Light at the end of the European tunnel?

29 OCTOBER 2011

European leaders struck a deal with Greek debtors, who agreed to take a 50% haircut (which would reduce Greek Government debt to 120% of its GDP, which EU leaders believe can be serviced) in the hope to be able to recover the balance 50%. That piece of good news, combined with a stronger than expected 2.5% GDP increase, at an annual rate, in the US, cheered global investors and catapulted the sensex 515 points, or 3%, on Friday, a belated Divali gift.----------------------------- Don't Miss! Best of The Daily Reckoning... -----------------------------

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The EU leaders also shored up the EFSF (European Financial Stability Fund; a lot of Fs in one word though) to 1 trillion euro, to give it enough firepower to serve the needs of European banks when other weak countries would come, as they will, under attack. Is this the light at the end of a gloomy tunnel? Markets rallied globally after the news, indicating that investors, fed up with the abysmal returns on moneys parked in the safe haven of US Treasury bonds, found the news cheerful.

If Greek were the only distressed economy, this surely would be the light at the end of the tunnel, but then again, if Greek were the only economy, global markets would not have been as depressed. European economies, however, resemble the hat being passed around, for donations, in a church, though with the difference that here the parishioners are more willing to pull something out than put something in. Italy seems to be the next wobbly ninepin; its coalition Government cannot agree to the needed fiscal austerity measures to get a bailout. Perhaps the coalition partners are chagrined at not being invited to Berlusconi's bunga bunga party. The EU is asking Italy to reform its labour markets and improve its infrastructure (sounds just like India). Just like in India, coalition partners, more focussed on removing the opposition than on improving the country's economy, will not permit any meaningful reform.

And then there is Spain. Maybe France!

The other news that lent cheer was the better than expected GDP growth in the US, at an annual rate of 2.5%. This was fuelled by higher consumption (and lower saving) by US households. This raises questions about how US debt, untenably high and rising, would be repaid, if people are saving less. In contrast, UK has had the highest household savings rate, at 7.4%, in the past two years.

How does the Indian economy compare? It is most certainly better than Europe and the US. Forecast for GDP growth, which was over 8.5% at the start of the year, has now been tapered down to below 8%, sacrificed to curb inflation. The Reserve Bank of India RBI raised interest rates, by 25 basis points (0.25%) for the 13th time in succession. However, it indicated that we may be close to the end of the rising interest rate cycle, which the market viewed positively.

But is monetary policy enough to tame inflation? No.

Not when the public sector, which is far less impacted by market signals, continues to account for a large chunk of the economy. As per a recent survey "Adventures in Capitalism" in the Economist of Oct 22, public sector firms accounted for 41% of profits of the top 100 companies. They dominate in the energy sector (ONGC and Oil India in upstream, IOC, HPCL and BPCL downstream, and GAIL) and in the banking sector, where PSU banks still have 70% of the nation's deposits.

We have seen how Government, till recently, controlled prices of petro products, to the financial ruin of the downstream companies. It continues with them on certain products like kerosene and LPG, withdrawing the subsidies in a socially acceptable pace. However, the interest rate policy would not send price signals to these firms.

The recent (RBI) policy freed up interest rates on deposits, and some private sector banks, like Yes Bank, immediately announced a hike to 6%. Till now the RBI interest rate policy did not send any signals, since interest rate could not be set by the banks.

Similarly, the Government's welfare schemes are also impervious to RBI interest rate hikes.

So RBI Governor, Dr. Subba Rao is not, by himself, Atlas, to take on his shoulders, the weighty responsibility of curbing inflation on his solitary shoulders. Pranab must lend a hand by reining in expenditure and controlling the fiscal deficit.

One has spoken about the propensity of politicians, whether in Italy or in India, to be more concerned about their own political future rather than the country's future. So the only way to bring the fiscal deficit under control is to link it to the political future of the sitting MPs, who pass laws. Warren Buffet's excellent suggestion is to penalise all sitting MPs for failure to keep the fiscal deficit to within a targeted amount of GDP, say 4%, by telling them that in the next election, they would lose, say, 20% of their votes if they do not manage to control it! One would then see such exemplary sensible behaviour from those who are otherwise known to fling furniture.

One option, of course, would be for Government to jettison irretrievably sick PSUs like Air India, in which they continue to pump in money. The Group of Ministers is meeting to discuss a further infusion of equity into it (a bottomless pit) whilst simultaneously depriving banks like SBI and Union of capital which the RBI says is sorely needed to maintain capital adequacy. SBI got downgraded as a result. Such a policy of depriving food to those who are hungry but able but continuing to feed the gluttonous and inept, is inexplicable.

It is not the preserve of India - there was a news item of a nurse in California raking in some $ 590,000 in overtime, even as the State laid off teachers for inability to meet their salaries. Civil Aviation Minister Vyalar Ravi says, however, that a sale of stake is not on the cards. The woes of Air India affect others - it owes, for example, Rs 2300 crores to public sector oil marketing companies who are forced by the Government to continue supplying it with fuel, never mind the interest cost of doing so! The OMCs, in turn, have been bankrupted by the subsidies on petro products and were being bailed out by upstream companies. A sort of incestuous merry-go-round.

The market rallied sharply on news of the EU bail out of Greece and funding of the EFSF, and the better than expected GDP show by the US.

The BSE-Sensex rose a whopping 1119 points, ending the week at 17804 and the NSE-Nifty was up 320 to close at 5367.

What next? The sensex level of 18500 presents the next resistance.

What would cause the rally to falter? Another crisis in Euroland, maybe? Only those with nimble feet may enter.

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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9 Responses to "Light at the end of the European tunnel?"

Akhil Banthiya

Nov 9, 2011

The next reistence level can be seen at 18,500 pts, if the coalition govt of Italy approves to the bail out deal.
I think the suggestion given by warren buffet must be taken into consideration by the european union for penalizing the vote bank of the politicians in case of Fiscal deficits occour.
The monies recieved by Iyaly and greek in the bail out would ultimatly get invested by them in the emerging economies like india, this is also because of the fact that the european countries would not like to see the hyper inflationary conditions which may turn out due to the bail out deal and thus in order to avoid such hyper infation they would invest the moonies emerging econimies like india.
On the other hand if the bail out deal does not take place than it would lead to depression in the debt defaulting countries like greece nad Italy.
Thus, in order to avoid hyper inflation as well as depresion situations it is important that the bail out deal occour and the monies recieved being ultimatly be invested in emerging economies like India.


Hasit Hemani

Nov 7, 2011

Mr J Mulraj, you really hit the nail on its head. A rare skill.



Oct 31, 2011

One of the contributing factors for inflation in India is MNREGA which is nothing but the official bribery of rural Indians using Taxpayers' money.It is nothing but aimed at garnering votes for the UPA and heavens! IT WORKS!.Come next elections and the payout will be substantially hiked.Who will bear the brunt?You and me.
All that talk about "empowering" the rural masses by this MNREGA,is a complete hogwash.



Oct 31, 2011

I totally agree with you. The government should get out of the loss making airlines business. there are enough private firms ready to serve the airline industry.

why should the government spend thousands of crores of taxpayers money on loss making airline business??



Oct 30, 2011


How about providing some answers to the govt. GOM should take a very very bold step and sell Air India to top bidder. At least the numerous properties it owns would be worth sum substantial value to the buyer.

Secondly, instead of looking for profits from sale of equity and making an attempt to reduce the deficit, it can sell these shares to retail indian investors. The holding can be restricted to 500 / 1000 shares per individual. The offer price has to be at a substantial discount. The loss it is going to incur in sale at a reduced price can be offset, by announcing at the issue time that no dividend will be issued for say 5 / 6 yrs and the profits will be retained by the company to make good the loss at the issue price. Retailers will be able to get appericiation, hopefully the share would be at double the price within the next five yrs. In other words, the retailers investment will double in five yrs. This would be an incentive than keeping monies in savings account or any fixed deposits. After five yrs, govt can give dividends depending on the profitability.
Further incentives if necessary could be added, no capital gain tax for next ten yrs etc., The issue has to be to individual investors only, No institution/Company Pvt or public/ firm or any group of people would be allotted any shares. Nor can these people accquire shares from the market at least for the next five years.In short, the issue would be for Individual investors only with a cap of 1000 sh. per individual. Benami shares would be confisticated.Submission of PAN No. is compulsory.
Once listed,Individual investors can buy these shares from the market also. And if they wish to accumalate, well fair enough.At least that would be at market rates.
Moreover these shares will be in trade to trade category for a minimum of 2 years, ie. No day to day trdg, no speculation, No derivaties, PLAIN AND SIMPLE INVESTMENT AND APPERICIATION OF INVESTMENT. FOR THE PUBLIC AS THE COMPANIES BELONG TO THE INDIAN PUBLIC.

Surprising if a common man can think of such a way, what are the IAS / IFS beureacrats/ Ministers are worth????????????????????????????????? nn???????????????


Laxman Suvarna

Oct 29, 2011

Unnatural exuberance building up another potential bubble in stock markets across the world!



Oct 29, 2011

World wonder number one is the manipulative economy of US which continue to print currencies to overcome inflation than working on normal sound economic principles which result in world recession and savings of poorer countries are eaten away by over debted US citizens. When will others wake up to reality or when will US economy collapse to set right the world clock in order. Only God knows when?


Andrew L D Cunha

Oct 29, 2011

Yes, we can see a light at the end of the Eurozone tunnel - a light of INCOMING TRAIN. So be prepared for the danger.



Oct 29, 2011


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