If you have read the previous write-up, you would have realised by now that the current Indian Real estate situation looks very much similar to the one in US in 2004-05. A booming economy with the property rates soaring high and everyone wanting to get a piece of the pie. However the Indian banks do not have structured finance products (so far) like CDO, etc. that depend on the mortgage securities so the risk of amplifying the problem is low. However the subprime crisis has resulted in speculations about a recession in US.
How is the possibility of US recession going to affect India? Well, to start with, U.S has the largest customer base of Indian services companies and so with a slowdown in the US economy, there is going to be a slowdown in the demand for new and innovative services products making it tough for Indian IT industry to maintain high growth rates. Solution: The Indian companies must start diversifying the customer base by tapping Europe, China, Russia and South America. This will ensure that only a small percentage of the company turnover will depend on American clients.
The decoupling effort (minimize the dependency of Indian market on situation in US) will take a hit as FDI and FII from the US will increase (O). NOW THIS MAY SOUND CONFUSING. On one hand we say that the US investors are trying to bail out of their investments by selling off (as we saw in the recent market slump on Dalal Street) and on the other hand we say that FDI and FII will increase. How is that possible? The answer is as follows: The US Federal Reserve has decreased the interest rate to 3% while RBI is reluctant in reducing it even by a small margin in order to avoid the inflation rising again. What this will do is create a credit crunch in India while at the same time money is going to be pumped in the US due to lower interest rates. The foreign investors will prefer the promising Indian market over the unpredictable and slowing US market. At the same time due to a decrease in the interest rates in the US, the liquidity from the ‘Yen carry trade’ (People borrow money in Yen at extremely low interest rate of .25% and lend/invest in high interest rate US market to earn the difference in interests) may be directed to the developing economies like India. This will cause further problems for government economists who are already clueless on how to control the credit flow in Indian market without hampering the growth rate.
The subprime market has already caused the US dollar to depreciate as compared to other currencies (including the Rupee). The imports are going to be cheaper and the inflation will be pushed down by an appreciating rupee which is good for the country. But the $ depreciation is bad for Indian export industry, specially the Indian IT and BPO/KPO industries. Also the US firms in other sectors having operations in India will find the cost advantage of India getting nullified causing job and salary cuts. The solution to this problem is to increase the efficiency and cost effectiveness of these companies which will offset the depreciating dollar.
Conclusion: On the whole the Indian market seems fairly immune to the US subprime meltdown due to unavailability of US mortgage securities to Indian banks. The slowdown in the US economy and the possibility of a recession will have effects as the complete decoupling of Indian markets is still just hypothetical. But the effects are going to be minimal. However the markets will tend to remain volatile due to many more reasons that will be discussed in the subsequent write-ups.
-Mayank
How is the possibility of US recession going to affect India? Well, to start with, U.S has the largest customer base of Indian services companies and so with a slowdown in the US economy, there is going to be a slowdown in the demand for new and innovative services products making it tough for Indian IT industry to maintain high growth rates. Solution: The Indian companies must start diversifying the customer base by tapping Europe, China, Russia and South America. This will ensure that only a small percentage of the company turnover will depend on American clients.
The decoupling effort (minimize the dependency of Indian market on situation in US) will take a hit as FDI and FII from the US will increase (O). NOW THIS MAY SOUND CONFUSING. On one hand we say that the US investors are trying to bail out of their investments by selling off (as we saw in the recent market slump on Dalal Street) and on the other hand we say that FDI and FII will increase. How is that possible? The answer is as follows: The US Federal Reserve has decreased the interest rate to 3% while RBI is reluctant in reducing it even by a small margin in order to avoid the inflation rising again. What this will do is create a credit crunch in India while at the same time money is going to be pumped in the US due to lower interest rates. The foreign investors will prefer the promising Indian market over the unpredictable and slowing US market. At the same time due to a decrease in the interest rates in the US, the liquidity from the ‘Yen carry trade’ (People borrow money in Yen at extremely low interest rate of .25% and lend/invest in high interest rate US market to earn the difference in interests) may be directed to the developing economies like India. This will cause further problems for government economists who are already clueless on how to control the credit flow in Indian market without hampering the growth rate.
The subprime market has already caused the US dollar to depreciate as compared to other currencies (including the Rupee). The imports are going to be cheaper and the inflation will be pushed down by an appreciating rupee which is good for the country. But the $ depreciation is bad for Indian export industry, specially the Indian IT and BPO/KPO industries. Also the US firms in other sectors having operations in India will find the cost advantage of India getting nullified causing job and salary cuts. The solution to this problem is to increase the efficiency and cost effectiveness of these companies which will offset the depreciating dollar.
Conclusion: On the whole the Indian market seems fairly immune to the US subprime meltdown due to unavailability of US mortgage securities to Indian banks. The slowdown in the US economy and the possibility of a recession will have effects as the complete decoupling of Indian markets is still just hypothetical. But the effects are going to be minimal. However the markets will tend to remain volatile due to many more reasons that will be discussed in the subsequent write-ups.
-Mayank
2/2/2008
1 comment:
Hey Mayank, nice article. Can u elaborate more on structured finance products (e.g. CDO)? How do they work?
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