The real reason behind India's current account deficit

This post is for those of my friends who believe that the stock market is a plaything of the rich and bored and it has no real significance in the real economic progress of India.

The last few months India has seen a free-fall of the rupee with respect to the dollar. From Rs 45 it has gone to Rs 56 in a matter of months. The steep Rs. 7.5 hike in petrol prices has been attributed to this fall in rupee. During this period, crude oil, the other component of petrol price, has come down from $125 to about $105.


So why is the rupee falling like nine pins?
The answer to that question lies in India's current account deficit. To understand in simple terms what the current account deficit means, lets look at its constituents. Roughly, Current A/C (CA) = Balance of Trade (BoT) + FDI flows + FII flows + Remittances. Out of this BoT is  the difference between export and import. 


Whenever there is a change in price, it means there is a change in the demand-supply situation. Similarly, if rupee is falling, it means, dollars are more in demand than Rupee. Exporters sell their products and earn in dollars and they convert them to Rupees. And importers buy  these dollars with Rupees. Currently, importers are buying more dollars than exporters selling rupees. That is one main reason why the rupee keeps falling.


Then why did the Rupee appreciate (go up) during Jan-Feb this year?
Now, we come to the interesting part. India has been historically a trade deficit (negative BoT) country because we have to import oil. We also import a lot of gold and increase in taxes & duties on gold by the FM this year was to in some ways to prevent the outflow of dollars. So, what changed earlier this year? Or what held the rupee to around Rs 45 for such a long time? The joker in the pack is FII inflows. India has been making up for its BoT deficit by primarily FII inflows into the stock market and to some extent through remittances from expats abroad. If you look at remittances, RBI has increased NRI deposit rates to attract this, but without much success. That leaves us with FII inflows. If you track net FII inflows, you will see a marked correlation with the dollar-rupee conversion rates. With the ineffective policy making, GAAR, scams and trouble in the Euro zone, the FIIs are spooked. They are taking away money from the Indian markets and leading the pressure on the Rupee. 


So, to my sceptic friends, the stock market does impact you, whether you invest or not, in more ways than you can imagine!

It is unfortunate that such a large country has to be dependent on FIIs for its economic well-being, but that is the way it is. It is likely to remain that way till we can make such policies which increase our exports.

Stock Holding Period: Don't Follow Buffet Blindly!

A lot of long term investors follow Warren Buffet. Buffet has probably done more to make value investing popular than any other man. His favourite holding period is "forever" and he has been amazingly consistent and held on to his old investments like American Express, Coca-Cola, Washington Post. Most people take his words literally and hold on to their investments for a long long time, often ignoring the deteriorating fundamentals. If you go back 10-20-30 years, you will realize that some of the companies used to rule the markets are no longer there in the top 500 companies list anymore. From the companies that were there in Sensex in 1991, only 9 companies are there till today. That means 2/3 of the companies have been pushed out. Think of companies like Bombay Dyeing, Hindustan Motors, Premier Automobiles, Mukand Iron & Steel and other such names which used to rule the roost back then.

The point I am trying to make is that if you follow Buffet blindly without understanding the context in which the great man makes a statement like holding forever, then you are headed for trouble. Buffet says you need to ensure that the management is a custodian of shareholder wealth, the business has a great moat. Also, Buffet buys when there is great pessimism in the markets regarding the company. He bought Amex and Coke during times when the companies had severe short-term troubles. That was when "normal" retail investors where selling in panic. He bought when he thought there was "value" but the franchises of the businesses were intact.

I think for small investors, a reasonable time frame for holding is one business cycle or approximately 3-4 years or till such time the business fundamentals are intact. Of course, that would mean keeping a constant vigil on the company and ensuring they are doing what they said they would. Buy-and-forget may be injurious to an investor's health.

Incentive Caused Bias and the Indian Politicians

Charlie Munger refers to incentive caused bias as one of the most potent of all biases that mankind is afflicted with. And we see it everywhere around us, all the time. I was thinking of this when I saw one leading mutual fund manager mention on his facebook account on the ills of the RBI not cutting rates quick enough to boost growth. He was peeved that RBI was more concerned about taming inflation than looking at industrial growth. Here, I thought, is a classical case of incentive caused bias. A fund manager, would obviously love industry to grow, so the stock market performs better and he gets a better bonus.


The non-stock-investing common people (I read somewhere that in India about 5% people invest in equities, so that leaves the the majority in this category) want higher bank deposit rates. People with home loans want their home loan rates to go down. People with cars want petrol prices to go down and those with diesel cars want diesel prices to remain where they are.


The politicians are also trapped within their own set of incentive caused biases, primary among them is winning the next election. Financial and economic propriety is irrelevant when it comes up against such a strong bias. So, who gives a damn about the fiscal deficit or the trade deficit! Most people in India wouldn't even know what these terms mean or what impact they have on their lives.


Every subsidy that the government doles out has a set of people who have very strong incentives in continuing with them, so it becomes very difficult to break the setup. As the French have shown us recently, no one likes austerity for the long-term greater good. The hell with good economics as long as we can live well now. That has been the downfall of all (atleast nearly all) great civilizations before ours. It will be interesting to see, if it is the same for us!


The only solution to this is to align long term interests of the nation to those of the elected politicians. For example, factors like reduction in absolute poverty levels (the threshold is immaterial - whether its Rs 28 per day or Rs 40 per day it does not really matter, as long as it is fixed and their is a steady decline in number  of people below it), increase in education levels at all levels (not only primary, but also secondary, college, professional and technical), healthcare availability, access to clean potable water, access to roads, availability of 24x7 electricity and other such critical parameters. If the politicians cannot deliver, then all the MPs will be debarred from contesting elections for the next 10 years. Then we shall see real progress as the ministers and all the opposition MPs will have incentives in ensuring that the country makes actual progress!


P.S. I know this will never happen and we will continue to perform pathetically in the future, just as we did in the past! But, no harm in dreaming, is there!

GuruSpeak: Charlie Munger speaks to Becky Quick of CNBC

Charlie Munger speaks to Becky Quick of CNBC.