India's GDP $ 40 Trillion in year 2020?

Can you believe it? India's GDP will be $ 40 Trillion in the year 2020, that is 40 times what it is today!. You do not believe it? But that is what the stock market tells us.

From the lows of March 2009, Nifty has gone up by about 2500 points in about 6 and a half months (roughly 160 trading days). The rate is about 19 points per day. During the period 2003 to Sept 2007, in a period of four years, Nifty gained only about 3500 points at an average of 3.5 points a day. This was when there was no apparent problem with the economy and the GDP growth rate was touching 9%. Considering the rate at which stock market is growing, i.e. 16 points a day, which is about 4.5 times the rate of the previous bull run, it points to a 40% GDP growth rate. Over eleven years, this should translate into a GDP of $ 40 Trillion. WOW! And what about the market? At this rate of growth we shall see Sensex close to 2,00,000 by the year 2020..

Obviously, the above is most unlikely. This points to an absolutely irrational market today, which should see a correction sooner or later. We need to be patient.

Is it time for Nifty to correct?

Nifty touched new highs last week within touching distance of 4900. While many experts feel that the market upmove shall continue, I think it is time for a correction. Whether the correction shall be a steep one like the year 2008 or it would be a milder one which precedes the next bull run cannot be stated with confidence, but a correction nevertheless is due and should happen within the next few weeks if not the next few days.

The reason why I am so confident is that the markets have run up ahead of the fundamentals. A look at the fundamentals tells the following story.

Real Estate

At the peak of the market crash last year, real estate construction had come a virtual grinding halt. There was little or no construction activity in the period Sept. to Nov 2008. Since then construction has indeed picked up. But the activity is nowhere near what it was in the frenzied months of 2007 and the first half of 2008. Any Civil Engineer worth his salt will tell that the pace of construction is very slow and many projects would take much more time than what the builders claim. There are certain projects where not even a single worker can be seen. Yet, new projects are being launched at a frenzy that suggests that the construction activity was in full swing. However, I suspect that it is not so. In many cases, funds raised from the launch of new projects are likely to be diverted towards the completion of older projects. The new projects are most likely to take much longer than what the builders are promising. In some cases builders are promising to pay a small sum per month in case they are unable to complete the projects in time. A CA friend remarked that raising funds by launching new projects would perhaps be a cheaper than borrowing from banks and financial institutions. To say the least real estate remains in trouble as of yet.

Exports

Exports continue to fall year on year. The rate of fall is about 30% give or take a couple of percent. An improvement in the rate of fall by a percent or two here or there cannot be treated as green shoots. By this time, last year, the major world economies had already fallen sharply and imports were falling, which means Indian exports were already falling. A 28% odd reduction from there in exports cannot be said to be better than a 30% odd fall a couple of months earlier on the grounds that the rate of fall has fallen. Since the major economies of the world are still experiencing deflation, revival of exports is a long way off.

Agriculture

A deficient monsoon, especially in North India has already hit the Kharif crop. A 20% odd fall in the sowing of Kharif crops, is definitely going to hit rural economy and income. A late surge in monsoon in the last week of August and first week of September cannot compensate for the fall in sowing of Kharif crops as the sowing time is well past. At best it would help improve the yield of the standing crops and save a potentially disastrous Rabi season. With a fall in rural incomes, demand is bound to fall too.

Inflation

India calculates inflation using WPI. Besides the point that the basket of goods that represent WPI needs revision, a negative WPI only points to a poor demand for wholesale products vis-a-vis a year earlier. The WPI is now inching up back towards zero and prediction of RBI as well as other economists is that it shall reach 5% towards the end of the year or the end of the financial year. But what is of concern is the CPI. The CPI has been going up and is closing on to 12% (look at the chart below). If WPI goes up to 5%, what will happen to CPI? Could it go closer to 15% or 20%? Indeed the inflation faced by consumers is uncomfortably high already. A move to 15-20% could really impact demand. Not only this sooner or later RBI would be forced to tighten the monetary policy by raising interest rates to control the inflation. That would have a direct bearing on the businesses, real estate as well as markets.

CPI-Chart courtesy tradingeconomics.com (Click on chart for a larger view)

Fiscal Deficit

Fiscal deficit for the first four months stands at 1,55,000 cr. At this rate the fiscal deficit target should be comfortably burst. A deficient monsoon is likely to add to the woes. Part of the deficit could be covered by disinvestment, but disinvestment is not a solution towards managing deficits. Disinvestment should be part of liberalization policy only, though it would help cover deficits a bit. As anybody would know, selling fixed assets for the purpose of raising working capital is not a sign of a vibrant company, similarly selling assets (PSUs) for the purpose of covering deficits does not indicate a vibrant govt. financial condition. If indeed fiscal deficit breaches the target of about 4 Lakh crore for this fiscal, expect trouble. Rating agencies may downgrade India, govt. may have to raise taxes and of course markets may react negatively.

The graph below shows the rise in fiscal deficit in absolute terms. Economists argue that fiscal deficit should be seen as a ratio of the GDP to see whether it is a cause for alarm or not. As a percentage of GDP fiscal deficit is targeted at 6.8% for the year, which is likely to be breached. But this figure is only for the central govt. If state govt. deficits and off balance sheet items are added we are looking at around 11% of the GDP, which is high. The graph below shows the deficit in absolute terms. What needs to be noted is the sharp rise to about 4 times as earlier in the last year and a half after having been stable for about 6 years before that.In my view the absolute amount of fiscal deficit is equally important as it shows how much needs to be financed.

(Click on the chart for a larger view)

The above are some of the issues that seem to me as obvious reasons why markets should not go up from here. We seem overheated. It is time for a correction.

Fiscal Deficit - April-July 2009

The Period of April-July 2009 saw a fiscal deficit of Rs. 1.55 Lakh crores. This is about 39.5% of the target for the full year. At this rate we will comfortably burst the full year target. Considering the monsoon failure, it is more than likely we will indeed go past the target. However, there is a silver lining, though one should not react to one data point very quickly. The addition to fiscal deficit in July was about 0.31 Lakh crores. This does show that the deficit was controlled better in July. Why was it so? We need more data to be able to see how this happened and whether this is sustainable. The detailed data is yet to be released by the govt.

More details on release of detailed data

Fiscal Deficit - Now it is Pranabda who speaks

Pranabda has said that high fiscal deficit is unsustainable. Well, what does that mean? An end to further stimulus? If so, the govt. sponsored improvement in economy is likely to die out soon. Watch out for green shoots withering and turning brown.

Agriculture - An area of concern

India may be a long term growth story, but we do have our areas of concern. One such is agriculture. No, i am not going to write on the failure of monsoon, but what is evident if we do some data analysis.

India, with about 160 million hectares under agriculture has the second largest land under agriculture, just behind the United States. This area is larger than the area in Europe or the area in China devoted to this activity. So what is the problem?

Consider the following.
1. Agricultural growth in India has been much slower than our population growth in recent years.
2. Despite being the second largest producer of wheat and rice in the world, our productivity is way behind many countries.
3. With increasing industrialization and urbanization, the land under agriculture will reduce in the coming years.
4. Population in our country is likely to grow by about 30-40 crores in the next 40 years.
5. Population of the world may grow by about 150 crores in the world during the same period.
6. In view of 5 above, do not expect availability of much food through imports.
7. With better standards of living in the country, per capita consumption of food is bound to go up.

Should we worry? I think yes. If we do not improve our yields soon, we may see food problems in the years to come, monsoon or no monsoon.

Why great economies and nations fail?

History has shown us that nations and economies often fail, soon after they have become so strong that nothing seemed to come in their way. In recent history, the United Kingdom lost its position of the global leader as well as its empire in a matter of decades. Earlier, history is replete with stories about the decline of other empires, notably the Roman empire. Our own country, was perhaps the most important place in the entire world just a few centuries ago, a place of great learning, resources and wealth. By the time the British left in 1947, we stood almost 180 degrees away from our position a thousand years earlier. So what destroys great nations? What makes them so weak that others can steam roll them over?

The answer perhaps lies in the inability of a nation to recognize slow but definite changes in the environment. Failure to adjust to these changes and sometimes overconfidence in one's own abilities lead to a nation's downfall.

I am reminded of a story i heard at school. A frog thrown into boiling water would jump out quickly in order to save itself, but if a frog is put into cool water placed on a fire, it would not react. As the water heats up, the frog adjusts to it, never realizing that the water temperature is changing. By the time realization dawns on the frog, it is too late.

Are economies and nations like that? I think so. The Romans perhaps failed to foresee changes around them. That led to their downfall. Indians were busy amongst themselves, not realizing the growing power and the aspiration of the people in middle east. Later they, failed to see the changes in Europe and thus failed to ward off the British. The British themselves, at the pinnacle of their power, failed to see a changing world and lost their position by the time the Second World War ended. Now it seems, it is the time of the Americans? Would they be able to meet the challenges of a changing world in the future? I think not. History has a funny habit of repeating itself. My bet is that a few decades down the line, US shall no longer be the leading nation of the world.

Perhaps, it is time for India to rise again. Lets hope we do and become at least one of the leading nations of the world over the next few decades. Lets hope we take the bull by the horn and make use of all the opportunities. A few decades to enjoy prosperity and power, before history once again repeats itself.

Where does the money come from?

Keynesian economists conveniently ignore this question when they preach govt spending/stimulus to revive economies out of downturns. Now Warren Buffet has raised this question. Not necessarily always right (nobody can be always right), nevertheless, when Warren Buffet speaks, one must listen.

The link is
http://www.fortunewatch.com/warren-buffet-america-has-hit-the-panic-button/

We must also stop and take stock. Should India be on the path of high deficit? Mind you Krugman suggested just a few days back that in an interview suggested that the plan to balance the budget can wait till the next year. Do we want to follow his advise and reach a stage where somebody like Warren Buffet reminds us that things are no longer good?

Excerpt of Krugman's interview published in Economic Times dated 11th Aug 2009 is pasted below

What will be your advice to India as our budget balance is fairly scary, but the FM has said: I’ll worry about it later and play for the growth now?
I think that’s right. You do have to have a plan in place to restore a healthy budget but not this year. Not with the world economy still so fragile, not with so much excess capacity still out there.