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Posted On Monday, Sep 01, 2014
I came across two articles on www.equitymaster.com, about Japan, one was The Daily Reckoning by Bill Bonner titled “What will Japan do next?” and the other was titled “Demographics and the Bond Market” by Asad Dosani.
That got me thinking about Japan and of course, India. Similarities between the two countries are amazing, both boast of a proud history, both steeped in culture and the arts. Music, painting and other art forms (including the martial) of both nations is appreciated the world over.
Coming back to the articles, the essence of what they said was – an ageing population in Japan meant less appetite for risky investments, and hence more money would go into Bonds, resulting in high bond prices and lower yields.
Bill Bonner predicted doomsday for Japan- an ageing population means less ability to save and less ability to lend. How will Japan repay its debt which at last count was closer to 500% of GDP?!Increase in yields would be devastating to the Japanese economy given the high debt levels.
Here is the crux, bond investors would eventually realise that the economy does not have enough earning power to service the high debt, and would be unwilling to lend more. Less money to lend means higher interest rates and less income from a slowing economy to service them.
Okay, I got a gist of Japan. What about India?? We should be grateful that India does not have this kind of a problem - of an ageing population. India has 65% of the population below 35 years of age, not to mention the fact that we are the world’s second most populous nation with around 1.2 billion people living in India. Thus armed with this demographic capital, the stock markets are expected to perform strongly over the next two decades as compared to bond markets.
Moreover, India does not have such a high level of debt, as Japan does - although it is approximately 128% of GDP.
However, we need growth, to keep the young population employed. A 6.5% GDP growth is good enough, but many are expecting 8% growth given the change in the government. The reference point for 8% is the high growth witnessed during 2004-2008.
The period of 2004-2008 had the benefit of:
• Good global growth, average rate from 2004 to 2008 was 3.5% (source: world bank)
• Low inflation in India-average CPI inflation in this period was 5.7% (source: Bloomberg)
• The interest rate on 10 year government bond was 5.14% in 2004 having declined from 10.76% in year 2000.
• The change in interest rates resulted in capex and consumption boom and resultant high GDP growth. Overall Debt to GDP level was at 119% having grown from 92% in year 2000.
To repeat the 8% growth this time around, is doable but is a tall order.
• There is a suspect recovery in global growth- Euro and China is growing slowly. Average global growth from 2009 to 2013 was 1.87% and looking ahead, the picture is still bleak.
• Inflation is high in India – means little ability to save or to consume. Average since 2009 has been 10.1% (source: Bloomberg) and current reading is above 7%.
• Overall Debt to GDP ratio is 128%.
The expectation of a massive change in interest rates is low. So unless the productivity gains improve significantly, the assumption of 8% GDP growth is difficult to meet.
A word of caution for investors- a 6.5% GDP growth is good but stock prices of many companies are probably reflecting expectation of a higher growth.
A lower GDP growth compared to expectations mean actual earnings being lower than expectations. This could disappoint investors and inflated equity prices may deflate rapidly. While I am extremely optimistic on India for the long term, I would urge investors to be cautious at the current levels of the market, which seem to be hitting new highs.
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