How Wall Street’s crisis affects the Indian economy
By, Adhvith Dhuddu
By, Adhvith Dhuddu
Wall Street’s landscape and the face of the US economy changed dramatically in the past few months. It’s famously known that when the US sneezes, the world gets a cold, and it’s looking ominously similar this time around. Despite the resilience and growing strength of the Indian economy, these changes will significantly affect Indian business, trade and commerce. It’s also becoming clear that our economy is in fact intertwined with the world economy and has not decoupled with the US economy in any way.
Risky leveraging by investment banks and a slump in the real estate markets in US were the root causes of this quandary which put the financial system in peril. In the last few years, the ability to leverage gave institutions on Wall Street access to ample capital and increased their risk appetite (which increased fund flows to emerging markets). Momentum built up in leveraging was felt across the globe as capital was pumped continuously into emerging markets and unconventional assets. But this financial fallout and recent government intervention has forced many firms to deleverage and use cash conservatively. The ability to raise $600 million with $20 million collateral (1:30 leverage) is a thing of the past and this will drastically impact capital inflows to India. We will see a significant slowdown in foreign capital inflows and foreign direct investment as a direct effect of deleveraging, inaccessibility to new capital and higher cost of credit in the US and Europe.
It’s extremely important to recognize that the accelerated growth in our economy was driven significantly by foreign investments, which are sure to dry up in the short to medium term. Not because India is a less attractive investment destination, but because of insufficient capital and inability to leverage available capital. When investment banks, hedge funds and high net worth individuals could borrow $1 billion with only $50 million in collateral (1:20 leverage), the $1 billion could be distributed to India, China, Brazil and Middle East into equity, real estate, commodities and fixed income assets. But when the amount available is only $50 million (no leverage) or $250 million (1:5 leverage), any amount of distribution to emerging markets and asset classes translates to less capital inflows into India and other emerging markets. This credit crunch, or more appropriately, “capital crunch,” forces us to realize that there is less capital available for disposal around the world.
Consequences of this fallout will be far reaching and be felt in emerging markets at least temporarily. The US is a consumer driven economy (70 percent of GDP) fueled by credit and buoyed by cheap imports; Asian economies that export heavily to the US will feel the pain as spending slows down and credit gets expensive. Here in India and in Bangalore, IT bellwethers, who garnered major portions of their business from financial companies, could feel the brunt when US corporations delay IT spending plans. Financial firms are struggling to capitalize even their daily chores, so this environment will undoubtedly create less spending and reserved capital expenditure plans.
Not only will this crisis dampen the mood of investors, but will send many of them into hibernation. A lot of wealth has been eroded in this financial crisis, and investors in the US are worried more about wealth preservation than wealth creation for now. More individuals and funds will look for steady returns with less volatility leading to more conventional and safe haven assets. A rush to quality will attract many investors to established economies like the US, UK and Japan. One argument is that companies in emerging markets are undervalued now and offer good bargains which should attract investors. But this is also true in developed markets where global giants like GE, Boeing and Microsoft are trading at extremely attractive PE ratios (Click Here: DOW 30 stocks with quotes, charts and key ratios like PE, EPS, etc). The only bright spot from a foreign investor’s perspective is the weak Indian currency. This is the only factor which could attract investors to India. The fall in the Rupee is a classic sign of foreign investors exiting India, at least temporarily. This decline doesn’t necessarily imply a weak Indian economy, but underscores the temporary rise in demand for the US dollar, as assets are sold all over the world and money is sent back to US to recapitalize banks and companies.
The drastic weakening of the Rupee (Click Here: US Dollar-Indian Rupee Chart) will be short lived as federal intervention and an increase in money supply will eventually dent the US dollar. The US dollar’s rise is temporary and is not being driven by a strong fundamental economy. Usually when any country around the world has a financial crisis, it’s cost of borrowing sky rockets, except for USA. When the US was in a full blown financial and economic crisis, the cost of borrowing for the US government was at an all time low, reflecting the raw power of the US, and the fact that humongous amounts of debt are transacted in US dollars.
Risky leveraging by investment banks and a slump in the real estate markets in US were the root causes of this quandary which put the financial system in peril. In the last few years, the ability to leverage gave institutions on Wall Street access to ample capital and increased their risk appetite (which increased fund flows to emerging markets). Momentum built up in leveraging was felt across the globe as capital was pumped continuously into emerging markets and unconventional assets. But this financial fallout and recent government intervention has forced many firms to deleverage and use cash conservatively. The ability to raise $600 million with $20 million collateral (1:30 leverage) is a thing of the past and this will drastically impact capital inflows to India. We will see a significant slowdown in foreign capital inflows and foreign direct investment as a direct effect of deleveraging, inaccessibility to new capital and higher cost of credit in the US and Europe.
It’s extremely important to recognize that the accelerated growth in our economy was driven significantly by foreign investments, which are sure to dry up in the short to medium term. Not because India is a less attractive investment destination, but because of insufficient capital and inability to leverage available capital. When investment banks, hedge funds and high net worth individuals could borrow $1 billion with only $50 million in collateral (1:20 leverage), the $1 billion could be distributed to India, China, Brazil and Middle East into equity, real estate, commodities and fixed income assets. But when the amount available is only $50 million (no leverage) or $250 million (1:5 leverage), any amount of distribution to emerging markets and asset classes translates to less capital inflows into India and other emerging markets. This credit crunch, or more appropriately, “capital crunch,” forces us to realize that there is less capital available for disposal around the world.
Consequences of this fallout will be far reaching and be felt in emerging markets at least temporarily. The US is a consumer driven economy (70 percent of GDP) fueled by credit and buoyed by cheap imports; Asian economies that export heavily to the US will feel the pain as spending slows down and credit gets expensive. Here in India and in Bangalore, IT bellwethers, who garnered major portions of their business from financial companies, could feel the brunt when US corporations delay IT spending plans. Financial firms are struggling to capitalize even their daily chores, so this environment will undoubtedly create less spending and reserved capital expenditure plans.
Not only will this crisis dampen the mood of investors, but will send many of them into hibernation. A lot of wealth has been eroded in this financial crisis, and investors in the US are worried more about wealth preservation than wealth creation for now. More individuals and funds will look for steady returns with less volatility leading to more conventional and safe haven assets. A rush to quality will attract many investors to established economies like the US, UK and Japan. One argument is that companies in emerging markets are undervalued now and offer good bargains which should attract investors. But this is also true in developed markets where global giants like GE, Boeing and Microsoft are trading at extremely attractive PE ratios (Click Here: DOW 30 stocks with quotes, charts and key ratios like PE, EPS, etc). The only bright spot from a foreign investor’s perspective is the weak Indian currency. This is the only factor which could attract investors to India. The fall in the Rupee is a classic sign of foreign investors exiting India, at least temporarily. This decline doesn’t necessarily imply a weak Indian economy, but underscores the temporary rise in demand for the US dollar, as assets are sold all over the world and money is sent back to US to recapitalize banks and companies.
The drastic weakening of the Rupee (Click Here: US Dollar-Indian Rupee Chart) will be short lived as federal intervention and an increase in money supply will eventually dent the US dollar. The US dollar’s rise is temporary and is not being driven by a strong fundamental economy. Usually when any country around the world has a financial crisis, it’s cost of borrowing sky rockets, except for USA. When the US was in a full blown financial and economic crisis, the cost of borrowing for the US government was at an all time low, reflecting the raw power of the US, and the fact that humongous amounts of debt are transacted in US dollars.
Companies should incorporate this outlook into corporate plans and use this opportunity to rein in spending, accelerate cost cutting and optimize assets and resources in their organization. The future isn’t all that grim as a slower growth rate of 6-7 percent per annum is much better than no growth or negative GDP growth which the US has to confront soon. Many factors like increased local consumption, favorable demographics and a driven population will keep our economy and nation buoyant.
Online link to this article: Click Here
