• Investment World
• eWorld
• Brand Line
• Mentor
• Life
• Brand Quest
• The New Manager

Stocks

• Quotes
• SE Diary
• Scoreboard
• Open-End Mutual Fund

Cross Currency

• Rates
  
  

Shipping

• Ports
  
  

Archives

• Yesterday
• Datewise
• Resources
• In Focus
• In Depth
• Events 2007

Group Sites

• The Hindu
• The Hindu ePaper
• Business Line
• Business Line ePaper
• Sportstar
• Frontline
• The Hindu eBooks
• The Hindu Images

Last Monday, March 17, 2008, has gone down in stock market history as a day that saw the sharpest fall in the Sensex over a decade. It left investors, both Indian and foreign, that much poorer and relatively afraid to return to the market, feeding a further fear of fall.

Whatever the advocates of the theory of decoupling of India’s economy from the US economy may have meant, it is clear that decoupling is not relevant to the stock market. The Indian stock market reacted sharply to US cues as well as the corresponding Asian market developments. As the Indian market indices fell, they took a heavy toll on investors’ wealth. The question is “what next?”

Much depends on what happens in the US. The US is, of course, facing a difficult economic situation. Reflecting the fall in the stock market, the credit crunch in the US seems to have worsened. Banks and institutions have lost because of the fall in market value, such as mortgage-backed assets. Fortunately, the US Federal Reserve and the Government are reacting promptly and imaginatively with rate cuts and liquidity infusion as well as fiscal actions.

The innovative action by the Federal Reserve in recent times is its response to the Bear Stearns’ crisis. Bear Stearns, a well-known Investment Bank, which not only survived the crash of 1929 but thrived because of it, has faced a collapse because of the sub-prime crisis. Its failures had been due to its holding mortgage-backed bonds, which had fallen in value because of the sub-prime loan crisis.

The Federal Reserve did not stand by, idly watching, while Bear Stearns struggled to meet its obligations. The Federal Reserve was assisted in its rescue by J. P. Morgan Chase, one of the US’ leading banks, which acquired the shares for a small fraction of its value. The net result is that Bear Stearns, which serves an important role in the financial plumbing of the US’ markets, remained fully ready to meet its obligations.

The rescue of Bear Stearns is in sharp contrast to the action or inaction of the US Federal Reserve in the Great Depression of 1929 when it looked away while many banks failed. Obviously, the present-day Fed is blessed in having a Chairman such as Mr Ben Bernanke, who wrote Essays on the Great Depression. The Fed’s infusion of adequate liquidity and aid in the purchase of Bear Stearns is a shot in the arm for US’ financial institutions as a whole.

Some questions are, however, in order. Normally, the central bank is a lender of last resort to depository institutions, such as commercial banks, which take deposits from the public. The Bear Stearns episode shows that the central bank will be justified in extending its support to non-depository institutions as well. One asks: What is there to prevent the US Fed from extending such support to hedge funds themselves in the view that they are also important in financial plumbing? These are questions whose answers lie in the future.

The latest developments in the US are, no doubt, difficult. However, over the last few months, the situation has led to weakening of the dollar, which has, in turn, reflected itself, over time, in correspondingly strengthening US exports. In fact, experts point out that the US’ trade deficit in the recent quarter has declined compared to the previous periods.

The decline of the dollar is, however, bad news for Asian central banks and OPEC countries, who have invested their reserves primarily in dollar-denominated securities. The Asian central banks, having nearly a trillion dollars in reserves, must be suffering a lot of nearly $100 billion as a result of the dollar’s fall, although the fall is good news for the manufacturers in the US itself.

The debate rages as to whether the US is in a recession or a deeper crisis. The US has come close to accepting that its economy is facing a recession. But there are extenuating circumstances. The dollar fall itself is a prelude to a stronger economic growth in the US and reduction of job losses.

Further, the US economy is somehow the favoured destination of Asian savings. While the emerging economies when faced by a similar currency crisis would have been forced to adopt strong fiscal measures to contract the economy, the US is not in that position. Sovereign Wealth Funds seem to be ready to bridge the gap, instead of forcing a fiscal and monetary contraction.

The US economy has derived equilibrating support from those very Sovereign Wealth Funds, which the US’s policy-makers seem to be scared about. They are, in effect, the macroeconomic stabilisers of the US, similar to those which Lord Maynard Keynes had visualised in the domestic economy.

The fact that the housing crisis has led to the present imbroglio is obviously undeniable. But the total dimension of the sub-prime housing loans in relation to the US GDP is just 2.8 per cent. At this level, it cannot have a very long-term effect on the real economy, although it is difficult to say how much more pain is left in the financial system.

Observers have pointed out that the much criticised device of securitisation itself has led to wide dispersal of the sub-prime problem. Instead of its remaining in the books of the original lenders and thereby contracting their ability to lend further, it has dispersed the risks to the broader market. That, of course, raises its own problem for investment banks, such as Bear Stearns, which the Federal Reserve is trying to solve.

A related issue is how long the effects of the slowdown in the US economy will take to work out. Will the actions of the US Fed and the US Government counteract the slowdown in a relatively short period?

Experts differ in their judgment. But one important aspect of the US economy is that American corporates have generally had high cash balance and therefore may not depend too much on bank loans for their investment plans.

This may be a silver lining in the US economy’s otherwise grim story. At the same time, the fall in the US stock markets makes it more difficult for corporates to raise further equity funds. The fiscal stimulus contemplated by the US Government should be sufficient to induce the return of confidence for the US consumers and investors and this should bode well for the economy.

The media has been full of speculation as to what impact the US economy’s slowdown will have on India. The Indian stock market’s slowdown has already happened. Whether it will have further impact on India’s real economy is something that only time will tell.

However, it behoves the Indian Government and the RBI to take action to forestall the effects of the much awaited US recession, now at least.

The candidates for attention are employment-intensive industries, such as software, textiles and auto ancillaries and so on. I would expect the Government of India to be proactive and announce measures to handle the problem of these sectors. (The Government has already taken steps in regard to textiles.) The Government should act promptly in regard to garments and software also.

The threatened US recession is already a fact of life. We have to come to terms with it by adopting reasonable countermeasures, fiscal and monetary, as well as by increased productivity.

More Stories on : Stock Markets | Financial Markets

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Farm-loan waiver: Pawar’s assurance to poultry farmers

Copyright © 2008, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line