Wood was speaking at a conclave on the sub prime crisis in the US and its impact on India and other emerging markets organised by the Confederation of Indian Industry in Bangalore today.

Akash Prakash from Amansa Capital said that the US is slowing dramatically. He added that if the US goes into a recession, then markets would consistently go down globally.

Rajeev Malik of J P Morgan Chase Bank said though there has been some decline in sensitivity, outright decoupling is a bit of an exaggeration. Malik stated that a greater than expected slowdown in the US, has reverberations across emerging markets.

Samiran Chakrabarty, chief economist of ICICI Bank believes that the direct effects of subprime, on the Indian markets, are pretty limited. If the US slows down, the decoupling for emerging markets cannot be too far away, observed Chakrabarty.

What do you think of the situation in the US?
Akash Prakash: Clearly, the US is slowing quite dramatically. The markets are right now ignoring or wishfully thinking that the US consumer will not capitulate. The US consumer capitulation is a story that people have been talking for the last eight-ten years and they have been consistently wrong. But, obviously, that does not mean they will be wrong again.

The US will slow down significantly and the US consumer is at risk. That is something, which is a serious problem. If you look at market behaviour, over the last 10-15 years, whenever the Fed cut rates, it has normally been good for markets, provided that the US does not go into a recession.

If the US goes into a recession, then markets will consistently go down globally. The markets today, by going up and normalizing implicitly are saying that there is a very limited chance of a US recession and of the US consumer capitulating, the odds are greater in the market that is building in.

Therefore, the greater risk is that the market gets surprised by how weak the US does become. That would initially create a problem for markets and will impact it. People are being naïve to think that a 50 bps cut by the Fed has solved everything.

In the longer-term, the case for emerging markets is very strong. It has strengthened and people are buying into the decoupling argument. But till you transition, there will be a period of transition, where people get nervous by how bad the US gets. Then, over the longer-term, the structure points will re-engage the market some 3-6-9 months down the road.

We are in a very rocky patch for the next three months at least. The rupee will get consistently surprised to be negative, on how bad the US becomes. Eventually, that will impact the stock markets globally, US and Europe definitely and it will eventually impact India and emerging markets.

What does it mean for emerging economies and markets. Do you think the sub prime problem in the US, can actually be wished away as a localised problem?
Rajeev Malik: In a way, we are hinting at the talk about emerging markets and decoupling from the US. While it is fair to say that there has been some decline in sensitivity, outright decoupling is a bit of an exaggeration. In the end, any kind of a greater than expected slowdown in the US, has reverberations across emerging markets.

It must be acknowledged that, compared to the recent crisis that we had over the last 10-15 years, the cross section of emerging markets went into this crisis on a much stronger footing. If you look at a variety of indicators, whether it is emerging market debt issuance, the happenings on the fiscal front, the commodity prices, all of them have played an important role.

A lot of people say that emerging markets are growing much faster than the industrial world, but that is really passé now. The kind of slowdown or the differential that industrial countries, or G3 countries, are going to see will probably be widened. But it would be wrong to say that any kind of slowdown would not have any impact at all.

For example, Singapore is an economy, which we traditionally treat as a high beta economy. It is extremely open, both on the trade side and on the capital flows side. It is heavily geared into the electronic cycle and despite people talking about the increased possibility of a US recession, it is interesting that commodity prices are on a record high. It does not really tell much, in terms of sharp slowdown, as far as the global economy is concerned.

The Singapore equity market itself has hit a record high. It is certainly not telling you that investors are worried about any kind of a significant slowdown and this is a high beta economy in Asia. So, the bottomline is some things have changed for the better; emerging markets, as a class, went into this crisis on a much stronger footing. But trying to draw a conclusion that total and actual decoupling has taken place, is more of wishful thinking rather than hardcore reality.

We have been watching the global markets and talking about what is happening in the US and how it was affecting the rest of Asia and emerging markets as a basket. Are there any significant takeaways from the sub prime story for the Indian economy, Indian banks or even the Indian stock markets directly?
Samiran Chakraborty: It seems that the direct effects of sub prime on the Indian markets is pretty limited. We have to look only at the collateral dimension, if there is any. Collateral damage can come in two forms; one is through a generalised slowdown in the global economy, more specifically in the US. If the US slows down, then the decoupling for emerging markets cannot be too far away. So, that is one channel, which can work.

The other channel is typically we are getting more financially integrated across the world. Capital market integration means that if there is a liquidity crisis coming out of the subprime crisis, then that can affect us in some fashion.

It is true that we have gone into this sub prime crisis on a very strong footing. Among other emerging markets, we are one of the best performers. That gives us some amount of cushion to work with. But, at the same time, it is true that the sub prime crisis has hit us almost at the peak of tightening of monetary conditions, be it interest rates or exchange rates.

We are almost at a peak of a monetary cycle and any push, at the peak, can actually trip you into the downslide. We have to be careful that the monetary conditions are commensurate, with the extent of the sub prime crisis that is going to hit us.

If we see that the sub prime crisis is taking proportions, which can affect us, through the capital market integration channel, then we have to be proactive on the monetary policy front. We have to make monetary conditions easier, so that we do not trip on the other side of the cycle. That would be my first take on the effect of sub prime on India

If we had this discussion earlier, we would have been talking in a pretty different language than what we are talking right now, thanks to Mr Bernanke for 50 bps cut and to change the scenario altogether.

There has been a lot of talk about the linkages between the credit market and the equity markets globally. There are some who contend that this is a credit market problem or a localised financial problem, which should not have great ramifications for the economy or for the overall equity market. Do you think that is a bit of a fallacy?
Chris Wood: It is definitely a credit market problem, first and foremost. My advice to people, for the last 18 months, is to remain long in equities. But you put the hedge on the credit spreads, because we had a global credit bubble, not cantered on emerging markets, but centered on the developed world.

The credit spread has frankly become insanely low, because of this conjuring trick of structured finance, which basically makes bad credit look like good credits. That is what has blown up. So, credit risk is now being repriced throughout the system, which logically must have an impact on borrowing cost for ordinary consumers and companies in those countries, where the subprime structured finance crisis has hit.

So, to that extent, the impact will come down, but the downside is incidentally greater on credits for people who own credit instruments and equities.

The collateral damage in India is extremely limited, because Indian banks did not own the structured finance instruments. Because Indian banks were constrained, the money they could lend and the Indian banks have SLR, which has been a fantastic instrument for keeping the Indian banks'' system disciplined. In a sense, it is another temptation to go into this area.

The second point is that the RBI is about the only Central Bank, I am aware of globally, that changed the accounting rules on securatisation. The explicit aim of slowing it down is that they sell the security as a bank. You cannot mark-over the profit from selling that security up front. You have to amortize it over the length of the security owned. It is precisely the upfront payment quality and a massive boost to earnings on a RoE basis, which has caused the investment banks to pursue securatisation so aggressively.

In what shape and form do you see a resurfacing of the sub prime problem in the next three months? Do you expect it to show up in the housing market, in the form of a lot of trouble for the large financial institutions out there?
Akash Prakash: One aspect obviously is that there are a whole bunch of resets coming up in the next two-three months in the US. You could also see a possibility of more skeletons coming off the closet. If you have seen the data, for the last one-month, 90% of the data points in the US had been to the downside of the initial expectation.
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