India and US bubble burst!!

Once upon a time, there was a small island with 3 citizens namely, citizen A, citizen B and citizen C.  The net assets of that island were only 3 dollars, which included a piece of land worth 1 dollar and 2 dollars in the economy. B owned the land, A and C each owned 1-dollar. One fine day, C thought the land is a non-producible asset whose value will go up. So, he borrowed 1 dollar from A and including his own 1 dollar, he bought the land from B for 2 dollars. Thus, A gave a loan to C of 1 dollar, so his net asset was 1 dollar. B sold his land and got 2 dollars, so his net asset was 2 dollars. C owned the land worth 2 dollars and a debt of 1 dollar from A so his net asset was 1 dollar. The total net assets of the island were 4 dollars. When B saw the value of land rising, he hypothetically borrowed 1 dollar from A which was already a loan to C and bought the land back from C for 4 dollars. The payment for the land was done by 2 dollars cash (which he owned himself), cancellation of the 1 dollar loan to C (that C owed to A) and an assumed debt of 1 dollar from C. As a result, B now owned a piece of land worth 4 dollars. But since he owed a debt of 1 dollar each from A and C, his net assets were 2 dollars. Citizen A loaned 1 dollar to B, so his net asset was 1 dollar. C had 2 dollars only, as 1 dollar was cancelled against his loan from A and 1 dollar was assumed as a debt to B, now his net assets were 3 dollars. Total net assets of the country were 6 dollars. A bubble was building up…the value of land kept escalating and everybody made money.

One evil day, A and C thought what if the land price stop going up, how could B repay their loan. Nobody wanted to buy land anymore. Unfortunately, the land value came down to 1 dollar. So, at the end of the day, A possessed 1 dollar loan to B, B owned land worth 1 dollar now and 1 dollar debt from A and C each, his net asset was  –1 dollar. C’s networth were 2 dollars and 1 dollar debt to B. The net asset of the island = 3 dollars again.
 
B declared as bankrupt. A got the land in exchange of his loan to B.  C was the winner whereas B was the loser.
 
This is what happened in US when companies started using the leverage excessively. A company with a net worth of $10 billion borrowed 20 times of its net worth and created leveraged funds of $200 billion to invest or lend, loans were given to ineligible people who could not repay it in the best of time, default rate of mortgage repayments kept increasing and this vicious cycle formed a big bubble, which ultimately led to the bankruptcies of the institutions of Wall Street and ultimately, Financial Crisis in US.

India is in an interdependent globalized world where the future of all countries is related to the international financial system. India’s value markets are opened to the world and if they are affected, this will affect its capacity to finance its development. Indian stock markets have been victim of FII selling and liquidity crunch because of the systemic global risk and financial system instability that is common to entire world markets and not specific to Indian Market.

Fundamentally, Indian economy is one of the strongest economies in the world. If it were a closed economy, slowdown would not happen in India. Whatever India is facing today is because of the ripple effect, which can be compensated by domestic demand to some extent. As world markets have fallen, the emerging markets like India, with their higher growth rate would be the first one to recover. At this point of time, India can achieve a GDP growth rate of 7.5% to 8% and most pessimistically, not less than seven percent, despite the current global economic turmoil, which has only partially affected the country.

Crisis means both danger and opportunity. It may be an opportunity for Indian investors where, for me, it is just a bear phase for Indian market, within a long-term bull run, caused by external factors beyond its control. Right now we should look for buying opportunities, whenever they appear. Do not forget that legendary investor Warren Buffet has made a big BUY in this downturn.

How the global meltdown will impact India!!

· India is feeling the ripple effects of global financial crisis and is relatively less affected as our regulatory system in financial market is strong and our banks are well capitalised and well regulated.
· India now accounts only 16% of its total export to the US so the impact on domestic demand will be minimal moreover, favorable demographics indicate that the economy would not have severe demand constrain.
· We can see a clear bottom to the present correction in the real estate values in India. Indian demographics, where 50% of population aged around 25, make certain that at some lower value there will always be a buyer willing to invest in owning a house. The higher real estate values today are due to speculation like in the US.
· Cost-cutting by US firms and EU firms mainly in service sector may lead to greater dependence on Indian IT services as they are still cheaper and and labour-intensive.
· Despite the economic meltdown, companies worldwide have to maintain their back-end operations and the crisis will not affect any existing contracts.

What can be done in a downturn!!

· Maintain a sense of optimism about the future because things do get better from the heights of pessimism.
· Take a bottom up approach for investing, get in to take financial stocks when a recovery is seen the market.
· Cyclical and commodity stocks can be avoided as their profits fall down immediately when their raw material cost rises. But in a meltdown, a lot of consumers of commodities get benefit from the fall in commodity prices like two-wheeler companies/ancillaries companies such as Castrol Ltd., which have raw materials linked to crude oil.
· We can put a small portion of our investments in gold, as gold price tends to rise till the crisis continues. But keep in mind that once the crisis is over, gold will start decreasing.
· We should believe in India’s growth story, no need to panic, as the losses will be recovered in a year or so as India’s savings rate is as high as 35% of GDP.
· We can choose some traditional defensive sectors like FMCG and Pharmaceutical, some PSU banks with good credit quality, domestic driven utilities like city gas distribution, defence-related PSUs etc. as a good buy at current levels.
· Stay away from businesses with weak fundamentals even if they offer lucrative P/E.
· If you are running out of money, you can consider selling off your growth-oriented investments and invest this money in some risk-free regular income schemes. If this money is not sufficient, then you can liquidate your gold assets, followed by property. Withdrawing money from your provident fund should be the last option.
· Even Individual Health Insurance cannot be considered as an optional expense in this tight financial position because in case, your employer has taken a group health insurance policy, it may get ceased when you leave the company.
· For the current situation, fixed deposits can be considered as good investment where the PSU banks are giving 10.5% to 11% p.a. For medium term investment, one can invest in the equity market through diversified mutual funds where you can get a compounded annual return of 18% over the next five years. If you have long-term horizon, continue with SIPs as your investments will give you a good return in the medium to long term.
· Pay off your high interest debts like Credit cards and Personal loans as they are a very expensive liability, carrying a rate of  almost 20 per cent. If you are not able to  clear the debt, switch to a card with a lower rate of interest.

Remember that when a bubble builds up, everybody makes money but the debt of individuals also builds up. And when the bubble bursts, the person with cash is always a winner. The asset and loan holders may shrink or go bankrupt. If one is smart enough to realize that he/she is living in a bubble economy, what one can do is borrow money and take part in the game but should also be aware of right time to convert everything into cash because its human psychology only which decides the actual worth of one’s assets or stocks.