Professional Documents
Culture Documents
Prepared By -
Gurvinder Singh
Sakina Nisar
Kushagra Chaudhary
Rahil Siddiqui
Saima Mehar
Part I
2. Causes
Part II
2
2. “Hullo, Chidambaram Speaking…”
o 2.1 India the Optimist
4.Firefighting Measures
o 4.1 Reserve Bank of India
o 4.2 Securities and Exchange Control Board of India
o 4.3 Ministry of Finance
5. Now what?
6. Their Views
7. Sources
3
The What and Why of the Crisis
4
unemployment. In 1937, the American economy took an unexpected nosedive,
lasting through most of 1938. Production declined sharply, as did profits and
employment. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938. We
can sum up the effects of the depression in the following facts:
Coming back to the present, we now start talking about the current
financial storm that we are braving. Why is it that investors across the world are in
a state of absolute panic? Why are they dumping risky assets like shares and
rushing to safe havens like gold and government bonds, stock markets and
currencies across the world keep falling?
The financial crisis or in the terms of the media, “credit-crunch” saw
its beginning in the mid of 2007 when three things became clear; first, low income
or sub-prime US households with poor credit quality that had borrowed heavily
from banks and finance companies to buy homes were defaulting heavily on their
debt obligations. Second, the size of this sub-prime housing loan market was huge
at about $1.4 trillion. And third, Wall Street's financial engineers had packaged
these loans into complicated financial instruments called CDOs1. American and
European banks had invested heavily in these products. This led to a loss of
confidence of investors in the value of securitized mortgages (mortgages arranged
in groups and bonds issued on them) in the United States resulting in a liquidity
crisis. This led to a substantial injection of capital into financial markets by the
United States Federal Reserve and the European Central Bank. The TED2 spread,
an indicator of perceived credit risk in the general economy, spiked up in August
2007, remained volatile for a year, then spiked even higher in September 2008. No
amount of financial engineering could protect investors from one simple and
irrefutable principle—if these sub prime housing loans turned 'bad', the instruments
that were based on these loans would lose value. CDO prices started plummeting as
defaults on US home loans rose. Falling prices dented banks' investment portfolios
and these losses destroyed banks' capital. This means to say that as the assets of the
investment banks failed to give returns or rather become a cause of losses, the trust
of the shareholders of the banks would be shaken which would result in loss of
capital, as investors would start to pull out. The complexity of these instruments
meant that no one was too sure either about how big these losses were or which
banks had been hit the hardest. Banks usually never hold the exact amount of cash
that they need to disburse as credit. The ‘inter-bank’ market performs this critical
role of bringing cash-surplus and cash-deficit banks together and lubricates the
process of credit delivery to companies (for working capital and capacity creation)
and consumers (for buying cars, white goods etc). As the housing loan crisis
intensified, banks grew increasingly suspicious about each other's solvency and
1
Collateralized Debt Obligations
2
T-bill and Eurodollar ticker
5
ability to honor commitments. The inter-bank market shrank as a result and this
began to hurt the flow of funds to the 'real' economy. Wall Street blue chips like
Bear Stearns and Merrill Lynch have been acquired by other more 'solvent' banks at
bargain-basement prices. Lehman Brothers, which had survived every major
upheaval for the past 158 years, went bust. Panic begets panic and as the loan
market went into a tailspin, it sucked other markets into its centrifuge. The
meltdown in stock markets across the world is a victim of this contagion.
6
mortgage and ARM3 crisis. The accelerating rate of foreclosures caused an ever-
greater number of homes to be dumped onto the market. This glut of homes
decreased the value of other surrounding homes which themselves became subject
to foreclosure or abandonment. The resulting spiral underlay a developing financial
crisis.
Initially the companies affected were those directly involved in home
construction and mortgage lending such as Northern Rock and Countrywide
Financial. Financial institutions that had engaged in the securitization of mortgages
such as Bear Stearns then fell prey. On July 11, 2008, the largest mortgage lender in
the US collapsed. Federal regulators seized Indy Mac Bank’s assets after the
mortgage lender succumbed to the pressures of tighter credit, tumbling home prices
and rising foreclosures. The same day the financial markets plunged as investors
tried to find out whether the government would attempt to save mortgage lenders
Fannie Mae and Freddie Mac, which it did by placing the two companies into
federal conservatorship (or nationalization i.e. opposite of privatization) on
September 7, 2008 after the crisis further accelerated in late summer.
The sub prime crisis then began to affect the general availability of
credit to non-housing related businesses and to larger financial institutions not
directly connected with mortgage lending. At the heart of many of these institution's
portfolios were investments whose assets had been derived from bundled home
mortgages. Exposure to these mortgage-backed securities, or to the credit
derivatives used to insure them against failure, threatened an increasing number of
firms such as Lehman Brothers, AIG, Merrill Lynch, and HBOS. Other firms that
came under pressure included Washington Mutual, the largest savings and loan
association in the United States, and the remaining large investment firms, Morgan
Stanley and Goldman Sachs.
So why, why did it all happen? What led to such a terrible mishap?
Various economists, businesspersons, and politicians give several causes for this.
We shall try to look into them one by one and try to understand the ‘anatomy’ of
this crisis.
Boom and Bust in the Housing Market
A combination of low interest rates and large inflows of foreign
funds helped to create easy credit conditions for many years leading up to the
crisis. Sub prime borrowing was a major contributor to an increase in home
ownership rates and the demand for housing. The overall U.S. home ownership rate
increased from 64% in 1994 (about where it was since 1980) to a peak in 2004 with
an all-time high of 69.2%.
This demand helped fuel housing price increases and consumer
spending. Between 1997 and 2006, American home prices increased by 124%. For
the two decades until 2001, the national median home price went up and down, but
it remained between 2.9 and 3.1 times the median household income. By 2004,
however, the ratio of home prices to income hit 4.0, and by 2006, the ratio was
3
Adjustable Rate Mortgages
LIBOR- London Interbank Offered Rate
7
4.6. Some homeowners used the increased property value experienced in
the housing bubble to refinance their homes with lower interest rates and take out
second loans against the higher home values to use the funds for consumer
spending. U.S. household debt as a percentage of income rose to 130% during
2007, versus 100% earlier in the decade. A culture of consumerism is a factor ‘in an
economy based on immediate gratification’. Americans spent $800 billion per year
more than they earned. Household debt grew from $680 billion in 1974 to $14
trillion in 2008, with the total doubling since 2001. During 2008, the average U.S.
household owned 13 credit cards, and 40 % of them carried a balance, up from 6 %
in 1970.
Overbuilding during the boom period eventually led to a surplus
inventory of homes, causing home prices to decline, beginning in the summer of
2006. Easy credit, combined with the assumption that housing prices would
continue to appreciate, had encouraged many sub prime borrowers to obtain ARM’s
they could not afford after the initial incentive period. Once housing prices started
depreciating moderately in many parts of the U.S., refinancing became more
difficult. Some homeowners were unable to re-finance and began to default on
loans as their loans reset to higher interest rates and payment amounts.
An estimated 8.8 million homeowners — nearly 10.8% of total
homeowners — had zero or negative equity as of March 2008, meaning their homes
are worth less than their mortgage. This provided an incentive to “walk away” from
the home, despite the credit rating impact.
8
Increasing foreclosure rates and unwillingness of many homeowners
to sell their homes at reduced market prices had significantly increased the supply
of housing inventory available. Sales volume (units) of new homes dropped by
26.4% in 2007 versus the prior year. By January 2008, the inventory of unsold new
homes stood at 9.8 months based on December 2007 sales volume, the highest level
since 1981. Further, a record of nearly four million unsold existing homes was for
sale, including nearly 2.9 million that were vacant.
This excess supply of home inventory placed significant downward
pressure on prices. As prices declined, more homeowners were at risk of default
and foreclosure. According to the S&P/Case-Shiller price index, by November
2007, average U.S. housing prices had fallen approximately 8% from their Q2 2006
peak and by May 2008, they had fallen 18.4%. The price decline in December 2007
versus the year-ago period was 10.4% and for May 2008, it was 15.8%. Housing
prices are expected to continue declining until this inventory of surplus homes;
(excess supply) is reduced to more levels that are typical.
(a) Speculation
Speculation in real estate was a contributing factor. During 2006,
22% of homes purchased (1.65 million units) were for investment purposes, with an
additional 14% (1.07 million units) purchased as vacation homes. During 2005,
these figures were 28% and 12%, respectively. In other words, nearly 40% of home
purchases (record levels) were not primary residences. NAR4's chief economist at
the time, David Lereah, stated that the fall in investment buying was expected in
2006. “Speculators left the market in 2006, which caused investment sales to fall
much faster than the primary market.”
While homes had not traditionally been treated as investments
like stocks, this behavior changed during the housing boom. For example, one
company estimated that as many as 85% of condominium properties purchased in
Miami were for investment purposes. Media widely reported the behavior of
purchasing condominiums prior to completion, then “flipping” (selling) them for a
profit without ever living in the home. Some mortgage companies identified risks
inherent in this activity as early as 2005, after identifying investors assuming highly
leveraged positions in multiple properties.
Keynesian economist Hyman Minsky described three types of
speculative borrowing that can contribute to the accumulation of debt that
eventually leads to a collapse of asset values:
• the “hedge borrower” who borrows with the intent of making debt
payments from cash flows from other investments;
• the “speculative borrower” who borrows based on the belief that
they can service interest on the loan but who must continually roll
over the principal into new investments;
4
National Association of Realtors (USA)
9
• And the “Ponzi borrower” (named for Charles Ponzi), who relies on
the appreciation of the value of their assets (e.g. real estate) to
refinance or pay-off their debt but cannot repay the original loan.
The role of speculative borrowing has been cited as a contributing factor to the sub
prime mortgage crisis. As we can easily see, that right now the major factor
contributing to the crisis was the Ponzi borrower, who relies on the increase the
assets market value to refinance their debt but cannot repay his original debt. In
addition, another major contributor to the crisis is the speculative borrower, who
considered houses as a means of speculation and earn profit through that.
10
Inaccurate credit ratings
Credit rating agencies are now under scrutiny for giving investment-
grade ratings to securitization transactions (CDOs and MBS5s) based on sub prime
mortgage loans. Higher ratings were believed justified by various credit
enhancements including over-collateralization (pledging collateral in excess of debt
issued), credit default insurance, and equity investors willing to bear the first losses.
These high ratings encouraged the flow of investor funds into these securities,
helping finance the housing boom. The reliance on ratings by these investors and
the intertwined character of how ratings justified investment led many investors to
treat securitized products. Some of these based on sub prime mortgages — as
equivalent to higher quality securities and furthered by SEC6 removal of regulatory
barriers and reduced disclosure requirements in the wake of the Enron
scandal. Critics claim that conflicts of interest were involved, as rating agencies are
paid by the firms that organize and sell the debt to investors, such as investment
banks.
MBS Downgrade
5
Mortgage-Backed Securities
6
Securities and Exchange Commission
11
(c) Policies of Central Banks
Central banks are primarily concerned with managing monetary
policy; they are less concerned with avoiding asset bubbles, such as the housing
bubble and dot-com bubble. Central banks have generally chosen to react after such
bubbles burst to minimize collateral impact on the economy, rather than trying to
avoid the bubble itself. This is because identifying an asset bubble and determining
the proper monetary policy to properly deflate it are a matter of debate among
economists.
Federal Reserve actions raised concerns among some market
observers that these actions could create a moral hazard. Some industry officials
said that Federal Reserve Bank of New York involvement in the rescue of Long-
Term Capital Management in 1998 would encourage large financial institutions to
assume more risk, in the belief that the Federal Reserve would intervene on their
behalf.
A contributing factor to the rise in home prices was the lowering of
interest rates earlier in the decade by the Federal Reserve, to diminish the blow of
the collapse of the dot-com bubble and combat the risk of deflation. From 2000 to
2003, the Federal Reserve lowered the federal funds rate target from 6.5% to
1.0%. The central bank believed that interest rates could be lowered safely
primarily because the rate of inflation was low and disregarded other important
factors. The Federal Reserve's inflation figures, however, were flawed. Richard W.
Fisher, President and CEO of the Federal Reserve Bank of Dallas, stated that the
Federal Reserve's interest rate policy during this period was misguided by this
extremely low inflation data, thus contributing to the housing bubble.
Financial Institution Debt Levels or Leverage
Many financial institutions borrowed huge sums of money during
2004-2007 and made investments in MBS, essentially betting on the continued
appreciation of home values and sustained mortgage payments. Borrowing at a
lower interest rate to invest at a higher interest rate is using financial leverage. This
is analogous to an individual taking out a second mortgage on their home to invest
in the stock market. This strategy magnified profits during the housing boom
period, but drove large losses after the bust. Financial institutions and individual
investors holding MBS also suffered significant losses because of widespread and
increasing mortgage payment defaults or MBS devaluation beginning in 2007
onward.
12
A SEC regulatory ruling in 2004 greatly contributed to US
investment banks' ability to take on additional debt, which was then used to
purchase MBS. The top five US investment banks each significantly increased their
financial leverage during the 2004-2007 time period (see diagram), which increased
their vulnerability to the MBS losses. These five institutions reported over $4.1
trillion in debt for fiscal year 2007, a figure roughly 30% the size of the U.S.
economy. Three of the five either went bankrupt (Lehman Brothers) or were sold at
fire-sale prices to other banks (Bear Stearns and Merrill Lynch) during September
2008, creating instability in the global financial system. The remaining two
converted to commercial bank models, subjecting themselves to much tighter
regulation.
Why take “bet the firm” levels of risk? In 2006, Wall Street
executives took home bonuses totaling $23.9 billion, according to the New York
State Comptroller's Office-
"Wall Street traders were thinking of the bonus at the end of the year, not the long-
term health of their firm. The whole system—from mortgage brokers to Wall Street
risk managers—seemed tilted toward taking short-term risks while ignoring long-
term obligations. The most damning evidence is that most of the people at the top of
the banks didn't really understand how those [investments] worked.”
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We have talked a great deal about the crisis and what led its birth, it
would be unfair not to talk about the damages that this financial storm has left in its
path. Apart from that, we should also take a look at the events that shaped the
monster that we are facing today, in a chronological manner.
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The dates, the Destruction and the Distress…
*
Stock Indices
7
Standards And Poors
8
KOSPI
15
to drop over 60% that day. Poor economic data on manufacturing contributed to the
day's panic, but were eclipsed by the severe developments of the financial crisis. All
of these events culminated into a stock sell off that were experienced worldwide.
Overall, the Dow Jones Industrial plunged 504 points (4.4%) while the S&P 500
fell 59 points (4.7%). Asian and European markets rendered similarly sharp drops.
Government Steps In
The House of Representatives in a 228–205 vote on September 29
struck down the much-anticipated passage of the $700 billion bailout plan also
called the Emergency Economic Stabilization Act of 2008. The purpose of the plan
was to purchase bad assets, reduce uncertainty regarding the worth of the remaining
assets, and restore confidence in the credit markets. In the context of recent history,
the result was catastrophic for stocks. President Bush signed the bill into law within
hours of its enactment, creating a $700 billion Troubled Assets Relief Program to
purchase failing bank assets. The Dow Jones Industrial Average suffered a severe
777-point loss (7%), its worst point loss on record up to that date. The NASDAQ
tumbled 9.1% and the S&P 500 fell 8.8%, both of which the worst losses those
indices experienced since the 1987 stock market crash.
Despite congressional passage of historic bailout legislation, Dow
Jones Index tumbled further when markets resumed trading on Oct. 6. The Dow fell
below 10,000 points for the first time in almost four years, losing 800 points before
recovering to settle at -369.88 for the day. Stocks also continued to tumble to record
lows ending one of the worst weeks in the Stock Market since September 11, 2001.
It is also estimated that even with the passing of the so-called
bailout package; many banks within the United States will tumble and therefore
cease operating. It is estimated that over 100 banks in the United States will close
their doors because of the financial crisis. This will have a severe impact on the
economy and consumers. Because of the crisis, it is expected that it will take years
for the United States to recover from such a mess.
16
The sudden lack of credit also caused a slump in car
sales. Ford sales in October 2008 were down 33.8% from a year ago, General
Motors sales were down 15.6%, and Toyota sales had declined 32.3%. One in five
car dealerships are expected to close in fall of 2008.
Let us see the major events that took place because of this crisis on a point wise
basis until date
Northern Rock had difficulty finding finance to keep the business
going and was nationalized on 17 February 2008. As of 8th October
2008, UK taxpayer liability for the bank had climbed to £87Bn
($150Bn) according to Robert Chote, director of the Institute for Fiscal
Studies.
J.P. Morgan Chase acquired bear Stearns in March 2008 for $1.2
billion. In order for the deal to go through, the Fed issued a non-recourse
loan of $29 billion to Bear Stearns.
Fannie Mae and Freddie Mac. In September 2008, the Treasury
Department confirmed that both Fannie Mae and Freddie Mac would be
placed into conservatorship with the government taking over
management of the pair. The two GSEs have outstanding more than US$
5 trillion in MBS and debt.
Bank of America acquired Merrill Lynch in September 2008 for
$50 billion.
Lehman Brothers declared bankruptcy on 15 September 2008,
facing a refusal by the federal government to bail it out. Treasury
Secretary Hank Paulson cited moral hazard as a reason for not bailing
out Lehman Brothers
AIG: On 16 September 2008, The Federal Reserve provided an
emergency loan of $85 billion to AIG, which will be repaid by selling
off assets of the company. This intervention gave the US government a
79.9% equity stake at AIG. Just over three weeks later the Fed reported
that AIG had drawn down $70.3 billion of that $85 billion facility and
AIG announced that it might tap an additional $37.8 billion in secured
funding from the Federal Reserve.
Scottish banking group HBOS agreed on 17 September 2008 to be
acquired by UK rival Lloyds TSB in an emergency takeover after its
share price experienced significant falls amid fears over its exposure to
toxic debt. The deal was encouraged by the UK government, who agreed
to waive competition rules to allow the takeover to go ahead.
18th September: The UK Financial Services Authority imposes a
temporary ban on short selling financial stocks a move echoed in other
centers.
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19th September: US treasury secretary Henry Paulson calls for the
government to respond to spend billions of dollars to take toxic
mortgage assets of financial companies to restore financial stability.
29th September: Details emerge of the $700 billion US bailout plan.
21st September: Goldman Sachs Group Inc. and Morgan Stanley
become bank holding companies regulated by the Federal Reserve.
22nd September: Nomura Holdings Inc. says it will buy Lehman’s
franchise in Asia-Pacific and acquires Lehman’s business in Europe.
Mitsubishi UFJ Financial agrees to buy up to 20% of Morgan Stanley
for $8.5 billion.
24th September: Warren Buffet’s Berkshire Hathaway Inc. says it
will buy up to 9% of Goldman Sachs.
25th September: Washington Mutual declares bankruptcy as the
biggest failure of an American bank. The United States OTS9 announces
that it will seize WaMu and sell its functional assets to JPMorgan Chase
for $1.9 billion.
29 September: The UK government nationalized British bank
Bradford & Bingley. The government will take control of the bank's
£50bn mortgages and loans, while its savings operations and branches
are to be sold to Spain's Santander.
30th September: EU regulators endorse 6.4 billion euros public
bailout of Dexia SA, the Belgian-French financial services group.
1st October: US Senate passes bailout plan.
2nd October: Irish lawmakers vote to enact radical legislation
guaranteeing Irish bank deposits and debts up to a total of 400 billion
euros.
3rd October: the US House of Representatives passes a revised
bailout plan. Wells Fargo and co. says it will buy Wachovia Corp. for
about $16 billion. The Dutch Government buys Fortis for 16.8 billion
euros.
4th October: European leaders meet in Paris and commit to ensure
the stability of banking and financial systems.
5th October: Germany pledges to guarantee private deposit account.
Germany also clinches a revised rescue deal for lender Hypo Real Estate
after banks and insurers pulled out of a state-led 35 billion euro rescue
program.
6th October: France’s BNP Paribas scoops up the assets of Fortis in
Belgian and Luxemburg for 14.5 billion euros.
9
Office of Thrift Supervision
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7th October: Iceland facing a ‘national bankruptcy’ takes over
Landsbanki, its second largest bank and seeks loan from Russia.
8th October: The Federal Reserve leads a coordinated global round
of emergency interest rate cuts. China, The European Central Bank and
central banks in Britain, Canada, Sweden, and Switzerland also cut rates.
Britain offers to pump 50 billion pounds in its retail banks.
10th October: The Dow closes at 8451.19, losing 185 in its worst
week ever. Crude oil drops below $80 per barrel. RBI cuts CRR10 by a
full percentage point, BSE wraps up its worst ever week down by
15.95%.
13th October: The UK government unveils plan to inject up to $63
billion into Royal Bank of Scotland and the soon to be combined HBOS
and Lloyd TSB Group. Germany unveils bank bailout plan that could
cost up to $500 billion in state funds. The French government says it
will provide up to 360 billion euros to help banks.
Now we move from the US and the worlds’s various economies and
concentrate on how the crisis has affected the Indian economy. The graph below
shows the movement of the Sensex compared to the movement of the DJIA11
during the past troubled times.
10
Cash Reserve Ratio
11
Dow Jones Industrial Average
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Global Slowdown and its Effect on Different Sectors in India
The Real Sector Story
The Reserve Bank of India's (RBI) restriction on Indian banks from
financing real estate companies has added to the problem. Real estate firms were
mostly dependent on foreign funds through the FDI (foreign direct investment)
route and private equity. However, after the global crisis, private equities that
usually fund big projects are now shying away.
According to industry sources, several realty majors have decided to
go slow on their projects, especially in large cities, because of shortage of working
capital, as banks have not only withdrawn overdraft facility but also decided not to
process any more corporate loans.
In fact, the performance of realty stocks also reflected the ground
reality, with the index for the sector on the Bombay Stock Exchange (BSE) falling
by 11.3% the steepest among all the 13 sector-specific indices.
The index has fallen more than a whopping 75 % over the past year. The stock of
DLF, for example, is now precariously close to its 52-week low and so is the case
with Jaiprakash Associates, Unitech and other realty majors.
City Check
Property prices in up market areas like Malabar Hill in South
Mumbai have moved up from around Rs 12,000 per square foot in 2003 to twice
that figure this year. More importantly, there was a deal struck at Rs 60,000 per
square foot earlier this year.
In Kolkata, the impact has been greater in the outer reaches of the
city. It has not been that bad in the city as such. Actual users have booked most
apartments in the city. Therefore, there is no question of speculative buying.
Transactional volumes in the residential segment have dropped across India. Right
now, there is no demand for an outright purchase and many people are going for the
lease option. In a falling market, that is a more practical solution. IT and ITES,
account for 80 % of all commercial space in India.
Besides, 70% of that industry is dollar denominated. That is exactly
what is affecting Bangalore.
The real estate funds, for that matter, have been a worried lot with
the deployment going very slow over the last 3-4 months. The scenario is pretty
negative. The approach now will be one of wait and watch and one will wait for the
right opportunity.
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Case Study
The story today has been on the lines of a fairly stable market for
commercial property in cities like Mumbai and Delhi with even Bangalore, Delhi
and Hyderabad moving up by just about 10% between June 2007 and March this
year. Nitesh Shetty, chairman and managing director of Bangalore-based Nitesh
Estates, says rentals in the city’s Central Business District (CBD), are still high.
“Suburban Bangalore is witnessing a slowdown. Here, there has been a 5-10% drop
in rentals,” he adds. In the overall scenario, there could be some serious challenges.
“In the commercial space, we will come back to the levels that we had touched two
years ago. That will not be very long from now. This is definitely not the bottom,”
warns Knight Frank’s Vakil. Of course, a city like Kolkata is up against a different
situation where there is not too much of stock available.
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Reduced Spending
Rising unemployment and reduced spending by the Americans have
forced some of the leading brands in the U.S. to close down their outlets, which in
turn has affected the apparel industry here. The U.S. accounts for 55 % of all global
apparel imports.
According to Sandeep Walia, Chief Executive Officer of Arwind
Apparels, the apparel industry was in “recessionary mode,” and industries were
looking at “building in efficiency” and “cutting out all the fat” by cutting down on
expenses, such as avoidable air travel, and “increasing plant efficiency.”
The fact that people in Europe and the U.S. are not walking into
stores of branded apparels and buying brands such as GAP, Lands End, Ann Taylor,
West Seal and J.C. Penny has affected business,
Many of these brands, which have businesses in India, have seen
delayed purchase.
Meanwhile, the downward trend has turned the heat on about six
lakh garment workers in the city. The industries are resorting to reducing the shift
size and giving offs to the employees.
Case Study
A company on Mysore Road, which employs 2,700 workers, has
been giving weeklong holidays to employees by turns. “They have been paid for
this period and told that they should compensate for it when work picks up again,”
said K.R. Jayaram of Garment and Textile Workers Union.
A manager of a unit near Nelamanagala said he had instructions to
cut about 10 % of the employee strength after strict performance appraisals.
Overtime wages had been stopped, he added.
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Food and Agriculture Organization
22
What's more, the global slowdown will also interrupt the demand
growth in importing countries. As signs of revival in prices are bleak, the
commodity plantation sector has only one alternative and that is to improve the
quality of its product, to become cost-effective and globally competitive in a price-
sensitive situation. Even on the working capital front, the entire plantation sector is
heading for a major debt crisis, most of them have exhausted their bank overdraft
limit, bankers are holding up advances as repayment of principal, and interest
amounts have fallen.
Case Study
In Karnataka, the largest producer of coffee in the country, growers
have been unable to repay loans amounting to about Rs 20 billion and most of them
are on the verge of defaulting. Many have resorted to chopping trees in their
plantations or selling their estate vehicles to meet their mounting loan or wage
commitments,"
Says United Planters' Association of India's (Upasi) out-going president E K
Joseph.
Rising Interest Rates
Interest rates on home loans have gone up substantially in the last
one year. The rates have gone up from around 7.5% in 2005 to 9% in 2006 further
to around 12% at present. This has led to increase in the equated monthly
installments (EMI) in the last one year by around 23% and by 37% since 2005.
High interest rates have already dented property demand in the past few quarters
and expectations were that rates would soften after the Reserve Bank of India
announced a 100-basis point cut in the repo rate to 8% and another 250 basis points
cut in the CRR to 6.50 %. However, the country’s largest bank, State Bank of India,
on Monday said it would keep its lending rates, including home loan rates,
unaltered. With rising interest costs and high property prices, buyers were holding
their hopes on loan rate cuts to buy homes.
23
for at least another three to four years as the financial services sector goes through a
major restructuring.
Coming to the IT sector, approximately 61% of the Indian IT
sector’s revenues are from US clients. So we can easily understand the impact on
the industry as the cash flow in the US is restricted which comes down to fall in
demand of our IT services.
A recent study by Forrester reveals that 43% of Western companies
are cutting back their IT expenditure and nearly 30 % are examining IT projects for
better returns. Some of this can lead to off shoring, but the impact of overall
reduction in discretionary IT expenditure, including offshore work, cannot be
denied. The slowing U.S. economy has seen 70 % of firms negotiating lower rates
with suppliers and nearly 60 % are cutting back on contractors. With budgets
squeezed, just over 40 % of companies plan to increase their use of offshore
vendors.
Feeling the Heat
A lethal mix of the falling sales, rising inflation, increasing input
costs and choking cash flow along with US economy slowdown is hurting India
industry hard. The major impact of recession or economic slowdown is with the
small exporters and importers in the country as most of them are facing the problem
of heavy duties.
The input prices have risen up mainly because of the steel prices
that have surged up. The reason behind the sky-scrapping input costs is not only
because of rising steel prices, but also due to hike in prices of aluminum and
copper. Steel prices have gone up by 40 to 50 % and aluminum has gone up by 50
% accurately,” says Dr. S.N. Dash; Secretary, Ministry of Heavy Industries &
Public Enterprises.
“Hullo, Chidambaram Speaking…”
Indian financial markets would be indirectly affected by the global
cash crunch, though it would be limited. Describing the situation as “one of the
most difficult ones in modern history”, Chidambaram said the global crisis will not
impact the country directly as India's financial system had “sound fundamentals”
and the country had a transparent, efficient market.
However, indirectly the cash crunch prevailing in the world will
certainly affect our financial markets too, though at a limited scale. Saying it was
the “testing time for the world and for globalization,” the minister urged world
leaders to work in “close cooperation” to ensure that the crisis does not worsen “the
already abysmal living conditions of the poor people of the world.”
According to Chidambaram, Indian economic growth had been
affected recently, but mainly due to the high fuel prices that had been in the upward
trajectory for the major part of this year.
“Inflation crossed the 12 % mark, mainly due to our dependence on oil imports and
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94 % of the week-on-week increase in inflation was attributable to petroleum
products,”
-Chidambaram, Finance Minister of India.
In addition, India is largely self-sufficient in food grain production
and is in no way responsible for rise in food prices, noting that the country had
achieved an all time record production of food grains. Despite the global slowdown,
Indian economy would grow at an average of over 8%.
All this insulation and the economy is secured talk doesn’t seem
right to me; it seems more like dark humor. With only 4% of the population
engaged in investment market and only 14% of the population keep their savings in
a bank; I feel we have not suffered a shock like other countries because our
economy was not developed enough. It is as if the saying-ignorance is bliss- turned
to reality for India. The politicians know that they can make any cock-and-bull
story and feed it to the public (okay some of it is true) and the gullible public
accepts it. Instead of asking people to cut down on wasteful spending, they keep
telling that every thing is under control, which is far from truth.
India the Optimist
Global economic slowdown has not seriously dented optimism of the
investors looking to pump in money to India. The ING Investor Dashboard
Sentiment Index for India still continues to reflect the highest level of investor
optimism across Asia, with India continuing to be the most optimistic market there.
Though local investors have been affected by external developments, India's
fundamentally strong domestic economy has helped to minimize the impact on their
investments, survey says. & Vineet K. Vohra, Managing Director & CEO, ING
Investment Management India said, "Although the ING Investor Sentiment Index
reveals that the sub prime crisis and recent credit crunch have made investors more
cautious, the core sentiment of Indian investors remains optimistic in the country
compared to other economies."
India's investor sentiment falls to 156 for Q3 2008 from 168 for the same quarter
last year (Q3 2007) as investors become more balanced and less aggressive in their
investment approach. India continues to be the most optimistic market in Asia.
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How well is India facing the music?
26
in 2006-07 at least 40% of house buyers borrowed from their relatives
and friends.
Therefore, in the current situation, we don’t see any reason for sweat
on our brows due to the fear of banks going down with same fever as those of the
US.
But it does create an irony. Shoring up sagging residential housing
demand is one strategy that can be considered to ensure a softer landing for the
Indian economy in a slowing global growth scenario and to achieve that, some
easing of interest rates on loans rather than any fear to limit loan exposure could
be a desirable step.
“India’s corporate balance sheet is the healthiest in Asia and Indian corporate
have too much of cash—around $40 billion— whose value may go down with
higher inflation. We do expect Asian and other markets to face slow down. India
also may face some slow down in one two years but the country would be more
immune to global slowdown. ”
- Mr. Paul Sheard, Global Chief Economist, Lehman Brothers
“Investments from this country are not flying away and the economy is pretty
insulated”
-Mr. Prabhat Awasthi, Head of Equity Research for India, Lehman Brothers
A sectoral analysis shows that the effect of the financial breakdown may not be as
bad as it is made out to be. Here, let’s take a look…
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Firefighting Measures
Following are the steps taken by governmental regulators to improve liquidity and
their effect:
6th October:
o Measure- CRR reduced by 50 basis points form 8.5% to 8 % effective 11th
October.
Effect- To release Rs20, 000 crore cash into the system, ease liquidity.
10th October:
o Measure: CRR slashed again by 100 basis points to 7.5%, effective 11th
October.
Effect- This brings total Rs60, 000 crore cash after a cut of 150 basis
points in the CRR.
o Measure- Rs10, 000 crore government bond auction called off.
Effect- If the government had gone ahead with this it would have
nullified the CRR cut.
13th October:
o Measure- Banks allowed transacting in interest rates futures.
Effect- A tool for banks to hedge interest rates.
14th October:
o Measure- 14 day special repo window opened where banks can borrow
Rs20, 000 crore and pass on the funds to mutual funds.
Effect- Lifeline for those mutual funds that are facing redemption
pressures.
13
Statuary Liquidity Ratio
14
Liquidity Adjustment Facility
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15th October:
o Measure- CRR cut by another 100 basis points to 6.5%.
Effect- Another Rs40, 000 crore pumped into the economy.
o Measure- Banks are allowed to keep 23.5% of their deposits in SLR
securities, instead of 24%. Yet another cut in the SLR.
Effect- Banks can use the headroom to borrow from RBI for mutual
funds.
o Measure- Interest rates on NRI deposits slashed by another 50 basis points.
Effect- The object is to increase overseas funds flow even as FII’s are
increasingly pulling out money from Indian equities.
o Measure- Banks can borrow funds from their overseas branches up to 50%
of their capital of $10 million whichever is higher.
Effect- Another way of increasing liquidity.
15th October:
o Measure- SEBI decides to disseminate data on securities lent by FIIs
overseas twice a week.
Effect- It leads to a crack down on a parallel offshore market for short
selling Indian stocks by foreign investors that may have been leading to the
stock market fall.
Ministry of Finance
21st September:
o Measure- External commercial borrowings limit for infrastructure sector
increased to $500 million from $100 million.
Effect- With domestic liquidity being squeezed, alternative source of
fund raising being opened for Indian firms.
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Participatory Notes
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15th October:
o Measure- FIIs investment in debt market doubled to $6 billion.
Effect- To increase foreign capital inflows in to India. With risk aversion,
growing, foreign funds may focus on debt instead of equity, which they
have been selling daily.
o Measure- Recapitalization of relatively less capitalized banks to raise their
capital adequacy ratio to 12%.
Effect- This will lend strength to banks’ balance sheets and give them
more power to absorb shocks.
o Measure- Banks to be given Rs25, 000 crore as part compensation of the
money they spent in offering relief package to farmers in June.
Effect- This will help funds-starved banks to generate liquidity and offer
fresh loans to farmers.
Now what?
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Inflation (so very obvious). A loose monetary policy may seem like
a bad idea when WPI16 inflation is running at around 11%. The RBI governor raised
the inflation concern recently, just after loosening the monetary view. Monetary
Policy is backward looking. It works with a gap. It has to be based on predictions of
future inflation. Recently, monthly inflation was in the 4%-5% range. The global
demand slowdown really removes inflation as an immediate threat, so there should
be no holding back on shoring up the financial sector.
The falling rupee. Only recently, we were face to face with problem
of the Rupee being too high. The RBI has engaged in an exercise in total futility,
trying to manage the level of the rupee. India is unlikely to see a speculative attack
on its currency, given its decent domestic economic fundamentals. In fact, the
rupee’s weakness right now is really the dollar’s strength. That, in turn, is likely to
be a temporary phenomenon, until financial markets begin to recover. Using up
foreign exchange reserves to defend some illogical level of the rupee seems to be
pointless. Fighting currency volatility right now also seems pointless. It’s a much
better idea to give domestic firms as much freedom as possible to evade currency
risk individually as they see right, through liquid, deep and well-designed currency
futures markets.
The stock market. Foreign leverage and foreign capital contributed
to the stock market run-up. Now the excess leverage and capital are going away.
The Indian stock market itself is quite efficient, and will correct itself. Its impact on
the overall economy is still relatively small, in any case (remember the 4%).
16
Wholesale Price Index
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Their Views
Here are some of the views of the people who are in touch with our team and told
us their views on this financial crisis.
“In terms of impact on me; I have many friends who have lost their jobs; I am
worried about losing mine. I and all the people I know have lost up to 60% of our
retirement money as the stock market has dropped. I do not expect a bonus, am
happy to have a job at the moment and have reduced my spending on everything
but the essentials. Many people are thinking this way and this will likely lead to a
longer recession more unemployment and a continuing vicious cycle. This is the
scariest time we are witnessing and more bad news is sure to come ”
-Manjeet Kaur; resident USA.
“ As RBI has taken strong steps to check inflation but till today the impact of RBI’s
steps have not proved much effective because of that the crises is not only
spreading in India but spreading globally. Due to inflation the cost of household
commodities are increasing day by day. So the common man is suffering badly and
is becoming very tough to survive. The most important cause of the failure of banks
in America the liberally of loan to all and the recovery of loan amount is very low.
The target, so that the NPA (Non Performing Assets) increases and the banks are
suffering downfall. As a regards the market is going down the reason of this is to
withdrawing money by foreign investor. So the impact on the common man and
small time businessmen. ”
-Sadhan Kumar; Assistant Manager, Reserve Bank of India.
“We have our market only in the USA and since the financial crisis, we have lost
almost 80% of our market. This has forced us to look for local markets within India
and other markets apart from the US. We have reduced our work force by almost
half and changed working ours working hours in order to save on electricity and
thus cut working costs. All our expansion plans that we had been planning for a
long time, have been put on hold until things get better. Basically focusing on re
deploying resources now. We do not see the global markets becoming better before
”
at least 11 months to 2 years.
-Paramjeet Singh; Owner home textiles export house, Betterliving.
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Sources:
Newspaper articles from-
• Times of India
1. Anatomy of A Crisis
Series- Learning with the Times, by- Abheek Barua
• Mint
1. Are We Facing The Abyss
Column-Eye on India, by-Nirvikar Singh
2. Summit Stresses Impact of Finance Crisis on Developing World
By- AFP
3. Why India Is Worse Off Today Than In 2006
Column- Mint Analysis, by- Nesil Staney and Ravi Krishnan
4. A Crisis and New Opportunities
Column-Their View, by-Mukul G. Asher
5. The Decline and Fall of Financial Capitalism
Column- Conservative Corner, by- Jaithirth Rao
6. Why Indian Banks Are Immune To The US Disease
Column- Loan Economics, By- Christopher Butel
7. What Next For India
Column- Eye on India, By- Nirvikar Singh
8. Growth may have slowed to 7%: Sen
Series- Economic Slowdown, By- Asit Ranjan Misra
• The Wall Street Journal
1. A Crash felt Around the World
By- Joanna Slater
• The Hindustan Times
1. We have good news
By- Rajendra Palande
• Websites
1. www.wikipedia.org
2. www.dowjones.com
3. www.livemint.com
4. www.timesofindia.com
5. www.hindu.com
6. www.businessstandard.com
7. www.zeenews.com
8. www.presstrustofindia.com
9. www.economictimes.com
10. www.propertywire.com
Note: The list of sources given above has not been prepared in the order of usage or
chronological order. We solemnly regret this inconvenience.
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