collateral damage to India as a result of the sub prime crisis is extremely limited
since Indian banks do not own structured finance instruments, said Chris Wood
global strategist, CLSA.
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.
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
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
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.
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.
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.
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.
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.
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?
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.
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.
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.
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.
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?
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
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.
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.
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
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
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.
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
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.
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
to that extent, the impact will come down, but the downside is incidentally greater
on credits for people who own credit instruments and equities.
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.
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.
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?
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
also see : General
reports on Economy