CASE STUDY

US SUB.PRIME MORTGAGE CRISIS AND ITS INITIAL IMPACT ON INDIA'S FINANCIAL MARKET
primarily the liquidity The US sub-prime mortgage crisis is a form of financial crisis impacting

a year and a half , stormed of the banking system. tieilergeO in the USA in late 2006 and, within mart<-et. The lndian financial market could not remain aloof of the spill-

the internatioial financial over effects of the crisis. per cent ln the wake of rising prices of real estate in the USA, which was as large as 124 huge demand for bank loans by the real estate dealers' The during 1997-2006, there-was a But when the price bankJ too adopted a more lenient ipproach while selecting the mortgages' mortgages turned-sub-prime' lt of real estate began to ebb sharply diring the late 2006, those loans. Consequently' was beneficial for the borrowers io-defaullon loan rather than to repay the that reached $ 200-300 billion by December 2007. The banks had to there were huge defaults their investment made in bear colossal losses. ln order to make up their losses, they withdrew the disinvestment process, financial markets the domestic and international financial market. With plummeted' The earnings of r.n"ny countries had to experience a jolt. The stock market index participants at the siock exchanges were badly affected' The exchange rate of the of the ln short, the currency and the activities in the foreign exchange market were severely a{fected. ultimately the growth rate of the economy' entire financial activities turned slow impacting affect the Despite belief in the "decoupling" concept, that recession in one country may not of the other insofar as the latter maintains strong economic linkages also with other economy

sets of countries (Akin and Kose, 2007), the impact of the sub-prime crisis and recession in the US economy was felt in the activities in the lndian financial market. Let us take up, first, the case of Flls' investment in lndian secondary market. ln the wake of the US crisis, the Flls pulled back their investment from the lndian markel perhaps for the purpose of making up the losses in the US market. They also pulled back their investment in those securities where price oscillations were greater. lt is a psychological phenomenon that whenever there is a crisis, the investors try to avoid risk-taking and make investment only in less risky channels. The pull back was large and resultantly, their net"disinvestment in lndia was as large as$ 2.747 billion in January 2008.

1.049 billion. But, again, in March 2008, there was net disinvestment amounting to $ 250 million. ln other words, the fourth quarter of FY 2007-08 witnessed a net disinvestment for $ 1.949 billion on Flls'account compared to a quarterly average of $ 5.262 billion of net investment during the preceding three quarters. The SEBI eased the registration norms of Flls and, as a result, the number of Flls getting registration from it increased. There were 68 new registrations during one and a half months of 2008 compared lo 226 during the whole ol 2007. Nevertheless, Flls' net investment failed to improve. Since Flls dominate the lndian secondary market, their pulling back of investment was

ln

February,

the situation improved showing a net Investment amounting

to

manifest in the crash of stock price index at the lndian stock exchanges. ln January 2008 alone, the fall was recorded at 16 per cent which was higher than those of the emerging market as a whole in which case it was 12.44 per cent, although being lower than those in Russia (16.120/0), China (21 .40%) and in Turkey (22.7O%l (Financial Express, 12.2.2008). ln February and March 2008, there was a further drop in the share price index. A comparative analysis shows that the BSE Sensex which was 20,301 on the first of January 2008 plunged to 14833 on 18th March 2008. The respective figures for NSE Nifty were 6144 and 4533. The secondary market effects crossed over to the lndian primary market for securities. lt is observed that after the secondary market crash since January 2008, the retail primary market investors failed to respond to the issues. The maiden issue of Wockhardt Hospitals ran into rough water. Similar was the case of Emaar-MGF Land Ltd. ln both the cases, price had to be reduced after bleak response. Even then there was no response (ibid.,6.2.20O8). Surya Foods and Agro had to postpone their IPO for Rs. 1500 million (ibid., 15.3.2008). Thus, in view ol making the primary market lucrative and to do away with the grey market, SEBI made changes in the public issue process reducing the gap between opening ol the public issue and its listing to less than five days and increasing the application money that the institutional investors had to put up from 10 per cent to 100 per cent. lt also reduced the fees for filing offer documents for public issues and mutual funds from 0.03% to 0.005% and the annual fee lor registration of mutual funds to 0.0005% of assets under custody from then existing O.001%.The registration fee

forventure capital funds was halved to Rs.5lakh (ibid,6.3.2008). SEBI proposeda2S"/"price band on the issue price on the listing day of an IPO up to a size of Rs. 2.5 billion to arrest the price volume volatility on the day of listing of IPO under this size. The band should assist in a more orderly price discovery over a period of time. Again, to implement the suggestions of the SEB|-appointed Committee on reforming lPOs, the deposit of qualified institutional buyers was to be 100% of the bid amount instead of 10 per cent earlier; the ceiling on the application ol a single investor was to be doubled to 0.2 million shares; and the allotment of shares must be done on a proportionate basis rather than on a discretionary basis. The positive effect of these
measures was not felt immediately. Again, in the case of the fund mobilisation through the euroissues, the last quarter of FY 2007-08 witnessed a big drop. lt was barely equivalent to Rs. 30.15 billion compared to Rs. 269.83 billion during lhe corresponding period of the preceding financial year (Hindustan Times, 3.4.2008). Besides, the mutual funds could not keep themselves away from the brunt of the crisis. The investors started giving cold shoulders to new fund offerings. The maiden fund offering of Mirae Asset Global lnvestment Management (lndia) Pvt. Ltd. could collect only Rs. 700 million by March 10, 2008. Morgan Stanley's ACE Fund managed to collect barely Rs. 800 million during the same period. These figures were far lower thari'Rs. 56.6 billion collected by Reliance Capital Asset Management Company's Natural Resource Fund in the first week ol February 2008 (Mint,
15.3.2008).

Chapter

Developments irx International _ Monetary System

made a srudv of 14 such rirms and steep rall in their ADR/GDR

tirr.. il pubrished by Business +'rlooa ano's.a.200b. irrrir.d that "uideni'f;,i,i"-o"r" out;i'ri';""., onty 2cases marked appreciation in the market price or e on.. ti ttre ,esi eo extent of the drop in orices vari;J*id;;. ,riJ price ;;'is.."r"", *,";;;iJft".market rhan prunged. The ""*.", rn 34 cases, it was over 20.0 ress 20.0 per cenr. per over 40'0 per cent bur ress ""n*iuii"...tn* +b.o p!, ili"n oo.d p"r'"""t Thgr" *Jr" """L'rri 29 cases, the price ebbed 60'0 per cent' on comparing ru# where the drop was over t"rr'in in1 n"onloon pri""" *-niiiil" domestic share prices of rhe same firms, it ir r"u""j"Jln; ''," in tn" ?orriJr'*"".rij"p", ",
standard on . Mint (2s.3.2008) has ""';il;" i*"i""xa pri";.;;;;; tom"t oui oi"i;'3i#:_ firms, 13 experienced a rheir ioJ ;#'p;es

Again, the impact.was seen arso on ,n" oi:": of the ADRs/ pnce crash durino the last quarter GDRs of the rndian or riziibi-oe.is

ffiiXiil,lli
OUESTIONS

touched a six_month However, the lndian financiar sector has lf precautions are taken,.th" itnp""i 1ryq s,Jrong enough to sustain temporary shocks. oiin't'Jin"tion"t.rinanliai turirr"i"" continue to srow i"t"in'"rpporrive ,"in" pi"""". wiu onry be short-rived. or economic deveropment "no

lI;1:?TS

to srarr buyins back the o"oislcuiitieJ.'rcrc.ednt rate. tn the rndian firms had "rctic""es, rr,i. i"rslii,,back overseas bonds that were ro mature in ZOiZ 1Uint, f Si.eil#,,;;"r. $ 50 milion worrh of read' rn other words. issuing ouer"eas'oJnlr.iio njt;;;;i;j;,;r;ile. banks might foilow the rn view of this probrem, be used ror the bquitv or FDlcap (Financial e"pr".., Let us see how f*'ili" provision ioi-'i6bet. is worrabtJ.ecessary The impact of the sub-prit" arso on the exchange rate. of funds on Fts' account,- iaring with the outfrow rto*-rlri.f,,,'no"" Ln; investments on account ot of the infrow of fresh _riqudity crr""riir',r," overseas ;;ri;'the^rupee around 2's per cenr during tn" depreciated by r".t'qu"rt"i eobr:dffi;;;ln'ing rz.s "i'Fv nr","r,"ri:;&l,,[oee per cent durins the same financi"r y"",. on

noiinrv in n" non.ibtdr'iri"", """d bonds issued overseas bv the abroad. The prices or were- arsl';"";# Ioo ,n FY 2007-{8' The vield.tur"Logl;i"il';un'ii."^"ouoon rhe finar quarter of

of.ADRs and GDRs, the debt firms mav rise abnormarv. The burden of the lndian rr,"t-inJ converted into equity shaies atter ""pi"I"il* i.at a pre-oeteimineo i.ru" FCCBs that are Jome iime greater than the conversion price, rate. rf the stock price is tne ooio. converted into eqJtv shares the burden of inrerest p"vrlnrano "r". Lo"ur"", i" ou"i. ilr;'i;;;:"nversion and, in tn" liqrer, the wake of falling stock-prices, price is greater in rt ir-IJi'irrthe inteiest-;'#'il,to equity shares. servicing oi oonol convert the pcbgs into rn4or.proh"r. i"j#,rhe varued at $ 17.7 biilion are facing " ft,is'piorrem. However, ,"nlr-iirr. tndian firms with FCCBs the conversion price under the have managed to rower reseicrlr"" be revised with a t"ll]1,,1" ,r,e conversion price mighr price oerow'"'-pi"o"t"rrined Embroidaries Ltd. rowered *," rever. pioneer or"" by 30.0 p", 2008' it had arreadv the"oni"irioi price iv ido p", i.ni. frargh 2008. rn ..lanuary ""rit'in the fa, in prrce' the dilution tn tn:-:gynn.may of 'o-*:r"g the conversion turn irigier and the tir, ,"v

berween rbrh Januury 3,HrllhYfij"il,j,3?t;,,1'"1,'",3iH:#ffili ,n" '"",o-""onl,iiJrJno","ntars have, in racr, Moreover' tn tn"- y-"1: or

ro*"ii"g price

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;;;;; d"il;;'tne ;;;;;;fiin"r" iil;il;;

*il#

iJ;,,IIfi

Again' rhe downtrend. is

oo."r"J

the issue of more shares.

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1.

2. 3'

What do you mean by tJS sub_prime crisis? How did it emerge? Explain the concept of decoupling.

ff5r,l}"ff..activities

in the lndian flnanciar marker were affected by rhe Us