The global financial crisis assumed unprecedented proportions over the last few weeks. Governments across the world had to intervene and bail out many large and leading financial institutions, and the
entire financial system was on the brink of collapse in the USA and Europe. Not surprisingly, the equity markets globally have turned extremely edgy. The ruthless carnage has taken our markets to the 10,000 levels—that’s a correction of over 50% from the highs of 21,000 in January 2008. Clearly, these are difficult times and equity markets are truly sailing in uncharted waters.
In the past few weeks, all the major stand-alone US investment banks have either fallen (Lehman Brothers Holdings), sold out (Merrill Lynch) or turned themselves into old-fashioned retail banks (Goldman Sachs and Morgan Stanley), thereby bringing to an end the era of standalone investment banking institutions in the USA. The US Federal Reserve has had to bail out mortgage giants Fannie Mae and Freddie Mac as well as the nation’s largest insurer, American International Group (AIG). Commercial banks like Washington Mutual Inc and Wachovia have also fallen pray to the contagion, which has spread to the other sections of the financial sector. The ripples of the crisis are beginning to show up in the other global economies too. In Europe, several financial institutions had to be bailed out and required fresh infusion of capital. Halifax Bank of Scotland, Bradford & Bingley Plc,
Fortis, Dexia SA…the list goes on.
In light of all these events, the probability of a global recession has increased, which has forced regulators worldwide to roll out unprecedented measures to check further deterioration in the situation. In the USA, the US Congress has approved the US government’s $700-billion bail-out package whereas the German government has unveiled a •500-billion rescue package for banks. The UK government is infusing $80 million as fresh equity capital into its major banks. Apart from this, there are other initiatives such as extending guarantee on bank deposits and/or debt taken by banks. However, some of the smaller European countries do not have the required resources to extend the helping hand to their banks, resulting in virtual bankruptcy of Iceland.
Ripple effect in India
The fears of the contagion spreading to the Indian banking space, which is already reeling under tight liquidity conditions, led the Reserve Bank of India to lower the cash reserve ratio by 250 basis points
to 6.5%. This has released over Rs 100,000 crore into the banking system. In addition, the RBI has taken steps to help mutual funds meet their redemption obligations, increase capital inflows on raising deposit rates on NRI accounts etc.
On the positive side, the dip in the prices of crude oil below $75 per barrel, the collapse of the commodity rally would ease the pressure on the ballooning current account deficit. Further, domestic inflation has declined well below the 12% levels and the central bank is clearly showing the change in its preference to “avoiding slowdown in growth” from an “anti-inflation” stance taken earlier. The continued downturn in the commodities market would remain the key to the RBI’s target of reducing inflation to 7% by the end of FY2009. The tighter liquidity conditions along with cooling off in growth of key monitorables (M3, credit, deposit) builds up a case for earlier reversal in interest rate cycle than previously expected.
The Indian markets have been battered by the rising risk aversion globally that has resulted in capital flight from emerging markets including India. The foreign institution investors (FIIs) have been net sellers to the tune of over $10 billion in 2008. Apart from the global mayhem, some negative data points have emerged in the Indian economy. The shocking industrial output growth of 1.3% announced for August 2008 added to the weakness in sentiments. Owing to the relentless selling in the stock market and the heavy demand for dollars from the oil refiners and importers, the rupee too has plunged to a five-year low of ~Rs 49 against the dollar, further adding to the concerns of global investors.
Given the situation, the Indian equity market could remain jittery in the days ahead resulting in high volatility. Apart from the global cues, the stock-specific movements would be influenced by the second quarter results. The growth expectations are relatively modest with estimates of around a 10% growth in the Sensex’ earnings (ex-oil) in Q2FY2009. Another factor to watch out for is the review of the RBI’s credit policy by its new chief at the end of the month. Another rate cut could boost market sentiments as could the announcement of financial sector reforms in the monsoon session of the Parliament slated to reconvene from October 17. On the global front, investors would be keenly watching the impact of the recent coordinated efforts taken by central banks across the world to infuse liquidity and unfreeze the credit markets.
Source: Various reports published by ICICI Direct, Sharekhan & newspapers
