Several cliffs loom ahead - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Several cliffs loom ahead A  A  A

15 NOVEMBER 2013

Indian stock markets, as also global ones, are buoyant, despite the dangers of the several cliffs looming ahead.

  1. The over-indebtedness cliff: Everyone knows this one. Almost all developed countries, led by Japan, have unsustainably high levels of national debt. Yet the leading nations, starting with the US ($85 b. per month), Japan ($ 75b. per month), EU, etc. continue with the policy of quantitative easing. This is intended to boost the economy by providing liquidity to consumers for spending and thus create economic growth with employment. It hasn't worked out that way. The money has gone into assets, such as global stock markets, into bonds, into select real estate, and other assets, creating bubbles (which will ultimately burst, causing more pain) and have not created economic growth or employment simply because the liquidity is misdirected. In the quarter ended Sep 13, the Eurozone has grown its GDP by barely 0.1%. Japan kicked in with a 1.9% annualised GDP growth rate in the Sep quarter, half of 3.8% in the June quarter, and 4.3% in the March quarter, after Abenomics started, with a $ 75 b. monetary injection. So the cliff of over-indebtedness has not solved the problems that caused the indebtedness, but has created asset bubbles which will pop some time, with serious consequences.

  2. The energy shortage cliff: A lot has been written about peak oil and that the world has reached a peak in production of the easier to find fossil fuels. Much has also been written about (including in this column) the new technology of horizontal fracturing, or fracking, which has allowed extraction of oil and gas from tight formations. The US is placing a huge emphasis on shale oil and gas, with estimated reserves higher than that of Saudi Arabia's crude oil, to bring back manufacturing, attracted by low energy cost, and thus propel GDP growth and employment. It then hopes to pare down its debt. But, while it is true that the US has reserves of shale oil and gas aplenty, there is a cost associated with its extraction. As this wonderful, must read blog explains, our oil problems aren't over yet. The easy to extract shale reserves have been extracted and now, merely to maintain production of shale oil/gas, the US has to spend some $ 30b. annually. In order to attract finance for this investment, the price of crude oil must remain above $ 100/barrel. And, presuming China and India's economies grow, and the affluence results in a higher demand for petro products, the reserves of fossil fuels will vanish and prices will remain high, to allow extraction of tight oil. Hence we cannot expect a drop in the cost of energy to boost global economic growth.

  3. The nuclear cliff: In its quest for energy, humankind has tapped nuclear energy, and we are now facing prospects of a nuclear disaster that would be much worse than Chernobyl. Building number 4 at the Fukushima nuclear facility in Japan, which was damaged by the typhoon, is in a dilapidated state, and has no walls. Yet it holds some 1500 fuel rods, each of 300 kgs, and containing plutonium, which are precariously perched at a height of 18m. These rods have been damaged. In a week or two, TEPCO, the Japanese company which owns the facility, is embarking on a mission to remove these rods to safety, for fear that another earthquake, magnitude 7 or above (93% chance of it happening within 3 years) would cause a nuclear accident. These rods have to be removed individually, without disturbing the other, like a deadly game of sticks. Should one break open (they are damaged) or, heaven forbid, fall from 18m. and crack, the nuclear radiation would necessitate the evacuation of Tokyo. Should one crack and cause others to fall, it endangers the northern hemisphere. Readers should google this and read articles like 'Fukushima could still Armageddon the world'. After Building # 4 is tackled, TEPCO would have to tackle # 3, which is in a far more dangerous state. And, as if that were not enough, the US and Israel have introduced a computer virus called Stuxnet, in an attempt to disrupt Iran's nuclear programme. The Stuxnet virus has spread, as viruses do, uncontrollably, and now threaten other nuclear power plants.

  4. The ecological cliff: As a result of the accident at Fukushima a lot of debris went into the sea. Some sank, some floated. There is now an island of debris, including radioactive debris, which is the size of Texas, floating towards the West Coast of America. Now, a disaster in Fukushima, Japan, would affect the world's # 2 economy horrendously. And if the island of debris hits West Coast America, the cost of cleanup would hit the # 1 economy.

  5. The employment cliff: The US Fed prints $85 b. a month to buy US Treasury bills. It hopes that the money goes into funding consumption and investment in order to provide jobs. It is creating new money amounting to 29 cents to the $. (Read Larry Kottlikof's piece on 'Is Hyperinflation Around the Corner?'. The US already has obligations worth $ 205 trillion which requires a 57% hike in all taxes to fill. Technology is replacing human jobs (last week Barclays cut 1,700 jobs to automation in a variety of ways. For a country like India, which banks on a demographic dividend as its young population enters the job stream, it is imperitive that jobs have to be created. Else the demographic dividend will become a social nightmare. But such is the appalling state of the incumbent Government that it has put no thought towards this. Instead it is wallowing in a sea of corruption scandals and has become paralysed in terms of policy directions and outcomes. As far as the developed countries are concerned, joblessness adds to their social welfare costs which is already $ 205 trillion in the hole.

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The Indian stockmarket was closed on Friday. On the first three days of the week it slid. It recovered on Thursday, thanks to US Fed incoming Chairman, Janet Yellen, stating that the QE programme would continue as long as the economy needs it. The market junkies got a high on this new monetary injection. Over the week the sensex lost 266 points to close at 20,399 whilst the Nifty dropped 84 points to close at 6,056.

The investment community is making two assumptions. One that it will continue to get its fix in the form of liquidity injections. The US, Japan and the Eurozone are in a crazy game of debasing their currencies by printing money. One day, as Larry Kotlikoff rightly points out, it will result in hyperinflation.

The other assumption is easier to make. Namely that whichever Government emerges after the 2014 general elections, governance has to improve. In contradistinction to the 5 peaks mentioned above, India is hitting one depth. Namely the depth of governance.

Consider the statements made by senior persons which can best be described as being economical with the truth. P Chidambaram had once state that NSEL was an unregulated exchange, implying that any investor who lost his money ought not to approach the Government for help. As this blog says, the Bombay High Court has said that NSEL was, in fact, regulated by FMC.

Even were it to have been unregulated, there has been an outright fraud and investors have to appeal to the Government to recover stolen property. Does PC expect them to take matters into their own hands? There was no audit of stocks, in fact the warehouses were not registered, as they ought to have been, there was no due diligence of borrowers, minutes of board meetings were forged, and the company law board itself opines that no one from the group should continue as director in any of the companies.

All this evidence is with Arvind Mayaram, Secretary Department of Financial Services, Ministry of Finance. Yet he has made an utterly inane and thoughtless statement, that recovery would be a slow process, that Financial Technologies has to be handled with kid gloves because it has supplied software to international exchanges, hence the credibility of India is at stake (sic), and that though the Enforcement Directorate could attach properties of defaulters, there was no provision, unlike in the SEBI Act, for the investors to be repaid out of this.

Okay, lets take this one by one and show how absurd the statements are.

As regards provisions in law for the Enforcement Directorate, if, indeed, it is not legally empowered to restore investors money out of the attached properties of defaulters, is there any reason why the Government cannot change the law to so empower? Just consider. When the Government itself felt deprived of Rs 11,000 crores of tax revenue it felt was its due from Vodafone, it went on to retrospectively change the law after the Supreme Court declared against it. So, when over 15,000 investors suffer a fraud of half the amount, why is it not possible for the Government to pass a law (not even retrospectively) which will allow the same priveleges and rights to the Enforcement Directorate as already held by SEBI? If anyone can give me even half a logical explanation I would be appreciative.

As regards the danger to other international stock exchanges and to the impact on India's reputation, one needs to point out the following. When this scam first broke, the same Arvind Mayaram had told us that there was no systemic risk. Now he says there is. Please make up your mind Mr Mayaram. Second, trading software is available for the asking. In one of the exchanges, the FT group, an equal partner, dropped to minority, because the other partner opted for an alternative trading software. It is no risk. As for the reputation of India, it would be far better served by PROTECTING investors than by shielding scamsters.

The Indian polity is, lamentably, always in favour of villains. As another example of the ease of amending laws when deemed necessary, the UPA Government passed an oridnance, to overturn another Supreme Court decision, allowing criminals to continue as MPs even after being convicted. So does Mr Mayaram feel that protecting criminals convicted of crimes like rape, dacoity and even murder, to continue as MPs is more important than amending a law that, through oversight by the Government in the first instance, does not empower its agency to recompense individual investors who have been defrauded?

Similarly, whilst residents of the housing colony known as Campa Cola in India are facing the prospect of their unauthorised homes being demolished, there is nobody willing to take action against those who took bribes to clear the project, and then to allow the society to function for years, (with electricity, gas, phones provided), or, indeed, the builder who sold them the apartments without due authorisation.

The problem is that the Indian system does not have a single window clearance. Why is it not possible for a potential buyer of anything to go to some agency and get a stamped statement stating that all approvals have been obtained? Why does he have to later discover that oh, it was unauthorised, or oh, there was no regulator but you should have known that! Why does India always treat the victim as the culprit?

Given this attitude, any change of Government would, as the investment community believes, be an improvement.

One does not know how long investors will continue to ignore the five cliffs, and ride the liquidity driven rally. But the cliffs are worrying. Most especially the nuclear cliff. And, even as this is happening, our Government is about to close a deal with Japan for nuclear technology for power plants. Would the PM please google Fukushima Unit 4 and read what's happening? Or am I missing something here?

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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2 Responses to "Several cliffs loom ahead"
J Mulraj
Nov 18, 2013
Shri Gupta, thank you for your comments. We don't make bad choices for want of alternatives, and choosing to go for nuclear power after the Fukushima episode is a bad choice. Let us pray that nothing bad happens when fuel rods are removed from Unit 4 starting today.
There are reserves of conventional oil/gas as well as tight oil, such as shale, but at a price. In order to get funding to extract these reserves the price of crude oil needs to stay above $ 100.
A lot of work is being done on renewables, and solar seems to have promise. Costs are coming down and can fall to a level where solar energy is competitive, without subsidies. Toyota has just come out with a hydrogen fuel cell car, though the issue will be whether gas stations will have hydrogen pumps to supply it for refuelling.
The Japanese are known for their ordarliness, love for details, and their dedication. If, despite this, Fukushima happened, I wonder how bad the scene will be for India. We are not known for any of these qualities, but for corruption and a 'chalta hai' attitude.
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Vineet Kumar Gupta
Nov 16, 2013
The article indeed sums up the world affairs and impending risk quite well. However, I don't agree on couple of things. Oil prices are artificially kept high by stating that we have limited oil, which will diminish very fast. I have spoken to certain experts in this field as per them, there is enough oil for next 30-40 years and going by fast pace of technology improvements in today's environment, we will have alternatives and hence countries shall stop this wrong agenda justifying high oil price.
With regard to nuclear technology, its true fukushima disaster has happened. however, the disaster is due to human error, negligence in design. What my submission is that we shall learn from disaster and come out with a solution rather than completely stop using a particular technology. If nuclear is not the solution, respected Mr. Mulraj, what is the solution we have - coal, which is polluting the world and responsible for rise in average temp. Hydro - which can deliver only certain amount of MW.
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