Monday, March 17, 2008

Financial Contagion

The bloodbath on India’s capital markets continues. On Thursday 13 March the Bombay Sensitive Index plummeted 770.63 points, losing 4.78 % of its value. The Sensex closed at 15,357.35, down 27.5 % from its all-time high of 10 January, wiping out Rs 20 trillion worth of investor wealth. Investor fears were stoked by more bad news from Wall Street: Carlyle Capital Corp. a subsidiary of US private equity firm Carlyle Group, admitted that it had defaulted on $16.6 billion (Rs.67,000 crore) of debt and was likely to be liquidated. On 11 March, five central banks had announced a huge cash injection, including $200 billion from the US Federal Reserve, but even this failed to inspire confidence.

Shares of Carlyle Capital are down 97 % over the past year. Carlyle’s strategy of borrowing to invest proved to be its nemesis. Carlyle Group chairman David Rubenstein’s speech at the World Economic Forum in Davos earlier this year gave investors a forewarning when he observed that “the golden age of private equity” was over. “The industry has now entered its purgatory age. We have to atone for our sins a bit,” he said. Sure enough, there was even worse news when Bear Stearns, a marquee US investment bank went under, the latest victim of the sub-prime mortgage crisis.

In India, a steep fall in industrial production exacerbated an already delicate situation. Industrial growth slipped to 5.3% in the month of January, compared to 11.6% in the same month last year as growth in all major sectors comprising manufacturing, electricity and mining declined. Industrial growth, as measured by Index of Industrial Production (IIP), has moderated to 8.7% in the first 10 months of the current fiscal year, against 11.2% during the corresponding period of the previous year. The manufacture of consumer durables registered negative growth both in January and the first 10 months of this year. Production of consumer durables fell 3.1% in January against a 5.3% growth in January 2007. Between April and January, production declined 1.7% against 10.6% growth in the same period in the previous year.

These statistics pose a conundrum. As the saying goes, “Statistics are like bikinis, they hide more than what they reveal.” It is not possible for industrial production to tumble so drastically. Whatever a company produces is the result of a planning done from at least a couple of years back. Machinery, labour and inventory costs are planned in advance so it in unlikely that the IIP could face such a dramatic reversal in so short a period, despite slowing demand and high interest rates. While the data is being questioned, it was largely academic for Indian markets which panicked, treating the news as confirmation of their worst fears.

There is no doubt that the Indian economy is indeed slowing down amid fears of a full-blown recession in the US and record high oil prices. US investment bank Goldman Sachs estimates the price of crude oil could hit $175 a barrel in the next couple of years. Analysts believe it is highly unlikely that the markets will rebound in the next three to four months. Nevertheless, current valuations in Indian stock markets appear driven more by sentiment than fundamentals. Even 7% growth in a $1 trillion economy represents a huge increase in wealth. India, unlike much of East and Southeast Asia, is fortunate in that its economy is driven by domestic consumption. Its growing savings rate and steadily expanding middle class provide domestic manufacturers a cushion against global uncertainty.

But the contagion from the US sub-prime crisis is yet barely understood or accounted for. Financial institutions around the world are only now beginning to discover the extent of their exposure to the bad debts created by the reckless lending of US mortgage sellers. India is no exception: ICICI Bank has already had to take a write-down of Rs. 1,050 crore on its $ 2.2 billion credit derivative exposure. The next few months will surely bring more bad news as the scale of the problem unfolds. Credit markets all over the world will take time to digest their losses, as banks rebuild their capital through liquidation of assets and mergers. JPMorgan Chase Bank’s bargain basement purchase of Bear Stearns is an indication of the deadly price that investors will have to pay. But till the world’s financial services industry gets its house in order there’s little hope for a return to stability and growth. As the axiom has it, an economy is only as healthy as that of its banking system.


Bully: You will either love this movie or find it too repulsive. But either way its a must watch because of the moral questions posed by it.

House of sand and fog: If you are the kind who believes that testosterone stuff is what turns you one then watch this movie for a crash course in thought provoking cinema.


At 5:20 PM, Blogger sowmitra said...

baundi...gave a good account of what was happening...


Post a Comment

<< Home