Overseas funds have just dried up for treasury managers of domestic banks. But Indian banks are still making money. As of this week, short-term rates for these banks in the credit market have zoomed up to Libor plus 100 basis points. But even after accounting for administrative charges, there is a difference of almost 400 basis points between their lending rates and their cost of credit. ?What I lose on the forex desk, I recover on the rupee desk,? said a treasury manager of a leading bank.
In a stockmarket ravaged by a crisis which threatens to hit new lows as easily as it hit new peaks, there is a valuable lesson here. Rising and falling markets are essentially manifestations of the same forces, albeit moving in different directions. The punishment for a wrong bet can be humungous, but bets are there to be taken. Yet, before those bets can be taken, the a priori requirement is for the market?s rules to be laid out well enough to give participants confidence in taking them. Instead of laying out ground rules, we had more or less coaxed ourselves into the secure belief that Indian entities cannot be injured by the crisis. Thus did we refuse to grow up. The crisis, as many Parliament replies have borne out, was the result of bad lending practices in markets where, it was implied, regulators allowed too much lattitude.
Despite early warnings, the subprime gale has now come ashore full blast. Our good practices have not been able to keep the economy dry. But unless we quickly take the opportunity to strengthen the financial sector, the Indian taxpayer may end up paying far more for the eventual clean up than even some of the more open economies. For instance, in the last three biggest worldwide crash episodes since January, Indian markets have fallen far more than other Asian markets. On January 21 this year, the BSE Sensex dropped by 1,408 points. On March 3, it fell by 900 points. And on Monday, it tumbled by 951 points. In percentage terms, each of these drops was significantly larger than those experienced by Hong Kong?s Hang Seng index, Japan?s Nikkei 225, Korea?s Kospi and China?s Shanghai SE Composite. Such acute market vulnerability was unexpected. Remember, Indian capital markets have been kept relatively isolated from the maelstrom of global markets.
Again, while the travails of ICICI Bank have been noticed, almost all the big public sector banks had taken exposures in the derivatives market. Since such exposures do not need to be marked to market, the problems do not show up immediately. They show up later as NPAs.
One major implication of the disorder is that Indian financial markets are just as caught up with the subprime fallout as the rest of the world, with the additional caveat that no one?not even RBI, Sebi or the finance ministry?has any inkling of the extent of the possible damage. This is the clearest rebuttal of the thesis that Indian financial markets can be kept insulated from global dangers of such magnitude. It was obvious all along that it was just not possible, but now we have an acknowledgement from the finance minister himself. So, with that, it is time to reject that hypothesis lock, stock and barrel.
The voodoo of capital account convertibility has kept us locked in. But, confounding many observers, the feared reverse flow of FII capital has not materialised. Since January, the net outgo of FIIs has been only $4 billion. They still hold $150 billion worth of stock in a market of over $800 billion by capitalisation. Instead, it is the lack of fresh flows that has spooked the market. It is these cues that are alarming.
The underperformance of equity markets could have been compensated for by a robust debt market. Fixed income papers usually rise in such a scenario. But that prospect has been let down by lack of interest from both Sebi and RBI in doing something about it. In the process, the money raising capacity of Indian corporates would come under severe strain this year. As the overseas debt window has been almost totally shut, and domestic interest rates are absurdly high, there is going to be a significant impact on the investment plans of Indian companies.
The same process has occurred in commodity and bullion markets. Prices there are moving up in tandem with the upswing in CBoT and LME. It is a no-brainer that the losses in BSE and NSE could be made good here. But we have kept banks and financial institutions out of commodity exchanges. So their trading volumes are thin. This means that in the possible eventuality of a run on money threatening to hit equity markets, the only way out would be to resort to dubious lending from banks or cooperatives. If the same rules had been applied to treasury managers of banks, the implications would have been horrific.
Having jettisoned the delusion that keeping windows closed would save us from financial turmoil, it is essential to adopt the curative powers of financial sector reforms. The inevitable clean up after the subprime gale will be far less costly.
