The Hindu Business Line : Benchmarks likely to move up

Under the shade: The Bombay Stock Exchange (BSE) building in Mumbai. Equities collapsed across the world last week on Thursday and the BSE Sensex tanked over 770 points to close at six and a half month low of 15,357.35 points. But it recovered about 400 points on Friday following value buying. –

We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of un-collateralised receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” This was Mr Warren Buffett’s warning in a letter to Berkshire shareholders in 2002.

Mr Buffett’s experience in handling derivatives business had been bitter. He acquired General Re in 1998, the year in which Long-Term Capital Management hedge funds lost $5 billion, and the after-shock nearly annihilated the global monetary system.

He could not find a single buyer for Gen Re’s derivatives business and unwinding it was costly.

House of cards

The global financial markets, including that in India, are grudgingly learning it now. The worth of all derivatives globally has grown, perhaps, more complex and larger – from about a “notional” $100 trillion then to $516 trillion by 2007, according to the latest Bank of International Settlements report. This figure, however, does not include private deals between two non-reporting entities. The 2007 BIS study further notes that the $11 trillion “gross market values provide a more accurate measure of the scale of financial risk transfer taking place in derivatives markets.”

Derivatives are now not just risk management tools. As some see it, the real problem is that derivatives are now a new way of creating money outside the normal central bank liquidity rules because they are private contracts between two companies or institutions. The basic premise for concern is that the derivatives are not backed up by adequate reserves with the central banks and hence create deep systemic vulnerabilities.

Distant rumblings?

Is this apprehension of a new crisis, after the sub-prime mess, overdone in India or is it an imported long-distance media event?

Last week, when dollar touched a record low against the yen and Swiss franc, and the global stock markets fell sharply on unwinding of the derivatives, Dalal Street felt a sentimentally globalised impact on its indices.

But the real influence of derivatives losses on the profitability of the Indian companies, including some banks, is still unknown and un-quantified.

Mr V.K. Sharma, research head of Anagram Securities, airing serious concern over unreported losses by Indian companies wrote in a note to the investors in December 2007: “It may be wrong to quote a figure here, but the mark-to-market losses are understood to be substantial enough to warrant a closer look by the authorities. Some of the corporates have taken exposure with more than one bank for the same underlying, multiplying their risk. Some of the companies that have taken exposure to the currency options do not even have one dollar of foreign exchange earnings. Some of these corporates are refusing to own up the mounting mark-to-market losses”.

As long as disclosures or official investigations do not pin point the figures, it would remain an “uncertainty,” which Dalal Street appears to give a benefit of doubt in the short-term and may like to carry it forward till the time it explodes. (After all, monetary and fiscal authorities must be having a close watch on the unfolding scenario.)

Rate cut hopes

According to market intelligence, the indices are likely to move up this week, truncated by holidays, on buying interest.

On Monday, local indices may open lower on global cues, but expectation of a substantial rate cut by the US Fed is likely to buoy the sentiment during the week.

Markets hope to see a 75-100 basis points cut in the US rate, which would help global players tide over the short-term liquidity problem. The markets are also expecting some policy signals towards the new derivatives problems from the FOMC.

The local corporate advance tax figures, which are scheduled to come out this week, may not bring about any negative surprise. But if, they do, then Dalal Street may have reasons to correct valuations accordingly.

(Responses may be sent to jayanta_mallick

@thehindu.co.in)

More Stories on : Stock Markets | Outlook | A Ringside View

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