Finance, Economy and Stockmarkets – Probably the only subject which can hold any audience for an hour atleast. It’s all about money, honey – as someone said earlier. Easily one of my favorite topics (don’t ask how I ended up in Consulting…that’s another story) – I guess for my first subject-specific blog – it couldn’t have got any better.
My view of the market as a whole in the world now is slightly bearish. Although in the ensuing discussion, I would put forth my viewpoints which probably would point to the market being extremely bearish (rather than slightly and never mind the sentiment on the Indian Stock Market which is hitting new highs every week) – I am also confident that some market would beat the world index by a positive margin.
1) Sub-prime crisis – I guess by now, every Tom, Dick and Harry would have heard this term a million-times over – understanding the issue either completely, partially or nothing at all. Definitions aside (lending to parties who do not satisfy the criteria of the three Cs – credit, capacity and collateral completely), I think there is a serious chance that US might slump into a recession. I would be the first one to agree to the fact that the US is resilient to certain shocks (Great Depression in 1929, Savings and Loan Crisis in 1986), but couple the fact of this crisis with the depreciating dollar and its appreciating exponential budget deficit (not to talk of the costs of wars in Iraq and Aghanistan) make the situation a little tough even for the the biggest economy of the world to handle.
Impact on India – What does a US economy slowdown mean to India? (and probably China as well) – US is the biggest consumer of goods – and although basic consumption might not take a hit, purchasing power will and with that happening, demand for extraneous goods would fall dramatically impacting India’s as well as China’s economy. The biggest gainer from the US economy in the past has been the IT sector – but this slowdown would essentially mean that IT budgets in US companies would be cut, projects put on hold till the economy (and/or the company) is back on track. There is a contrarian view – which indicates more work being outsourced to India due to cost pressures. However, my view on this is slightly negative and even if that happens, revenues would start flowing only 12-24 months hence and not immediately. (Couple this with the depreciating dollar vis-a-vis rupee, I know where my increment is going…it is going the dollar way 😦 ).
2) Increase in LIBOR rate – LIBOR is European’s standard lending rate (London Interbank Offered Rate) defined by the ECB (known in India as PLR (Prime Lending Rate) defined by the RBI). LIBOR has been increased (partly as a fallout of subprime which also has hit the European markets) from 5.3% to 6.3%. So, why should the market be bearish on this fact? Let me turn to India to answer that question.
Impact on India – As of March 31, 2007, Indian companies had borrowed nearly 72,000 cr. ECBs (External Commercial Borrowings), and between April and June, a further Rs. 34,000 cr. was added. This is a net of Rs. 106,000 cr…approx $24 billion. LIBOR has been increased by 1%, which essentially means an additional interest burden of $240 million a year…approx 1000 crores. Let me further delve deeper and look at some companies who have been heavy borrowers in the ECB market. Tata steel (for its steep ECB loan to acquire Corus), ICICI Bank (when I last read ET, they had borrowed around $12 billion in the last two years in ECBs), Reliance Industries, Reliance Communications, Bharti Airtel and probably many many more. As per my knowledge, except for Reliance, all other companies have booked forex gains gained against the dollar. Watch out for the hit on their bottomline (or is it their bottom on the line? 🙂 ) in the coming quarters.
3) Fallout of the Yen-carry trade – Yen-carry trade, for the uninitiated involves borrowing money from Japan at very low rates (actually, it is close to 0%) and investing the money in markets like India and China where the safest bonds yield around 8-9% annually. Although simplistically, the margin seems too huge – taking into account various currency conversions, administrative costs etc., the margins are razor thin and money is made only through huge volumes. Since international mutual funds, hedge funds had the capability, they raised huge amounts of money in Japan and invested in emerging markets like India and China. So, what would happen if Japan increases its lending rate by 1% – simply put, the funds who have raised this money have to close shop unless they pay off the borrowed amount almost immediately.
Impact on India – As soon as Japan raises the lending rate, fund houses would not be able to sustain their investment and hence would do a massive sell-off to pay back Japan. In this sell-off, the major markets affected would be India and China (since that is where majority of the yen-carry money has been invested) – resulting in a huge spiral of the Sensex – and bearish sentiment for a long time to come.
4) Depegging of Dirham to Dollar – (This information was passed on by a friend of mine staying in Dubai. The resulting analysis of this speculation is the following joint effort) – The authorities in the Middle East are seriously considering depegging of Dirham to the Dollar (The logic behind this is quite voluminous – however, simply put – because their currency is linked to the dollar, their economics have to follow US economics. So, even though there is an inflationary environment in the Middle East currently, since the Fed is cutting interest rates, Middle East also has to – which might compound the problem of inflation). However, our take on this is that although depegging might not happen, they might revalue their dirham – which essentially means from 1 Dirham = 3.26 Dollars currently, they might probably have to bring it to 3 dollars.
Impact on India – Although the decision to revalue the currency is internal to the Middle East, the revaluation would hit oil exporters margins – and they would cover it up by increasing the oil prices (partially ignoring OPEC’s pricing policy and politics) – directly impacting the world economy – which already is reeling under heavy oil prices. Couple with the fact of approaching elections (which essentially means domestic oil prices would not be increased) – the Indian budget is going to take a massive hit.
Investment tip: Sit on cash, invest spare cash in Gold.
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