Posted by: Prashanth Rajan | October 6, 2008

Global economic crisis and its effect on India

2008 – a year that has witnessed the fall of the big players in the investment field-

Bear sterns was taken over by JP Morgan

Fannie Mae and Freddie Mac were nationalized

Lehman Bros became bankrupt.

Merryl Lynch taken over by Bank of America for a meagre $50 bn !

With financial institutions falling prey one after another to the global credit crisis, the bailout packages announced by various governments across the globe are inching towards $2 trn mark — an amount nearly double the size of Indian economy !

The Wall street tremors will have aftershocks the world over, with global markets plummeting to new lows and with liquidity crisis in perspective, the world is facing a severe economic crisis and many are blindly hopeful of a bail-out plan. But …….let me guess what you are thinking…..

Q 1)  what in the world is going on right now?

Q 2 ) why does all this matter to me? and how do I, the Indian citizen stand to be affected by this?

THE WHOLE STORY:

The first signs of the sub-prime crisis was evident in the form of Bear Stearns whose 2 hedge funds collapsed in the mid of June 07 . Sadly , help in the form of $ 100 billion in liquidity courtesy Federal Reserve Bank and European Central Bank didn’t do much to solve the prevalent sub-prime crisis as the housing market continued to elevate without increase in interest rates. Then the wall street virtually went on a wild horse ride with one of the prestigious players Lehman brothers posting huge losses and eventually they din’t become lucky as the others as both Bank of America and Barclay’s refused to save the investment giant. The sole cause- Lehman Bros and Bear Sterns had relatively small balance sheets, they were heavily dependent on the mortgage market and were humungously reliant on the repurchase market (use as a short-term financing tool). The final nail in the coffin of the Lehman Brothers was put as it applied for a bankrupt protection on September 15th, which created a violent storm in the world financial system

AIG which was supposedly a basic insurance company also committed the erraneous speciality of investing in derivatives. Now for non- enthusiasts like some people out there, what are DERIVATIVES? Well, more on that later in this post.

IMPACT ON INDIA:

With many of the top IT companies save HCL having half their revenues from financial and banking segments, no doubt they are going to take a harsh beating, with Infosys already losing $2 bn the past week(Sept end) out of an approximate $10 bn lost by Indian IT companies listed on the US market. Banks may suffer as Lehman Brothers and Merrill Lynch had invested substantially in the formers’s stocks.

Supposedly, some of the PSU banks are also said to be affected even though assurances by the FM P.Chidambaram that none of the former are influenced. Well, that remains to be seen.

Now with traders possibly selling their stocks in India, Indian rupee stands to decline and hence imports will become costlier, one of the many things that stand to be affected, in line with many of the innumerable crisises that our country has still looming at large.

WHAT IS DERIVATIVES ( In Layman’s terms) in this case also know as HEDGING

–>The main use of a derivative is reducing risk for a party.

–>Derivative products derive their existence from actual market indices, hence the name derivatives.

I am not a expert on this, but with a great amount of thanks to my dad( who is pretty good at this stuff), I can put forward a vague idea what this is all about. Now supposing Mr.X  enters into a FUTURES CONTRACT with Mr.Y, say he pays a certain amount of money for a certain commodity from Mr.Y in the future(any fixed amount of time in the future) , now as the market can be totally unpredictable with fluctuating interest rates, such an agreement can reduce risks.

BENEFITS:

1. Mr.X now has an assured supply of commodity in the future at the existent market rates at that time.

2. Mr.Y now has an assured price for his commodity in the future from Mr.X

Something like this.

Now there are many forms of derivatives, one which caused the epicentre here in the sub prime crisis being mortgage-backed security (MBS). For more information on MBS, you can easily refer … say wikipedia or the article by Mohit Satyanand in Outlook MONEY was pretty awesome.

Now in the present case , since the housing rates didn’t shoot up, the investment banks couldn’t recover money and the growing housing markets only added to their downfall.. Voila !! this almost does it for a layman’s understanding to the current global economic crisis.

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Responses

  1. […] Global economic crisis and its effect on India October 2008 […]

  2. Thank you for another fantastic article. The place else may anyone get that kind of information in such an ideal means of writing?
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  3. An intriguing discussion is worth comment. I do believe that you ought to
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    talk about such topics. To the next! Many thanks!!


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