Subprime Crisis and the Impact on India

As interest rates started falling due to excess liquidity, house prices rose rapidly, creating a pool
of wealth in the hands of Americans, which they unlocked by contracting mortgage loans. It
benefited them in two ways — they got huge liquidity at inflated housing prices and interest rates
that were practically lowest in the last twenty years. This became a virtuous cycle, which
resulted in very high consumer spending, obviously fuelling global growth.

As interest rates started rising in the US due to inflation concerns, this virtuous cycle came to a
standstill and the demand for houses started tapering. This resulted in lower prices for houses and
many were unable to cover the mortgage loans. It has now hit the entire banking industry in the
US and the virtuous cycle is becoming a vicious cycle.

This subprime crisis has inevitably become an election issue, and the Democratic presidential
candidates have outlined plans to address it.

Obama’s stand, which avoids direct government spending, is more conservative and impractical,
as compared to Clinton’s, who has promised to allocate federal reserves to resolve the crisis.

What does all this mean for the Indian capital market? For one, the flow of capital coming to the
Indian stock market will be reduced. India was always considered one of the robust emerging
markets, but definitely with certain political and economic risks.

These risks, in recent times, were not priced into equity valuations as the excess liquidity was
chasing emerging market exposures and India became the investor’s darling, after China. Now
with the subprime crisis, excess liquidity will vanish and the market will correct for the price of
risks. Let us also look at domestic fundamentals. Indian markets will see a correction because of
high oil prices, high interest rates, slowing down of exports because of the slowing down of the
US economy and rupee appreciation. This will definitely have an impact on the GDP growth
rate.

The stock market has, in the recent past, rallied largely because of global cues and has almost
completely ignored the local issues. With liquidity drying up, the market will now focus on local
issues, including political uncertainties and corporate earnings. It is natural to expect that, finally,
fundamentals will rule over technicalities, and the market will look at ground realities.

A slowdown can be observed in the automobile sector, some slowing down is already being
witnessed in the real-estate segment and, with exports coming down, and it will not be too long
before we see the same in textiles, jewellery and other areas as well.

Perhaps a similar story will unfold in the next couple of months for these lenders who have lent
big money into the subprime markets. One or more banks will fold, just like Enron did, resulting
in a huge crisis of confidence. It would be naive to wish away this major problem inflicting the
global markets and to presume that the Indian market is decoupled. If the global super-tanker
US, which has a 25 per cent share of global GDP, slows down it will definitely have an impact
on the Indian economy.
Only time can decide which policy becomes successful. More importantly, no one can predict a
change of plans in the Oval office.

Tamal Roy

Hedge fund
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A hedge fund is a lightly regulated investment fund that is typically open to a limited range of
investors who pay a performance fee to the fund's investment manager.

Every hedge fund has its own investment strategy that determines the type of investments it
undertakes and these strategies are highly individual. As a class, hedge funds undertake a wider
range of investment and trading activities than traditional long-only investment funds, and invest
in a broader range of assets including long and short positions in shares, bonds and commodities.
As the name implies, hedge funds often seek to hedge some of the risks inherent in their
investments using a variety of methods, notably short selling and derivatives.

In most jurisdictions, hedge funds are open only to a limited range of professional or wealthy
investors who meet criteria set by regulators, and are accordingly exempted from many of the
regulations that govern ordinary investment funds. The net asset value of a hedge fund can run
into many billions of dollars, and the gross assets of the fund will usually be higher still due to
leverage. Hedge funds dominate certain specialty markets such as trading within derivatives with
high-yield ratings and distressed debt.[1]

Impact of US Subprime Crisis On India And China

Abstract:

The impact of US subprime crisis on India and China will not be felt to a very large extent.
Economists say that there are enough reasons to think likewise. The write up below gives
reasons as to why the impact will not be felt to a large extent.

The Impact of US subprime crisis on India and China may not be very large according to
economists. It is being anticipated that the developing countries might be spared for a year or
two and neither of the countries would be affected either by economic recession in the USA or
the prevailing US subprime crisis. This notion was put forward by the leading economist of the
World Bank.

Further, it is being fathomed that even if there is an impact of US subprime crisis on India and
China, it will not be taking place earlier than two years. However, it will be wrongly said if the
developing nations like India and China would be entirely untouched by the ripple effect. The
prevailing economic condition in these countries are so strong that it may not feel the upheaval
as it would have felt had the economy of these countries been sluggish.

Probable effects on financial markets of India and China:

One possible impact of US subprime crisis on global markets would be certain unforseen losses
pertaining to securities. If such a situation arises, it would further make credit conditions
stringent. Consequently, loss incurred on securities would increase. As a cumulative effect, the
financial markets would spiral downward causing the monetary policies to become more loose.

With regard to equity markets, it is being anticipated that equity markets may go down and the
cost of capital(effective) may rise by 200 basis points as compared to the baseline. As a result of
the credit constraints, business investment in the United States of America would drop,
unemployment would rise and there would be a prolonged phase of depression in the consumer
prices.

The need of the hour is to have a more open economy or be open to trade, attract investments,
which would re kindle innovative concepts and enhance foreign direct investment. The growth
has to be such that it is sustainable, only then will the impact of US subprime crisis on India and
China be negligible.

http://www.scribd.com/doc/16446923/Sub-Prime-Crisis-Its-Impact-on-Indian-Economy