How the crisis came home
Capitulation is actually a military term. However, last fortnight it was resonating across world markets as equities tumbled scarily. In tandem, commodities led by crude, and virtually all global currencies barring the dollar, dipped to new lows. Fears of a deep, long global recession gained ground even as the UK economy shrunk in July-September— for the first time in 16 years.
Chaos reigned back home, too. As the Sensex plunged to a threeyear low, and blue-chip stocks crashed by 40-50 per cent, talk of sovereign stabilisation funds and “unconventional” measures to infuse liquidity gained currency. “With other sources of funds drying up, the banking sector is saddled with twice the normal requirement for funds,” says Jitender Balakrishnan, Deputy Managing Director, IDBI Bank. Despite the central bank having pumped Rs 185,000 crore (till the time of BT going to press) into the banking system via a series of measures (see Interview with Reserve Bank of India Governor alongside), banks are still fearful of lending, and are parking surplus funds with the central bank. “Banks have not resumed lending to consumers or companies. It takes time for policy actions to trickle down,” says A.K.R. Nedungadi, President and Chief Financial Officer, UB Group. He hopes that when his company approaches the market for funds in another two months, things will have stabilised.
If the fall of Wall Street giants was a shock, then the rapidity of the reverberations on Dalal Street is unnerving. What happened? And why? Isn’t the Indian economy largely insulated from the global capital pool? How did the crisis come home?
| 400 large companies in India operate global treasuries, which implied that with a day’s lag, the difficulties of London money market were visible in the Indian money market |
A recent paper co-authored by Jahangir Aziz, Ila Patnaik and Ajay Shah under the aegis of NIPFP-DEA tries to explain the complex linkages between the seemingly unrelated events. Their hypothesis in brief: in trying to manage the exchange rate, growth and inflation, the central bank had kept the system chronically tight on liquidity. Several Indian companies that had been using the London money market fell short of dollar liquidity in mid-September. So they borrowed on the money market and took US dollars out. At the same time, corporations were liquidating their holdings in mutual funds. Mutual funds, too, then started making claims on the money market, leading to a colossal shortage of liquidity. This was accentuated by factors such as advance tax payments and sale of dollars by RBI to prop up the rupee.
Plausible? Perhaps, but that may not be the only explanation for the domestic turmoil, say finance heads of companies. “Yes, we did sell over Rs 200 crore of our holdings in mutual funds; yet, that was to meet our domestic requirements. The redemptions would not have happened if the consumer market was growing,” says the Chief Financial Officer of a consumer durables company. The rupee’s fall also hastened the outflow.
Whatever the reason, the heightened risk perception is cascading through the economy. Sample: fear of deteriorating credit quality of the papers subscribed by mutual funds under the Fixed Maturity Plans (FMPs), especially those by realtors and non-banking finance companies. On the liquid funds, credit rating major CRISIL gave eight debt mutual funds schemes a 30-day period forrealigning their portfolios in line with credit quality requirements so as to avoid a rating action. Though this represents a fraction of the overall investments, it indicates rising stress in the face of deteriorating macro-economic fundamentals.
| 26.5% fall in rupee value against the US dollar this year (till October 24, 2008) has upset the calculations of a majority of industry players who had been betting on the rupee appreciating |
Is there a way to manage this extraordinary crisis? In their paper cited above, the three economists point to a four-pronged strategy—increase rupee liquidity, increase dollar liquidity, refrain from artificial exchange rate stability, and remove currency mismatches. Author Ajay Shah believes the RBI has moved quite a bit on providing rupee liquidity but the weakest links in the coming days will be dollar liquidity and currency mismatches.
However, as M.M. Miyajiwala, CFO, Voltas, says: “In this scenario, normal measures by the RBI alone will not help.” The government, too, can help with measures like increased government spending. So would measures like a direct release of dollars to large companies.
