rating would mean that T Bills, viewed as a safe haven investment, would not be so viewed. That is why gold is rising, and, in the absence of a deal by Tuesday¸ would rise even further. Perhaps, after the floor cracks and markets fall, US political leaders will panic and come to some sort of an agreement for a short term fix.

For a long term fix, the US has to curtail its spending and increase its saving. Individuals are already doing this; at the height of the dotcom boom individuals were net dis-savers, borrowing against their assets like houses (whose prices were then rising) in order to finance consumption (going on a holiday). With falling asset prices (homes, stocks etc) and fear of job losses, individuals are reducing consumption. Since this accounts for 70% of US GDP, it is little wonder that US GDP grew at a lowly rate of 1.3% in the quarter ended June. Any deal that will be reached will involve both a cut back in Government spending (which is keeping the economy growing, as consumers are curtailing spending) and an increase in taxes.

One can thus expect that the US would not be the world's prime growth engine and would, in all probability, have a poor 1-2% GDP growth for an extended period, much as Japan has been having, for two decades.

The economic growth engines would be the BRIC countries, especially India and China. Thus, this provides us with an opportunity.

That is if we are ready ourselves. But our political parties are as busy scoring political points instead of building the nation, as are the US politicians. Last week it was the turn of the BJP to face a corruption scandal in the state of Karnataka, compelling the Chief Minister, Yeddyurappa, to resign. The Lokayukta (ombudsman) filed a report alleging payoffs to him by companies engaged in illegal mining in the district of Bellary.

Bellary provides 20% of India's iron ore, required for steel manufacture and 80% of the iron ore, of very high quality, is exported to countries like Japan. Sadly, the way our country is run, the profits which, according to Mint of July 30, are 1300%, after paying bribes accrue to a handful of mine owners and politicians who turn a blind eye to illegal mining. One third of the people in the district live below poverty line and it has a literacy rate below the State's average. According to the Lokayukta report, the profits are siphoned off to tax havens¸ even as the district languishes.

The report also indicts companies like JSW Steel, NMDC and Sesa Goa, shares of which took a beating. In the case of telecom scam, Telecom Minister Kapil Sibal has warned that corporate warfare (for acquiring scarce but cheap spectrum) would undermine the success story of the sector. So also, the success story in steel can be undermined because of the corporate warfare to acquire scarce but cheap (due to low royalty rates) iron ore mines. The Supreme Court has ordered a closure of Bellary mines which contribute 20% of output, and will affect both production and margins of steel manufacturers.

Yet there is a case for pricing spectrum low, in order to pass on benefits to consumers, as a result of which we now have 750 m. mobile phone users as well as the lowest call rates. There is none for providing iron ore at criminally low royalty rates, which only benefits a few.

India's big advantage over other BRIC countries is its demographic profile. It will have a larger working population than a retiring one.

This is called the demographic dividend, and will allow the economy to grow for several years. Due to its one child policy, China is having the problem of facing an aging population, with more older people, living longer, than working ones.

However, it will be a dividend if we provide jobs for them. Where will those jobs come from. As the chart in this article 'The Half Finished Revolution' in the Economist shows () the service sector amounts to nearly 58% of GDP, whilst the share of agriculture has fallen to 14%.

Alas, about 60% of people dependant on agriculture get 14% of national income, a highly unfair proposition. This continues because they do not have job prospects outside. Industry, whose share of GDP is around 28%, can provide the jobs, but needs flexible labour policies for it.

The problem for industry is that there are far too many changes in a globalised world and it needs the flexibility to shut down (after paying compensation) or re-jig its operations. Our political leaders are unable to tackle organised labour, which, itself, is a fraction of the total labour force which is outside the purview of benefits granted to organised labour.

Our demographic dividend can well turn into a bounced cheque if we do not provide jobs fast enough.

Corporate results are showing the impact of higher interest rates on both top and bottom lines. Last week the RBI raised interest rates more aggressively than expected, by 50 basis points (0.5%) against the 25 expected. Public sector banks have had to make higher provision for non performing assets, resulting in a drop in the net profits of most of them. There were some good results, net profits of JSW Steel grew 64%, of ICICI 30, of HUL 26, of ITC 24, of BHEL 22 and of RIL 17. The interest rate hike by RBI can be expected to adversely hit sales of goods dependent on borrowing (houses, cars, white goods) and impact profitability of companies.

The Indian stockmarket was first hit by the aggressive interest rate hike on Tuesday and then on nervousness about the approaching Aug 2 deadline. The BSE-Sensex fell 525 points to 18197 and the NSE-Nifty dropped 151 to close at 5482.

It seems unlikely that US political leaders will strike a deal¸ which can lead to a rise in gold and a fall in stocks and bond markets.

Perhaps then they may listen to the market and strike some sort of deal, which would lead to a relief rally. Any sharp dip on news of a failure to raise the debt ceiling may thus become a buying opportunity. India's long term story remains good but no thanks to any political leadership or sagacity, which is difficult to expect our of fighting cats.

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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6 Responses to "Will the floor fall out if ceiling is not raised?"
Krishna Kumar
Jul 30, 2011
Hello Mulraj
I admire your analysis. I also request you to bring your insight in to the problems of Mumbai. There are multiple objectives to be achieved if government takes a call to move out of CBD of Mumbai like Nariman Point and Churchgate. If LIC , RBI, Sachivalaya and BSE take a call to move to more space in suberbs it will bring relief to millions of humans who suffer great indignities. This benefit will compensate for few dozens of Bellary issues. Government will make 200 Lakh crores enough to change Maharashtra for good.
Like 
sachi
Jul 30, 2011
Hello,

I do agree that whether US raises its debt ceiling, its going to have extended decade of slow growth to no growth.

14 trillion dollars of debt and raing the ceiling is disastrous. India is not a place without problems. We should not be all hunky dorry just becuase we are a citizen of the country.

India needs to get its act together

1. Infrastructure being the first thing. I have not seen any improvement in terms of infrastructure for past 20 years. By the time a fly over is built, car volume has increased so much that Flyover is choked :) :) :)
2. I cannot get my business proposal passed through the red-tape even today. Infact corruption is more prevelant today then it was earlier.
3. We dont have a very good political system. Current government is struggling and there is no opposing party. Thats a dangerous sign.
4. Consumption story on which we are relying is not a good sign. We will turn into America sooner or later. The first step has already been taken.
5. Lets not just rely on what news we get, check it out on ground level as well.

I am a perma bull, but i dont really see any reason why we should be in multi decade bull market.


Thanks
Like 
RJ
Jul 30, 2011
And the floor will NOT fall out if the debt ceiling is not raised. Like 
RJ
Jul 30, 2011
Reckless spending by the US government is keeping the economy "going" not "growing".
The US is a country built on debt and debt alone.
All that glitter is not gold it is debt !
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Sundaravaradan
Jul 30, 2011
An excellent summary of Global events, as can be expected from J.Mulraj!
My WISh and Hope is that, within next decade, Indian Ruppee will become fully convertible and become International trading currency, replacing USD !!

(Chineese Yuan is artificially controlled. India will the only other country having best growth and reasonable Legal framework) (of course, our Indian politicians are forced to reform themselves, by then ?!)
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sthgnjaithapr
Jul 30, 2011
Moolraj Ji,
Your prognosis, brilliantly reflected and echoed beautifully thus :""WILL THE FLOOR FALL OUT IF THE CEILING IS NOT RAISED "" (Both eminently apply to any building constructed over the ground or to the great
Economy viz; the US Of A)!!

I have (for the first time deciphered from the article the brilliant observation that in the US of A, the current battle of wits revolves around (the Poor whose interests are to be safeguarded by Democarats) Versus the Rich(whose tax paymentsare sought to be reduced by The Republicans )!!

How I wish that the "Powers-that-be " in our own country
could (instead of acting like "fighting fat cats??)do something to enhance the democratic dividend slowly gathering momentum for a great GROWTH STORY for our economy ??
I hasten to conclude with my humble Kudos for the article brimming with brilliant Wisdom, MR Ji !!
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