1.

Introduction to present financial market in India

General Overview
As might be expected, the main impact of the global financial turmoil in India has
emanated from the significant change experienced in the capital account in 2008-09
so far, relative to the previous year
i
. otal net capital flo!s fell from "#$%&.' billion
in April-(une 200& to "#$%'.2 billion in April-(une 2008. )hile *oreign +irect
Investment ,*+I- inflo!s have continued to exhibit accelerated gro!th ,"#$ %..&
billion during April-August 2008 as compared !ith "#$ 8./ billion in the
corresponding period of 200&-, portfolio investments by foreign institutional
investors (FIIs) witnessed a net outflow of about US$ 6.4 billion in April-September
!!" as #ompared wit$ a net inflow of US$ %&.& billion in t$e #orresponding period
last 'ear.
#imilarly, external commercial borro!ings of the corporate sector declined from "#$
&.0 billion in April-(une 200& to "#$ %.. billion in April-(une 2008, partially in
response to policy measures in the face of excess flo!s in 200&-08, but also due to the
current turmoil in advanced economies. )hereas the real exchange rate appreciated
from an index of %00.9 ,base %99'-901%00- ,"#$% 1 2s. 0..%2- in #eptember 200. to
%%/.0 ,"#$ % 1 2s. 00.'0- in #eptember 200&, it has no! depreciated to a level of
%0%./ ,"# $ % 1 2s. 08.&0- as on 3ctober 8, 2008.
Primary Market
4rimary 5ar6et may be defined as a mar6et for ne! issues.
%
he primary mar6et is
the pacesetter for mobili7ing resources by corporates.
2
he bull-run in the secondary
mar6et enabled and emboldened companies to enter the mar6et !ith big issues and
attract investors and traders to invest in public issues to reap high profits follo!ing
their listing.
he companies profitability performance !as also good. he mar6et, ho!ever,
under!ent turmoil as soon as an *II-driven crisis developed in the secondary mar6et
and the mega crash occurred in (anuary second !ee6
(resentl') t$e primar' mar*et is in a bearis$ mood and t$is #an be seen from t$e
wa' t$e issues of +o#*$ardt ,ospital and -maar ./F $ave gone.
here are t!o factors for this depressing outloo6
Continuing uncertainties; and
Further crash of the stock prices and hesitation on the part of investors due to
fall in shares of Reliance Power as soon as they were listed. nvestors lost
nearly Rs !" per share on listing of Reliance Power.
3nly %9 companies have entered the capital mar6et in the current financial year so far,
mobili7ing 2s %,9.8 crore, the lo!est since 200'-00. Interestingly, of these %9 public
offers, only four are trading above the issue prices !hile %' are trading at discounts.
!o are not yet listed. I43 investors have become cautious as &0 per cent public
offers made last financial year are currently trading at a discount.
*ollo!ing this poor sho! of public offers and a slippery secondary mar6et, several
Indian promoters have !ithdra!n their plans to raise funds through public offers. he
#ecurities and 8xchange 9oard of India ,#ebi- data sho! that 20 promoters, !ho !ere
planning to raise 2s 2%,'00 crore, have either put their plans on hold or have
!ithdra!n their offer documents after submitting the red-herring prospectus.
'

%
2
'
According to 4rime +atabase, four companies, collectively planning to raise 2s 0,/%&
crore, have !ithdra!n their offer documents since April 2008. his includes (#)
8nergy ,2s 0,000 crore-, 2:# Infrastructure ,2s '00 crore-, ;ellebrum echnologies
,2s 200 crore- and 8lysium 4harmaceuticals ,2s %& crore-.
5any real estate and financial services sector companies have postponed or cancelled
their I43 plans after stoc6s from these sectors reported more than /0 per cent erosion
in their mar6et value. 4romoters of 8maar 5<* =and, )oc6hardt >ospitals and
#?8; ;onstructions pulled out their I43s, amounting to 2s %,'%& crore, due to lo!
response from retail investors. here are over %00 companies such as 8ssar 4o!er,
<52 8nergy, I;I;I #ecurities, =odha 9uilders, #terlite 8nergy and #2= 2anbaxy,
!hich had announced their I43 intentions but have no! stalled their plans.
#econdary Market
he sensex climbed at a rapid rate, touching record heights in 200& -2008. he
average Indian investor !ho traditionally has been a very conservative investor
became more confident and started investing heavily in the stoc6 mar6et. he stoc6
mar6et gre! in leaps and bounds and its gro!th in the last five years itself has been a
phenomenal t!enty five per cent.
he 9#8 #ensex increased significantly from a level of %',0&2 as at end-5arch 200&
to its pea6 of 20,8&' on (anuary 8, 2008 in the presence of heavy portfolio flo!s
responding to the high gro!th performance of the Indian corporate sector. )ith
portfolio flo!s reversing in 2008, partly because of the international mar6et turmoil,
the #ensex has no! dropped to a level of %%,'28 on 3ctober 8, 2008, in line !ith
similar large declines in other ma@or stoc6 mar6ets.
Against this bac6drop the unthin6able happened, the stoc6 mar6et 3f the "nited
states of America or )all street stoc6 exchange crashed due to a crisis in the housing
finance sector of its leading ban6s, caused due to delinAuency and non-repayment of
housing loans. his resulted in a panic in the !orld mar6et including India. he
*oreign Investment also came do!n heavily due to a liAuidity crunch in the ma@or
companies. he ban6s stopped lending to the ban6ers and in effect the mar6et came to
a sudden stop. he Indian investor panic6ed again and started selling li6e cra7y.
5a@or companies started ma6ing announcements li6e @ob layoffs to minimi7e their
losses.
0
Money Markets
Money markets are the mar6ets for short-term$ highly liAuid debt securities. 8xamples
of these include ban6erBs acceptances, repos, negotiable certificates of deposit, and
reasury 9ills !ith maturity of one year or less and often '0 days or less. 5oney
mar6et securities are generally very safe investments, !hich return relatively, lo!
interest rate that is most appropriate for temporary cash storage or short term time
needs. )hereas capital mar6ets are the mar6ets for intermediate, long-term debt and
corporate stoc6s. he :ational #toc6 8xchange, !here the stoc6s of the largest
Indian. ;orporations are traded, is a prime example of a capital primary mar6et.
2egarding timing, there is no hard and fast rule on this, but !hen describing debt
mar6ets, short term generally means less than one year, intermediate term means one
to five years, and long term means more than five years.
o mpact on money market
5oney 5ar6et is actually an inter-ban6 mar6et !here ban6s borro! and lend money
among them to meet short-term need for funds. 9an6s usually never hold the exact
amount of cash that they need to disburse as credit. he Cinter-ban6B mar6et performs
this critical role of bringing cash-surplus and cash-deficit ban6s together and
lubricates the process of credit delivery to companies ,for !or6ing capital and
capacity creation- and consumers ,for buying cars, !hite goods etc-. As the housing
loan crisis intensified, ban6s gre! increasingly suspicious about each otherBs solvency
and ability to honor commitments. he inter-ban6 mar6et shran6 as a result and this
began to hurt the flo! of funds to the CrealB economy. 4anic begets panic and as the
loan mar6et !ent into a tailspin, it suc6ed other mar6ets into its centrifuge.
he liAuidity crunch in the ban6s has resulted in a tight situation !here it has become
extremely difficult even for top companies to ta6e loans for their needs. A sense of
disbelief and extreme precaution is prevailing in the ban6ing sectors. he global
investment community has become extremely ris6-averse. hey are pulling out of
0
assets that are even remotely considered ris6y and buying things traditionally
considered safe-gold, government bonds and ban6 deposits ,in ban6s that are still
considered solvent-.
As such this financial crisis is the culmination of the above-mentioned problems in
the global ban6ing system. Inter-ban6 mar6ets across the !orld have fro7en over. he
meltdo!n in stoc6 mar6ets across the !orld is a victim of this contagion.
<overnments and central ban6s ,li6e *ed in "#- are trying every tric6 in the boo6 to
stabili7e the mar6ets. hey have pumped hundreds of billions of dollars into their
money mar6ets to try and unfree7e their inter-ban6 and credit mar6ets. =arge financial
entities have been nationali7ed. he "# government has set aside $&00 billion to buy
the CtoxicB assets li6e ;+3s that spar6ed off the crisis. ;entral ban6s have got
together to co-ordinate cuts in interest rates. :one of this has stabili7ed the global
mar6ets so far. >o!ever, it is hoped that proper monitoring and controlling of the
money mar6et !ill eventually control the situation.
2. Reasons for this turmoil
he turmoil in the international financial mar6ets of advanced economies that started
around mid-200& has exacerbated substantially since August 2008. he financial
mar6et crisis has led to the collapse of ma@or financial institutions and is no!
beginning to impact the real economy in the advanced economies. As this crisis is
unfolding, credit mar6ets appear to be drying up in the developed !orld.
%hy did this huge fall happen&
5any factors. he global crisis can be said to be a fault of the *ederal 9an6 of "#A.
3ne, there is a change in the global investment climate. 3ne of the primary triggers is
the huge fear of the "nited #tatesD economy going into a recession !ith foreign
institutional investors trying to reallocate their funds from ris6y emerging mar6ets to
stable developed mar6ets. Analysts are no! expecting a cut in "# interest rates.
'ad lending policies
In 200/-0& the property mar6ets !ere on a high gro!th path. he property prices 6ept
increasing. A sense of complacency had set in the real estate mar6ets. It !as assumed
that the residential property prices !ould 6eep increasing forever. 5ortgage lenders
relaxed lending standards. 9illions of dollars of sub-prime loans !ere to given
borro!ers !ith the s6etchiest credit histories on recommendations of mortgage
bro6ers !ho !ere more interested in their commission.
=oans !ere structured very innovatively. #ome gave borro!ers the ability to s6ip
repayments and some had interest rates that rose over the life of the loan. =enders
!ere not !orried about repayments as defaults if any, on loans, could be recouped
from the property itself.
;ontrary to this assumption, the property bubble burst leading to sharp depreciation in
property prices. As loans !ere given to people !ho could not repay it in the best of
time, mortgage repayments defaults 6ept increasing, triggering off a chain of events
that led to the ban6ruptcies of the hallo!ed institutions of )all #treet.
he rise in default rates in the sub-prime mar6et is essentially due to t!o things. Most
borrowers got into adjustable rate mortgages where the interest rates were reset
periodically. Second, as the S !ed relentlessly hiked policy rates "1# times
between 2$$% and 2$$&', mortgage rates rose as much as %$ per cent. Sub(prime
borrowers, characteri)ed by low and often *olatile incomes, found that they
could not ser*ice their loans any longer. +he result is the large default across the
board, which plagues the markets. herefore, the *ed has to shoulder at least part of
the blame for the current mess.
4erhaps the "# central ban6 could have been a little more prescient and figured out
that the series of rate hi6es had the potential to trigger a crisis of this 6ind. he
existence of the large Auantum of sub-prime assets and the impact of mortgage rate
resets should have figured more actively in their monetary policy discussions much
earlier. *inally, if the *ed had felt that the excess liAuidity !as !hipping up too much
froth in the housing mar6et, it should have excised the problem much earlier than
allo!ing festering.
As gro!th slo!s in the ".#. and 8urope, emerging economiesD exports to them !ill
slo!. In the past, a % percent decline in ".#. gro!th has led to a decline in gro!th in
emerging economies by 0./ to % percent, depending on trade and financial lin6s !ith
the "nited #tates.
he present crisis is the result of a perfect stormE a macroeconomic environment !ith
a prolonged period of lo! interest rates, high liAuidity and lo! volatility, !hich led
financial institutions to underestimate ris6s, a brea6do!n of credit and ris6
management practices in many financial institutions, and shortcomings in financial
regulation and supervision.
/
(his environment )oth fueled a *.#. housing )oom and encouraged )anks and
other institutions to take on e+cessive leverage to generate high returns.
Financial institutions weakened their lending standards and took on e+cessive
risk. (he most o)vious e+ample is the *# su),prime mortgage market$ )ut the
holders of these risks were not only in the *nited #tates$ and pro)lems may also
surface in other kinds of lending-for e+ample leveraged loans and consumer
credit-or other countries. .or is the pro)lem confined to industrial countries.
For e+ample loose credit in some emerging economies may lead to pro)lems
down the road.
/
0 )leaker economic outlook would in turn make it more difficult to get out of the
financial crisis$ )ecause it worsens the prospects of )usinesses and individuals.
(his is one reason that e1uity markets have fallen as the risks of a *.#. recession
and a glo)al downturn have grown
,. -re !oreign In*estors Responsible for this crisis
ntroduction
!II "!oreign Institutional In*estors' is used to denote an investor, it is mostly of the
form of a institution or entity !hich invests money in the financial mar6ets of a
/
.
country. he term *II is most commonly used in India to refer to companies that are
established or incorporated outside India, and is investing in the financial mar6ets of
India. hese investors must register !ith the #ecurities F 8xchange 9oard of India
,#89I- to ta6e part in the mar6et.
nfluence of Fs on ndian #tock Market
he current investments of *IIs is 2s. 2,//,0.0.00 ;rores. his is almost 9G of the
total mar6et capitali7ation.
&

hey increased depth and breadth of the mar6et.
hey played ma@or role in expanding securities business.
heir policy on focusing on fundamentals of the shares had caused efficient
pricing of shares.
hese impacts made the Indian stoc6 mar6et more attractive to *IIs and also domestic
investors, !hich involve the other ma@or player 5* ,5utual *unds-. he impact of
*IIs is so high that !henever *IIs tend to !ithdra! the money from mar6et, the
domestic investors become fearful and they also !ithdra! from mar6et.
Ma2or Collapses in '#3 #ense+
(ust to sho! the impact, !e analy7e belo! the %0 biggest falls of stoc6 mar6etE
8
-
.ay "/oints 0oss in 1ross /urchases 1ross Sales "Rs. 2et In*estments "Rs.
&
8
Sense3' "Rs. 4rores' 4rores' 4rores'
2%H0%H2008 ,%008- '0.2.00 %0.0.'0 200%.80
22H0%H2008 ,8&/- 28%'.'0 %.%8.20 %%9/.%0
%8H0/H200. ,8/.- &.%.80 /2&.00 2'0.00
%&H%2H200& ,82.- .&0.00 8.9.00 -%99.00
%8H%0H200& ,&%&- %%0&.00 %'&2./0 -2././0
%8H0%H2008 ,.8&- %0&&.20 %'08.00 -2&%.20
2%H%%H200& ,.&8- .00.&0 &9%.80 -%/%.%0
%.H08H200& ,.0'- 989./0 &/0.'0 2'9.20
02H08H200& ,.%&- /'0./0 /02.00 -&./0
0%H08H200& ,.%/- 809.00 9/..90 -%0&./0
*rom this table, !e can see that the ma@or falls are accompanied by the !ithdra!al of
investments by *IIs. a6e the case on (anuary %8, 2008, the #ensex lost almost .8&
points. >ere, the net sales by *IIs !as 2s. %'08.00 ;rores. his is a ma@or contributor
to the fall on that day. 9ut contrary to that day, ta6e the case on (anuary 2%, 2008, the
#ensex lost %008 points and the gross sales !as 2s. %0.0.'0 ;rores and the purchases
!ere 2s. '0.2.00 ;rores. #o this can be concluded that after the fall of mar6et, *IIs
had invested again into the mar6et. *rom this, !e can see the effect of *IIs.
.et nvestments of F from 4""5,"6
7
5ear 2et In*estment
200' '00/8.&
2000 '89./.%
200/ 0&%8%.2
200. './'9.&
200& &%08../
2008 ,%0H08H08- -29%.9
*rom this, !e can see that there is an increase in net investments till 200/ and there
9
!as small decrease in investments in the year 200.. 9ut there !as a steep increase in
the year 200&-08. his !as the best period in Indian stoc6 mar6et !here stoc6 prices
!ere increased and the mar6et !as in good mood.
)hen !e ta6e the investments in 2008, the net investments are negative. And !e
6no! the mar6et is volatile in this year. #o !e find that there is direct relation
bet!een net investments and movement of stoc6 mar6et.
*rom all the above discussions and data analysis, !e conclude that *II has a ma@or
impact in Indian stoc6 mar6et. 4articularly, the fall on 3ctober %&, 200&, in !hich @ust
a peculation about governments plan to control 4-:otes had caused the biggest fall in
Indian stoc6 mar6et, even mar6et had to be closed for one hour !ithout trade. he
impact is that even the domestic players and 5*s also follo! a close loo6 on *IIs. #o
if *IIs are confident in Indian mar6ets, there is a general perception that mar6et is on
a song.
*urthermore, +epreciation in rupee value has added to the !orries of *IIs.
+epreciation in currency leads to losses ,in dollar terms- for the *IIs, as they have to
periodically represent to mar6et value of their investments overseas. 5any analysts
fear the rupee may depreciate even more against the dollar. If that happens, *IIs !ill
have to report huge losses on the currency account, and hence are pulling out from the
domestic mar6ets.
Also, Analysts are pro@ecting a slo!do!n in the economic gro!th here due to
macroeconomic issues. he 29I has also do!ngraded the gro!th pro@ections to belo!
eight percent this year, based on the interim data released last month. Although
inflation is loo6ing flattened out at around %2 percent, the depreciation in the rupee
value !ill again give an up!ard push to it.
he softening crude oil prices has provided a bit of relief, but the rupee value
depreciation is a very big issue as it is countering a large portion of savings resulting
from lo!er crude oil prices.
It has also been found that the ma@or ,almost /0G- of *IIsD investments are from 4-
:otes. #o it implies that ma@or forces behind the *II investments are anonymous. his
has a negative impact on stoc6 mar6et. 9ecause money launders and even terrorists
use this facility to pump money to Indian mar6et and their sudden !ithdra!al causes
volatility in mar6ets.
%. /olicy followed by go*ernment for in*estors
In early 2008, the government liberalised its policy to!ards foreign investment in the
follo!ing 6ey economic sectors by increasing the maximum permitted foreign
investment toE
09 per cent for commodity exchanges
09 per cent for credit information companies
&0 per cent for non-scheduled airlines ,ho!ever, foreign airlines are not
allo!ed to invest in a scheduled airline company in India-, and
%00 per cent in titanium mining !ith prior Indian <overnment approval.
Participatory .otes
In 3ctober last year, the mar6ets regulator had put a 00 per cent cap on *IIsB total
asset holding via participatory notes or overseas derivatives instruments and stopped
them from issuing fresh 4-notes or rene!al of old ones !ith an %8-month deadline
ending in 5arch 2009 to do the needful. he moved !as aimed to 6eep trac6 of
foreign flo!s into the country. #89I has no! decided to do a!ay !ith the conditions
limiting *IIsB allocation of funds bet!een debt and eAuity to provide greater
flexibility and investment options to overseas investors.
#89I had done a!ay !ith the existing limit on distribution of *II investment a day
after the government doubled the cap on their investment in corporate debt to $.
billion. he decision came in the !a6e of *IIs pulling out of the Indian eAuity mar6et
and pumping money in the debt mar6et. *IIs have ta6en out "#$%%./. billion from
eAuity mar6et and bought net debt !orth "#$%.8 billion since (anuary. >o!ever,
another regulation that *IIs investing up to %00 per cent in the debt mar6et !ill have
to form a %00 per cent fund for this purpose and get it registered !ith #ebi remains,
the central ban6 said.
%0
%0
#ecurity Receipts
#o far as security receipts issued by the Asset 2econstruction ;ompanies ,A2;s- are
concerned, the total holding of a single *II in each tranche of scheme must not exceed
%0 per cent of the issue. 9esides, the total holding of all *IIs put together must not
exceed 09 per cent of the paid up value of each tranche of scheme of security receipts
issued by A2;s. he relaxation, according to #ebi, is aimed at according Igreater
flexibility to the *IIs to allocate investments across eAuity and debt.J
IIt !ill have a t!o-!ay positive impact. his !ill enable *IIs to invest !ithout any
obligation and !ill also enable Indian companies to get more funds for their
expansion plans,J observed :exgen ;apital 8Auity >ead (agannadham
hunuguntla.
%%
Corporate 8e)ts
he move comes a day after government doubled the limit of *II investment in
corporate debts to "#$. billion. *inance 5inister 4 ;hidambaram, on *riday, said
9#e)i had informed me that it would address any re1uest for rela+ation in the
proportion of investment in e1uity and de)t re1uired to )e maintained )y an F
under current regulations.:
#ebi said the enhanced limit for investment in corporate debts !ill be allocated among
the *IIs on a Ifirst come first servedJ basis up to a ceiling of "#$'00 million per
entity.
(wo views
%%
he *inance 5inister 4 ;hidambaram has urged ban6s to lo!er interest rates, in the
light of the steps ta6en by 29I both on liAuidity and interest rate, and several public
sector ban6s have already announced plans on reducing their prime lending rates.
9an6s have been as6ed to increase credit for productive purposes and ensure credit
Auality. 29I has also suggested to ban6s to restructure the dues of small and medium
enterprises on merits.
he 2eserve 9an6 of India had vigorously moved in 3ctober to bring do!n the cash
reserve ratio from a pea6 of 9 per cent to /./ per cent, reduce the 6ey policy interest
rate from 9 to &./ per cent and also the statutory liAuidity ratio by one percentage
point to 20 per cent of their net demand and time liabilities.
As part of measures to minimi7e the adverse impact of global crisis on domestic
economy, the *inance 5inister has reduced certain duties to give relief to some of the
affected sectors li6e steel and aviation. 3n the budgetary side, higher allocations for
social sectors and rural employment and other flagship programmes should generate
consumption, !hich contributes to economyBs gro!th.
6. Suggestions and 0essons 0earnt
%. ncrease rupee li1uidity
he demand for base money has increased. In order to hold interest rates at targeted
levels, the supply of base money needs to be increased. )hile there is a concern that a
massive in@ection of liAuidity could find its !ay into runa!ay credit gro!th fuelling
inflation ,!hich has declined only some!hat to belo! %2 percent on a year-on-year
basis in recent !ee6s- and so!ing the seeds of the next asset price bubble, the central
ban6 has instruments !ithin its existing frame!or6 ,including tighter regulatory
reAuirements- to absorb liAuidity if a particularly sharp acceleration in credit gro!th is
seen. In a financial crisis, other sources of financing have decreased. hus a certain
robust credit gro!th is a goal of monetary policy. hese are extraordinary
circumstances and it is preferable to err on the side of too much liAuidity rather than
too little. here are several measures that the government and the 29I can implement
Auic6ly to help restore liAuidity in the system.
A reduction of ;22
A reduction of #=2. his should release substantial liAuidity in the system.
As the cost of interban6 lending to some ban6s has risen sharply based on
fears that counterparty ris6 is difficult to gauge in the present circumstances,
the 5o*H29I could provide counterparty-ris6 insurance in interban6
transactions. his could be done at a mar6et-discovered price as a percentage
of interban6 lending, such that it is not seen as a blan6et government
guarantee. his !ould help increase participation in the interban6 mar6et, and
thus increase liAuidity in it. 8ven if the immediate need for this is not visible
right no!, setting up such a useful mechanism no! induces a reduction in the
perception of liAuidity ris6 in the money mar6et.
8asing the barriers faced by ban6s and insurance companies from buying the
bonds of :9*;s and real estate companies.
4. ncrease dollar li1uidity
Increase the avenues for capital inflo!s by raising the *II limit on corporate
bonds
2emove restrictions on capital account transactions for :2IBs.
he recent removal of capital controls against 4:s !as on the right trac6.
>o!ever, the 4: mar6et has collapsed o!ing to the heightened ris6
perception of counterparties such as the large investment ban6s !ho !ere the
main producers of 4:s. As a conseAuence, the unbanning of 4:s !ill have no
impact on dollar flo!s into India. he customers of 4:s are no! using the
:ifty futures in #<K. :o! the challenge lies in underta6ing deeper reform of
the *II frame!or6 to ma6e it easier for Aualified mar6et participants to
directly access the Indian mar6et, and choose to do so instead of going to
global venues such as #<K, :L#8, =#8, :A#+AM, etc.
'. 3+change rate policy
Almost all economists no! agree that !hen conditions change, the central ban6 must
not stand in the !ay of ad@ustment by the exchange rate. #ustained exchange-rate
misalignment is extremely damaging for the economy, either in terms of
undervaluation or in terms of overvaluation. Ad@ustment by the currency is a shoc6
absorber. )hen times are good, an I:2 appreciation is a stabili7ing influence, and
!hen times are bad, I:2 depreciation is a stabili7ing influence. 9y allo!ing the
exchange rate to fluctuate, !e reduce the fluctuations of the economy. ;onversely,
exchange rate rigidity forces the real economy to ad@ust since the currency mar6et !as
prevented from ad@usted by the central ban6.
In the present situation, preventing rupee depreciation !ould set off a financial crisis
at home, for domestic and foreign economic agents !ould be selling shares,
companies, bonds, and real estate, trying to reali7e "# dollars !hich !ould be pulled
out of the country and placed into "# reasury bills. All this !ould be driven by the
desire to profit from a coming depreciation of the rupee. If, in contrast, !hen bad
ne!s stri6es, it immediately generates an exchange rate depreciation after !hich both
appreciation or depreciation are eAually li6ely, then it !ould not set off the process of
selling off assets in India in order to profit from a coming depreciation. here is thus a
strong case for 29I avoiding any sort of management of the exchange rate ,in the
sense of the rupee-dollar rate-.
0. Other #uggestions
*ocus more on gro!th by improving public and private investment continue to
ta6e measures for improving liAuidityN enhance investor confidence to ensure
gro!th of industry.
All ban6s should be as6ed to ma6e a liAuidity plan and a solvency plan. 29I
should revie! these plans and insist that each of these plans have Auantitative
monitorable actions and targets. As an example, the solvency plan should
include suspension of payment of dividendsN this is the sort of measure !hich
shareholders are unli6ely to ta6e on their o!n !ithout a push from hese
plans should be triggered !hen measures of illiAuidity or insolvency are hit.
0essons 0earnt
he advantage of falling behind the curve in terms of financial mar6et development is
that, hopefully, !e get to learn from othersB mista6es. Indian mar6ets can learn from
the current global financial crisis that has stemmed from large default in the American
mortgage mar6et. It is important, ho!ever, that !e learn the right lessons and not
allo! events around lead us into an obscurantist financial policy regime.
>istorically, Indian ban6s have stayed a!ay from lending to segments that have had
the faintest !hiff of ris6. <iven a chance, ban6s !ould prefer an asset of portfolio
consisting of stodgy lo!-return blue chips than ta6e a chance !ith the odd promising
but ris6y entrepreneur. here !as some change, though, in the last fe! years. =oan
securiti7ation, for one, made some head!ay. 9etter credit information is no!
available on both retail and smaller corporate borro!ers. he credit boom in India of
the last four years has come not on the bac6 of increased lending to blue-chip
companies or individuals !ith assured high-income streams. It !as been driven by
ban6sB !illingness and enhanced ability to ta6e more ris6 on their boo6s. I !ould
argue that this !as a critical ingredient in pushing us on to a ne! gro!th tra@ectory. If
!e are to remain there, it is imperative to ensure that this process gains momentum.
)hat are the lessons to be learnt thenO ;learly there is a message in all this for the
credit rating companies. I do not claim to be an expert but from !hatever little I
understand of it there does not seem to be anything grossly !rong !ith the
methodology of rating these structured products. I certainly do not subscribe to the
no! popular conspiracy theory that the rating companies in league !ith structured
product mar6eters vetted the issue of @un6 credit as high investment grade
instruments. he methodology and safeguards that !ere used are reasonably
transparent. Instead the key problem with the current paradigm of ratings that
the crisis puts its finger on is its inability to predict large(scale default ade7uately
ahead.
12
*ollo!ing the sub-prime crisis in the "# over a year ago, the approach of 29I !as
cautious ,non-reformist according to critics- on all fronts P !hether in allo!ing the
hedge funds to invest in Indian eAuities and real estate, greater *+I in the ban6ing
sector or allo!ing excessive capital inflo!s.
hese lessons are particularly important for the 29I. If !e do stay on the current
gro!th tra@ectory, there is bound to be much more expansion in credit to increasingly
ris6ier segments. he central ban6 !ill have to facilitate this expansion and balance
this !ith the more conventional role of inflation management. It has to ma6e sure that
it doesnBt thro! the baby out !ith the bath!ater.
he present churnings in the global financial sector mainly the investment and
ban6ing sector has exposed chin6s in the Indian financial sector too in the form of
inadeAuacies !ithin the system to contain losses mainly because of the absence of a
healthy and effective ris6 assessment and management system and to absorb the
losses there should be the presence of a strong capital base.
In financial mar6et policies, emerging economies can learn from the ris6-management
and regulatory failures of industrial economies. All emerging mar6ets should build
regulatory capacities to safeguard against the ris6s associated !ith non-transparent
instruments and excesses in lending.
he present churnings in the global financial sector mainly the investment and
ban6ing sector has exposed chin6s in the Indian financial sector too in the form of
inadeAuacies !ithin the system to contain losses mainly because of the absence of a
healthy and effective ris6 assessment and management system and to absorb the
losses there should be the presence of a strong capital base.
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