Make no mistake, the global financial crisis will affect the Indian economy by way of shortage of international credit and drying up of portfolios inflows
We now know that the crisis in the US financial system is spreading into Europe, and the prognosis is that the developed countries are set for a painful recession. Therefore, the worry is not about how diversified away from the US our businesses are, but what happens to the globalisation strategies of companies. There are three implications. First, the crisis is in the credit markets, and spreads have widened too much for anyone to be able to afford to borrow in international markets. There is simply no one out there willing to take the risk of lending. Borrowing-based expansion plans of several companies will be impacted. Second, portfolio flows into emerging markets will take quite a while to resume. As institutional investors re-look their investment strategies, and hedge funds brace for redemptions, there will be very little global money seeking markets like India. Third, our large projects will face a setback due to lack of funding. The missed opportunity of enabling foreign investment in infrastructure and other capita-intensive sectors will hurt. Just as our expanding businesses have exhausted their internal resources, and have begun to consider borrowing, the markets for long-term debt have dried up.
Buy at leisure
The fall in prices from the peak is over 50 per cent in many cases, and several stocks have gone back to their April 2007 levels. Stock market enthusiasts have begun to point out that the time to buy is upon us. Markets tend to overreact to both optimism and pessimism. When the outlook is positive, investors believe that paying even 30 times the earnings of a company is cheap; when the outlook turns negative, even at 15 times earnings, there are no takers. The languishing markets are not factoring a 50 per cent drop in earnings and prospects for companies. They are simply indicating that the future is uncertain and unknown. The reluctance to buy comes from not being able to judge who will stay and survive, and who may close down. When the risks are so high, and the unknowns are too many, there is no hurry to buy. Battered markets do not turn up and run at short notice. Any gains from these levels will promptly be pruned by those that like to quit. Bear markets offer the rare indulgence to buy at leisure.
Rupee under pressure
The increasing trade deficit has brought back pressure on the rupee. As capital keeps moving out, RBI?s intervention has not helped the rupee from depreciating further. One would have expected the fall in international prices of crude to have eased the trade deficit. But the depreciating rupee has undone much of that benefit. While it may be politically feasible to control prices of petro-products, the problem it creates is that users do not curb consumption when they do not pay the higher market price. If the international prices had been passed on to the Indian consumer, we would have seen a pull back in demand, which would have helped bring our oil imports down, and thus the deficit. Ill thought out interventions in the market always tend to boomerang.
Monitor risk within ELDs
In the current markets, apart form the fixed maturity plans (FMPs) the other product that seems to have caught issuer and investors? fancy is structured products. These offer a combination of debt and derivatives. The investment in derivatives is done using the interest element of the debt instrument. The capital protection offered is in nominal terms. If Rs 100 is invested for three years at 10 per cent, it earns Rs 30 as interest, in simple terms. If the capital protection means that Rs 100 will be returned after three years, the Rs 30 earned as interest is available to invest in option contracts. Structured products are offered as ELDs (equity-linked debentures) to investors, combining the equity-linked options and debt into a single product. These instruments are issued by subsidiaries of banks and investment banks, and are listed. Given the growth in the size of the market in recent days, one question comes up. Who is monitoring the balance sheets of the issuers of these ELDs, to understand how they can service the debt they are issuing? Is someone other than the credit rating agency looking at the risks? What happens if there is a downgrade?
Flight to safety
There is so much of fear about possible default by real estate borrowers that FMPs today state upfront whether they will hold paper issued by this segment, and if so, what the cap would be. Apart from the indicative return, we now have information on the indicative portfolio, to tell investors that the portfolio may not be taking undue risks. The truth though is, given the credit crunch in short-term markets, investors are flocking back to good old bank deposits. In uncertain times they tend to prefer a safer investment than one with a higher post-tax yield.