Towards 10th Issue

An effort by Stockyard in association with Mantra Consultancy Group

16th November,2008

THERE, HERE AND NOW WHERE? – A PEEP INSIDE THE CRISIS ENVELOPE

TATA SAYS “TATA” TO SINGUR

INDIA –FACING LIQUIDITY CRUNCH

Issue 10

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……..the people

FROM EDITOR’S DESK

W

e are glad to present to you the tenth issue of our fortnightly pub-

lished magazine “towards…”.This magazine is fundamentally based on the core issue of market and its impact on the society and vice versa. In this issue we have covered many of the macroeconomic topics and also the Subprime crisis from its very root. The main focus of the magazine is to acquaint you people to all the possible knowledge and analysis done by the members of this team and present you the picture in a very refined manner. In the coming days of the SIP interviews and the placement interviews I think this magazine can prove to be of great help to all of us. In the current issue, the part of liquidity crunch has been given a new touch of analysis. The hot topic of TATA Nano has been included so as to make you all know the inner intricacies of the case and decide whether there is an opportunity loss for the West Bengal government or it is really going to give some benefit to them in the upcoming elections. The market analysis part focuses on the market statistics for the past two weeks. We as a team welcome your response and participation for writing articles. Kindly support this attempt to address your own needs in a better way and suggest for improvements. I hope you enjoy this journey towards a better placement and a better SIP.

Wish you all “good luck”. Wish you all “good reading”.

Editor

THERE, HERE AND NOW WHERE? – A PEEP INSIDE THE CRISIS ENVELOPE

……..the people

Subprime Crisis – two words that ring a bell around the world, more often than not for its strong connotation with the present financial situation prevailing globally. Even a nine year old girl finds familiarity with the word, not because she understands it technically, but because she has probably heard her father or mother use it often over dinner pondering upon the declining values of their small investments made in shares and funds. It is indeed a crisis; a critical situation, persistent everywhere now, and transcending all the surmountable boundaries possible. In this article, we start by briefing about the Subprime Crisis, go on to its impact on various economies around the world; with the main focus on its impact in India.

Origin of the crisis

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Beginning in summer of 2006, the over building of the houses in the US, especially during the boom period of housing market, eventually led to an excess of inventory of homes, causing the prices of the houses to decline. An increase in loan incentives such as easy initial terms, and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once housing prices started depreciating moderately in many parts of the U.S. and interest rates began to rise at the same time, homeowners were unable to re-finance and began to default on loans as their loans reset to higher interest rates and payment amounts. An estimated 8.8 million homeowners — nearly 10.8% of total homeowners — had zero or negative equity as of March 2008, meaning their homes are worth less than their mortgage. With the advent of securitization, the credit risk got transferred or distributed to the investors through Mortgage-Backed Securities (MBS). According to the figures, the mortgaged-backed securities increased from 54% in 2001 to 75% in 2006. It is believed that the securitization of home loans for people with poor credit is one of the main reasons for the present credit turmoil. Freddie Mac and Fannie Mae bought mortgages from lending institutions and then either held them in investment portfolios or resold them as mortgage-backed securities to investors. The two companies played a vital role in providing financing for the housing markets. But according to the reports published in the New York Times back in September, 1999, it was stated that Fannie Mae Corporation was easing the credit requirements on loans thus encouraging banks to extend home mortgages to individuals with low or moderate incomes whose credit is generally poor. On one side if it faced pressure from the Clinton Administration to expand mortgage loans, on the other side, it felt the pressure from stock holders to maintain its phenomenal growth in profits. It is also believed that the credit rating agencies provided investment-grade rating to the securitization transactions (CDOs and MBSs) based V O L U M E 1 , Ion S S Usubprime E 1 mortgages. High credit ratings encouraged the flow of investor funds into these securities, 3

helping finance the housing boom. But when the ratings were lowered from Quarter3, 2007 to Quarter2, 2008, it put pressure on the financial institutions to lower the value of their MBS.

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Impact and downturns in financial markets The economy started to feel the crisis in February 2007 with the gradual but continuous slowdown of the financial market. This led to a ‗domino effect‘ in the markets all around the world. The ‗domino effect‘ is a chain reaction that occurs when a small change causes a similar change nearby, which then will cause another similar change. Financial institutions from around the world have recognized subprime-related losses and write-downs exceeding US $501 billion as of August 2008. The financial sector began to feel the consequences of this crisis in February 2007 with the $10.5 billion write-down of HSBC, which was the first major CDO (Collateralized Debt Obligation) or MBS related loss to be reported. During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold. Top management has not escaped unscathed, as the CEOs of Merrill Lynch and Citigroup were forced to resign within a week of each other. Stock indices worldwide trended downward for several months since the first panic in July–August 2007.The crisis caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value". Financial speculation in commodity futures following the collapse of the financial derivatives markets has contributed to the world food price crisis and oil price increases due to a "commodities super-cycle‖. Financial speculators seeking quick returns have removed trillions of dollars from equities and mortgage bonds, some of which has been invested into food and raw materials. On 15 September 2008, a slew of financial concerns caused the indices to drop by their sharpest amounts since the 2001 terrorist attacks. That day, the most noteworthy trigger was the declared bankruptcy of investment bank Lehman Brothers. It was the largest casualty of the global credit crisis, and given its assets at the time of filing, Lehman surpassed WorldCom as the biggest U.S. bankruptcy filing till date. The investment banker had close to $639 billion in assets at the time of filing, while WorldCom had about $107 billion when it did the same in 2002. Additionally, Merrill Lynch was joined with Bank of America in a forced merger worth $50 billion. Finally, concerns over insurer American International Group's (AIG) ability to stay capitalized caused that stock to drop over 60% that day. Poor economic data on manufacturing contributed to the day's panic, but were eclipsed by the severe developments of the financial crisis. All of these events culminated into a stock selloff that was experienced worldwide.

Bailout package The much anticipated passage of the $700 billion bailout plan was struck down by the House of Representatives in a 228–205 vote on September 29. In the context of recent history, the result was catastrophic for stocks. The Dow Jones Industrial Average suffered a severe 777 point loss (7.0%), its worst point loss on record up to that date. The NASDAQ tumbled 9.1% and the S&P 500 fell 8.8%, both of VOLUME 1, ISSUE 1 which the worst losses were those indices experienced since the 1987 stock market crash. 4

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Despite congressional passage of historic bailout legislation, which was signed by President Bush on Oct, 4, Dow Jones Index tumbled further when markets resumed trading on Oct, 6. crisis it is expected that it will take years for the United States to recover from such a mess. It is also estimated that even with the passing of the so-called bailout package; many banks within the United States will tumble and therefore cease operating. It is estimated that over 100 banks in the United States will close their doors because of the financial crisis. This will have a severe impact on the economy and consumers. As a result of the President Bush also signed into law on 13 February, 2008 an economic stimulus package of $168 billion, mainly in the form of income tax rebates, to help stimulate economic growth. The economic stimulus package included the mailing of rebate checks to taxpayers. Such mailings started the week of 28 April 2008. These mailings, however, coincided with unexpected all-time jumps in food and gasoline prices. The U.S. federal government has made significant financial commitments through efforts to support the financial system. This includes pledges of up to $200 billion to protect Fannie Mae and Freddie Mac, an $85 billion bridge loan for AIG, and a $29 billion loan guarantee for Bear Stearns. The subprime crisis had a series of other economic effects. Housing price declines left consumers with less wealth, which placed downward pressure on consumption. The sudden lack of credit also caused a slump in car sales. Ford sales in October 2008 were down 33.8% from a year ago, General Motors sales were down 15.6%, and Toyota sales had declined 32.3%. One in five car dealerships are expected to close in fall of 2008. One possible impact of US subprime crisis on global markets would be certain unforeseen 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 looser. 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.

Impact on Indian economy

Also this crisis could hit developing economies that export a lot to the US. Around 40% of Chinese exports, for example, go to the US. About 22%of Indian goods exports go to the US and a significantly larger share of India‘s service exports. However it was stated by economists of the World Bank that the Impact of US subprime crisis on India and China may not be very large. But the VOLUME 1, ISSUE 1 actual picture is something

Movement of Sensex and Nifty from Jan-Oct 2008 5

different because this crisis has propelled both the economies on a slowing node. In last fiscal (2007-08), India and China have shown economic growth by 8.9% and 11.9% respectively but this time these are estimated at 7.7% and 10.1% respectively. Also in last 9 months, stock market in India has plunged by more than 50%. FIIs have pulled out $11.09 billion in 2008 as Indian markets joined the global meltdown triggered by the subprime and credit crises. A major reason for the 50 per cent fall in the Sensex this year is FII withdrawals.

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Impact on IT sector If we look closely at some of the sectors in India which have been hit significantly by the global crisis, then the IT sector, one of India‘s largest export-earners, is almost certain to be affected. The industry earns more than 60% of its revenue from the US and the recent wave of closures and mergers will mean the sprucing of many software-related services. A worse downward revision is expected this quarter as well, though some larger players like TCS and Satyam have officially denied any possible impact on growth. As we know, for the software services companies in India, 85-90% billing is done in US dollars. Therefore, the recent rupee depreciation will have a positive impact on their earnings, and in turn prove positive for the sector as a whole. In fact, according to reports that came in on 9 July, 2008 by outsourcing industry‘s top body - National Association of Software and Services Companies (NASSCOM) - Indian software exports grew 29% in the financial year just ended despite global economic turmoil. But looking at the flip side, firms like Infosys might lose some revenue owing to the fact that they obtain 28% of revenues from the Euro, British Pound and Australian Dollar and the US Dollar has been appreciating against these currencies. So, when these earnings are translated into US Dollars, they will have a negative 2% impact on the company‘s earnings. So, the currency depreciation need not necessarily paint a rosy picture for the IT sector.

Impact on Banking sector

As a consequence of the global events, banking industry in India has also affected. The Indian banks find it difficult to raise funds from abroad for their overseas operations and now have to rely on domestic borrowing. While ICICI Bank has lost as much as $264 million up until January due to its exposure in the overseas credit derivatives markets, other banks are also facing significant losses. Although the banks borrowed money from RBI, it wasn‘t sufficient. The country's finance minister and the RBI governor have repeatedly stepped in to cool the nerves, with comforting words, and immediate measures to ease the problems and forward-looking initiatives. The CRR has been decreased from 9% to 5.5%, Repo Rate from 9% to 7.5% and SLR from 25% to 24%. By these as well as some other measures, RBI has created liquidity in the market of worth 2,85,000Crore. RBI has used these tools to keep a tight control over the general interest rates in the economy. With high inflation rate on one hand and the herculean task of maintaining growth in the economy on the other, the RBI is taking keen measures and will have to continue balancing the CRR and Repo Rates. One must add here though, that the decline in prices globally of metals in particular and crude oil would both have a soothing effect on inflation during the year end quarter. Says a recent release by CRISIL, ―The profit levels of the Indian Banks are likely to be impacted by mark-tomarket provisions on investment portfolios and considerably lower profit on sale of investments, as comV O L U M E 1 , Ipared S S U E 1 with previous years.‖ To sum up, expect margins for banks to remain under pressure for some more time now. 6

To a question asked by a worried investor about how the fall in the market affects his investments, this is what the Telegraph had to say, ―A savings bank account gives you 3.5% interest — which means you are actually losing money when you factor in inflation. At the moment, the best bet is a bank fixed deposit that yields just above 10 per cent. Gold looked like a good bet but it is turning volatile now. Stocks and mutual funds are gutted in this turmoil — so you won‘t lose sleep if you have not parked your money there.‖ And, hopefully that applies to most of us as well.

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Impact on Education sector Amidst all this tumult, education sector in India has also affected drastically. One of the most confused is the set of students who are standing at the brink of their career starting-point, facing a harsh reality. Instead of hiring professionals, companies are seen either laying off hundreds of employees or cutting down on packages being offered to fresh graduates. This definitely has become the hottopic among the young graduates who, when started off with the respective engineering or commerce courses expecting a high return when they join the corporate world; whereas now, all that they have in hand are a few offer letters with much lower packages than before. Also, the students with offer letters fear the long wait and have started to look out for alternatives. The most hit are the Engineering and Management schools, with MBAs being offered much lower packages than their averaged college salary. It definitely sets in a gloomy atmosphere, with the students tending to change the entire career choice itself. But, career counselors look at the brighter side and ask the students to grab the best of out of the situation and learn from the crisis. They also maintain that India is not yet as adversely affected by the turmoil as other countries around the world. It is not just the jobs that the sector is deprived of. Institutes like IITs and IIMs are wary of a possible cut-back on the endowment funds because of the global economic slowdown. ―Funds received from alumni and companies are usually meant for specific projects. These funds pour in between October and December every year. Current projects will not be affected despite the economic slowdown, but new projects might take a hit,‖ said T KGhosal, deputy registrar (finance), the Indian Institute of Technology, Kharagpur.

The Subprime Crisis: Cause, Effect and Consequences argues that three basic issues are at the root of the problem, the first of which is an odious public policy partnership, spawned in Washington and comprising hundreds of companies, associations and government agencies, to enhance the availability of affordable housing via the use of creative financing techniques. Second, federal regulators have actively encouraged the rapid growth of over-the-counter (OTC) derivatives and securities by all types of financial institutions. And third, also bearing blame for the subprime crisis is the related embrace by the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board of fair value accounting. After reviewing the Bush administration's proposed solutions as flawed, this article recommends a strategy for subprime crisis resolution. Job one is to rebuild market confidence in structured assets by going back to V O L U M E 1 , Ifirst S S U E principles 1 on issues such as market transparency, standardization of contracts, and accounting treatment. 7

By reducing complexity on the trade of structured assets through simple deal structures and providing investors with the information they need to analyze collateral, for example by requiring SEC registration and public pricing of assets, much of the current liquidity problem is ameliorated.

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Greenspan, the former Chairman of the Federal Reserve, stated: "The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end…… Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business." Contributed by:

Mukesh Mangal Ramya Pragya

INVESTMENT QUOTES “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.” WARREN BUFFET

“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” WARREN BUFFET

“The financial markets generally are unpredictable. So that one has to have different scenarios... The idea that you can actually predict what's going to happen contradicts my way of looking at the market.” GEORGE SOROS

“Stock market bubbles don't grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.” GEORGE SOROS VOLUME 1, ISSUE 1

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MARKET WATCH

SENSEX 17th Oct: Sensex sinks below 10,000

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30-share Sensex on Friday plunged below the 10,000-level for the first time since July 2006.Indian stocks started their journey southward after the European markets turned weak. Also, the Dow Jones Industrial Average Futures index charted the same path. 12,000 10,000 8,000 6,000 Sensex

4,000

DJIA

2,000 0

24th Oct: Sensex loses 1,071; global stocks plummet Investors were witness to one of the blackest days in Indian stock market history as FIIs shed a record quantity of Indian stocks. The index collapsed to 2005 levels, breaching the 9000-mark to close at 8701 (down 1070.63). The central bank did not change any of the key interest rates; on the other hand, the GDP forecast was pegged down from 8 per cent to 7.5 per cent. The markets opened with a negative gap tracking other Asian markets which were trading down. The Nikkei was down 9.6 per cent and the Hang Sang down 4.66 per cent. The European markets too were trading in the red, the FTSE tanking 7 per cent. The Dow too was down 500 points overnight. 3rd Nov: Markets recover on RBI measures Equity and currency markets rose, buoyed by the massive liquidity support announced by the Reserve Bank of India. The benchmark Sensex regained the 10,000-mark. The index closed up 550 points or 5.62 per cent to close at 10337.68. 11th Nov: Sensex sheds 700 points on economic worries

Heavy profit booking after a two-day gain of more than 800 points hammered the benchmark index – the Sensex—down by almost 700 points. India‘s 15 per cent decline in exports in October – the highest decline VOLUME 1, ISSUE 1 in several years – also dampened investor sentiment, sparking off more selling. 9

TATA SAYS “TATA” TO SINGUR MISS BANERJEE’S LOSS, MR. MODI’S GAIN

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The much talked about Re.1 lakh, the people‘s car, made Singur a flashpoint and a hotspot for politics. The story began when CPI (M), the ruling party in the state had acquired 997.11 acres of land required for Nano. Cashing in on the situation, Mamta Banerjee, Trinamool Congress head started the agitation against the same, demanding more compensation for the farmers. It took a tragic turn when the police opened fire on the agitated people, killing 14 people and leaving many others injured. This agitation was the centre of media‘s attraction for quite a while. Little could Budhhadeb Bhattacharjee do when Tatas decided to step out of Singur. Just when CPM, the party ruling over West Bengal for more than 30 years was taking step away from its age old antiindustrialist policies towards industrialization and development, it was stalled by Mamta Banerjee. She took advantage of the situation and the communist mentality of the people. CPM is reaping what it had sown 30 years back. The Singur drama was the opportunity Miss Banerjee was looking for. She needed a platform to make it big in Bengal and she got it in the form of Singur. The Nano project is of national importance and would have changed the face of West Bengal and Singur forever. So, this should not have been made an issue for politics and election. Lok Sabha elections are scheduled for May 2009. Miss Banerjee took advantage of some 15-16% farmers who did not sell their land they were mostly illiterates, absentees or Trinmool congress workers. The farmers feared that government will pay them prices below market prices. Mamta was right or wrong depends on the individual perception. She can be perceived as savior by the farmers across India or a dirty politician by the urban working class. The picture will be clear only after 2009 Lok Sabha election. The reasons that forced Tatas to pull out from Singur was its policy of ―squeaky clean‖ public image. Tatas have always been very particular about their image. It took them decades to build upon that. How could they afford to risk it now by the controversies involved with Singur? So they thought it was wiser to quit and find a place free of controversy. At the same time, they gave their ―concern for employees‘ safety‖ as another reason to leave Singur. Also, this article would be incomplete without discussion on the most important and infamous reason for relocation of Tata Nano, Miss Mamta Banerjee. Miss Banerjee is a lawyer by education and amongst those few people who could make to the coveted Lok Sabha in their 20‘s. She is known to be aggressive (read stubborn) to the extent of being violent at times. Once she clasped the collar of Samajwadi MP Amar Singh in parliament. It is in fact one of the most devastating turn of events in Singur. Business houses will now think several times before putting a step forward in West Bengal. After all the turmoil, finally Nano has

VOLUME 1, ISSUE 1

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found a new home, at Sanand, a muncipality in Ahmedabad district of Gujrat . Narendra Modi has been prompt enough to provide Nano with the entire infrastructure required. After having his share of pie, now Narendra Modi is all set to improve upon his image as a chief minister who is very much concerned about the development of his state. All of a sudden his image has changed from ―Bad M‖ to ―Good M‖. Bengal‘s loss is Gujarat‘s gain; Nano is truly another feather in Modi‘s cap. The reasons behind choosing Gujarat amongst the other available options of Dharwad (Karnataka), Pune, Pantnagar(Uttarakhand) are very simple, as told by Mr Ratan Tata. The most important point Mr. Tata emphasized was the pace at which Gujarat CM Narendra Modi made the land available. Unlike most of the states that required approval from their assembly regarding the same. Also Tatas are not expecting any protests this time because Gujarat is an investor friendly state. Mr. Tata said that if they could move the plant in a day they could have actually started operating here. One year before Mr. Tata had said that ―It is stupid if you are not in Gujarat.‖ But the catch here is that Gujarat does not believe in concessions. Still according to Tata group the package given by Gujarat is almost similar to that of West

Bengal‘s. Whatever package Gujarat may give it can never be as cheap as Bengal as the prices of labour, land, etc prevailing are very low, this may add to Nano‘s cost considerably. It maybe not very far when we see price of Nano rise from its 1lakh tag. Given all the facts, Singur controversy is a perfect example of how politicians embark on agitations that block development. It is a sin to be involved in such kind of cheap politics. Though certain concerns raised by her were reasonable, but addressing them by inciting violence is not in anybody‘s interest. Mamta Bannerjee should realize that she has done no good to the people of Singur, by isolating them from development, by making them lose their future jobs. West Bengal will be out of race in the fast growing industrialization. Hopefully, Gujarat will prove to be lucky place for Nano plant and hopefully the stock prices which got shattered during Singur crisis will move up. Contributed by:

Amar Saboo Sugandha Chawla

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MACRO ECONOMY

INDIA: FACING LIQUIDITY CRUNCH

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When Lehman brothers filed for bankruptcy under chapter 11 the world was shocked by the decision. The rumors came in that ICICI bank, the largest private sector bank of India, has excess exposure in the bankrupt bank and will face severe problems in liquidity. Then we get a data from the RBI as follows:

Depositors pull out 17000crore from ICICI bank Deposits (Rs cr)

Rs. cr

Bank SBI

10 oct 2008 574643

31 march 2008 522583

Difference 52060

ICICI

227384

244431

-17047

PNB

181000

166457

14543

HDFC

131750

100769

30981

Canara Bank

165600

154072

11528

Bank of India

136655

125520

11135

We see that depositors pulled out in excess of 17Kcrore from the ICICI bank where as SBI received in excess of 52kcrores as deposits. This started the spark of the liquidity crisis in India which spread like wild fire and a series of events kept the entire sector as well as money market on tenterhooks, banks lacked trust in lending via call money markets thus the rates shot up overnight and the trouble began.

Change in %

Bank credit(Cr) Deposits(Cr) Credit/de posit

Sept 26 , 2008

Oct 10, 2008

Oct 10 , 2007

Fortnight

Year on year

25,42,467

2607404

2019175

2.55%

29.13

3442138

3469359

2858033

.79%

21.39

.7386

.7515

.7064

-

-

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As on October 10, let us analyze the liquidity position of the banks from a birds’ eye view We can infer the following from the above data

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We see an increase of bank credit by 29.19% and 2.55 % on YOY and fortnight basis while the deposit has increased by 21.39% and .79% on YOY and fortnight basis. These points towards those banks were facing a liquidity problem as the rate of increase of credit was not negated by the rate of increase on deposits. The credit deposit ratio as on September 26, 2008 was .7386 while on 10 October it was .7515 and last year it was .7064 clearly indicating that the industry was facing the liquidity crunch. Scrutiny of the borrowing and lending activity in the call money market

1-Aug

banks

banks

borrowed 11185

lent 11475

12401 15-Aug 11321 29-Aug 11812 12-Sep 10756 26-Sep 12427 10-Oct BL=amounts banks lent BB= amount banks borrowed

12661 11692 12389 11206 12909

diff

-290 -260 -371 -577 -450 -482

primary dealers borrowers 347 313 411 587 472 510

lenders 57

BB/BL 0.974728

PB/PL 6.087719

53 0.979464 5.90566 41 0.968269 10.02439 10 0.953426 58.7 22 0.959843 21.45455 28 0.962662 18.21429 PB=no of primary borrowers PL=no. of primary lenders

Let us analyze the situation from august till 10 October. We see that the difference between the amount borrowed and lent grew from 290 to 577 from 1 Aug to 12 Sept and declined to 450 in 26 Sept but increased to 482 in 10 October. However in percentage terms the difference (or the deficit) grew by 66%.

In the ratio terms , borrowed / lent increased till 15 august declined to .9534 in 12 September , V O L U M E 1 , Ibut S S U however E 1 the credit crunch took its toll on the banks and the ratio increased to .9626 forcing RBI to take some remedial action. 13

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We can correlate the above explanation with the ratio of no. of borrowers and lenders where we see that the ratio moves in opposite direction of the BB/BL. The ratio increased from 6.08 to 58.7 from 1 august to 12 September (when it peaked); however it declined to 18.21 on 10 October on account of increase in no. of lenders from 10 to 28 in the relevant period. But when we compare the ratio from august to October in increased above 200% indicating that borrowers increased from 347 to 510( increase of 47%) , while lenders decreased from 57 to 28 ( i.e. a decrease of over 50%) forcing RBI to take remedial action. More bad news! In October, RBI comes up with the data stating that incremental credit rose to 10.4% in the first half of this fiscal against 4.4% in the corresponding period last year while incremental deposits declined to 8.4% from 9.3%.

Infrastructure and consumer companies top the “top 50” liquidity challenges companies Sectors Infrastructure

Crunch companies 17

Consumer Healthcare Real-estate Chemicals Oil gas Media Technology Power Others

13 4 3 2 2 2 1 1 5

Infrastructure and consumer companies whose lifeline is credit face severe crunch as 17 infra companies and 13 consumer companies were identified who accepted that they were facing severe credit crunch. All the above were the indicators that the RBI needs to take extra ordinary measures to control a collapse of the banking system and save companies by making reforms ensuring better credit functioning. Events watch

Let us have a look at the series of events that were worth keeping track of, the reactions of the government and what happened as a result of the actions (discussed later). V O L U M E 1 , Iand S S U ERBI 1

14

Oct

Events

10

ICICI Bank said that it is facing no liquidity crisis and has as much as Rs 12,000 crore liquidity even in international markets and the bank does not use rupee liquidity to fund the growth of its international operations and says NPA is zero even in UK where the exposure is worth 4700 crore ICICI script plunges 17% amidst the fear that the bank is facing severe liquidity crunch.

13

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15

16

17 19

Reserve Bank of India said it will conduct the special fixed rate 14-day repo facility every day, as the auction for a notified amount of Rs 20,000 crore at 9 per cent to meet the liquidity requirements of mutual funds. RBI decides to raise the cap on deposit insurance from 1 lac to 2 lac to ensure confidence of the depositors in deposits The Reserve Bank said it would shortly issue Rs 100 denomination notes Government identified 14 commercial banks (11 public and 3 private) and will help them to raise over 5000 crore to increase the Capital Adequacy Ratio (CAR) to 12%. These banks include Central Bank of India, Allahabad Bank, Uco Bank, Indian Overseas Bank, ING Vysya Bank , Vijaya Bank , Bank of Maharashtra. However none of these banks had CAR less than 9% which is the prescribed limit as per the Basel 2 norms Hike in NRI deposits by 50 BPS to counter the out flux of the Forex reserves due to FII selling in Stocks Banks put SMEs on edge while lending amidst liquidity crisis. SMEs account for 40% of the exports and if the credit line dries up then their business prospects will take a hit and will further add to the declining foreign reserves( on account FIIs selling in sensex ). Government has also asked the RBI to release Rs 25,000 crore to banks and financial institutions immediately against their outgo under debt waiver scheme. No bank guarantee of LOC from foreign banks is accepted by domestic banks as they fear the failure of foreign banks would further acute their liquidity problems

20

Reserve Bank has lowered the repo rate by 1 per cent to 8% from 9% earlier, under LAF. The decision was aimed at improving the liquidity position in the country. The apex bank has opened a special repo window of Rs 20,000 crore for mutual fund industry to help them meet their liquidity needs and overcome redemption pressure.

22

Government promises full support and help to Public Sector Banks(PSBs) to improve CAR to 12%. Federal bank to review the acquisition of catholic Syrian bank amidst liquidity crisis. It will review the valuation of the bank as well as source of funds.

23

Banks ask RBI to ease reserve requirements else they will stop lending to infrastructure companies. ICICI Bank had raised the interest rate for new home loans from 12 per cent to 13 per cent earlier this month, but it kept unchanged the benchmark rates, including its Floating Reference Rate (FRR) for home and other consumer loans.

24

The Reserve Bank of India shall conduct a special fixed rate term repo at 8 per cent per annum against eligible securities for Rs.11,200 crore on October 24, 2008, due for reversal on November 7, 2008, with a view to enabling banks to meet the liquidity requirements of mutual funds

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Micro scan of the government action and the reaction of the money market

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Amount injected (Rs. Crore) Call money rates (min %) Call money rates (max %)

Oct 10 -

Oct 13 55440

Oct 14 66305

Oct 15 59090

Oct 16 10100

Oct 17 8640

Oct 20 -

14.25

8.5

8.6

8.5

5.65

5.5

3.5

22

10.05

10.15

10.5

7.1

7

7

RBI auctioned REPO under LAF which resulted in pulling the overall call money rates down. This was a result of injecting liquidity which in turn forced banks to bring the call money rates down. Let us see the movements of the call money rates from Oct 10 to Oct 17.

Oct 10 Rates reach as high as 22% while the minimum was 14.25%. Oct 13 RBI auctions repo and injects 55440 Crore that tames the call money rates to a maximum of 10.05 and minimum to as low as 8.5%

Oct 14 Further RBI injects 66305 cr. Via REPO auctions but we see a marginal increase call money rates Oct 15 Further 59090 cr. Is injected but there is no major decline in the rates on the same day Oct 16 However when a cumulative 180835 cr. Is injected in 3 days, the call money rates calm down further and hovered in the range of 5.65 to 7.1 Same day further 10100Crore is injected. Oct 17 Seeing that call money rates has declined significantly RBI auctioned just 8640Crore and rates seemed to be stable between 5.5 and 7%. Oct 20 Maximum rate remained at 7% while minimum rate declined to 3.5% Thus a total of 199525 cr. was injected in just 5 days time.

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What is the status of the money market as on 24 October 2008?

4.5-7.0 4.5-7.0 6.19-7.45 6.25-7.55

Rates in % Standard deviation .65 .49 .23 .28

Previous week 7.0-10.0 6.5-9.5 6.5-8.56 7.25-9.05

6.9-8.0 6.99-9.3

.24 .65

4.18-8.64 6.94-10.07

349.56 8435.12

551.65 5970.94

7.87-8.35

.11

7.88-8.43

442.43

297.27

This week

364 day T-bill 182 day T-bill GOI securities State government

From the above data we can infer the following: Decline in the minimum and maximum rates of the call money rates when compared with the previous week. The minimum rates have fallen from 7.0 to 4.5 while the maximum rates have fallen from 10.0 to 7.0. The volume in call money rates has seen an increase of 12.83% as compared to the previous week. Decline in the minimum and maximum rates in repo. The minimum rate has decreased from 6.5 to 4.5 while the maximum rate has declined from 9.5 to 7.0. the volume increase in this instrument as compared to the previous week is 15.84% 91 day and 364 day t-bill has witnessed a decline in the both minimum and maximum rates while the overall rates for the 182 day t-bill has increased. The volume of these instruments has registered a decline of 16.71%, increase of 126%, and 182 day T-bill has registered a decline of 36.66%. The minimum rates for the GOI securities has registered an increase of .05 %( which is marginal given the volatility) while the maximum rate has shown a decline of .14%. The increase in volume is 2465 Crore (or 41.29%). When comes to volatility in rates the most volatile instrument is call money rates and GOI securities which is .65 followed by repo. The least volatile was state government securities which was .11.

towards

……..the people

Call money Repo 91 day T-Bill

Volume (rs crore) This week Previous week 15767.26 13974.21 60756.13 52446.9 797.38 957.72 1715.64 756.10

Impact of the liquidity crisis on the Banking Index:

Bse –Bankex

24-october 2008 4649.87

1 week -16.17

1 month -32.25

1 year -53.15

We see that the Bankex index closed at 4649.87 and gave a negative return in 1 week, 1 month and 1 year of 16.17%, 32.25% and 53.15% respectively. There was a selling both from FIIs and retail inVOLUME 1, ISSUE 1 vestors. FIIs faced liquidity problems at home while retail investors feared safety of investments. ,

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Top turnover for the banking sectors for the week ended 24 October 200

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……..the people

Turnover(Cr) Return (%)

ICICI bank

Bank of India

SBI

HDFC

3445 -22.22

621 -24.83

3358 -18.02

2046 -6.08

Axis Bank 1696 -13.98

We can clearly see from the above that the most traded securities in the week ended 24 October 2008 eroded the wealth of the shareholders. ICICI bank, the largest private sector bank gave a negative return of over 22% while SBI, largest commercial bank, gave a negative return of over 18%. Other stocks too gave negative returns which included the heavy weight HDFC bank also. Do we need to worry? The answer is no. as we have seen that cut in repo and other measures has improved the credit system but our fingers are still crossed. RBI will continue to closely monitor the activities and take remedial action when ever required as we have seen one , On 26 October 2008, RBI allowed 7% savings bonds -2002 6.5% savings bonds 2003, and 8% savings bonds 2003 schemes to be pledged while taking loans. These bonds were, before reform, were illiquid and could not be used for raising money despite being classified as sovereign debt.

Where does our banking system stand as compared to other countries? Let us see the Loan Deposit Ratio of some of the countries and compare with India. Country Indonesia China India Turkey Israel Thailand Columbia Vietnam Mexico Pakistan

LDR Country LDR% % 0.62 Chile 0.99 When we see the loan to deposit ratios we see that 0.68 Poland 1.03 it is most favorable to Indonesia followed by China and India. The figure for these top 3 countries were south Af1.09 .62, .68 and .74 respectively. For a layman to un0.74 rica 0.83 Hungary 1.3 derstand the figure we can say that for every 0.87 Korea 1.3 100rupee received , Indian banks have granted 74 rupees of loans indicating that 24% of the amounts Kazakh0.88 1.3 received are still with the banks indicating better stan 0.89 Brazil 1.36 liquidity position when compared to lowest 3 countries Russia , Ukraine and brazil whose figure 0.91 Ukraine 1.37 was 1.82 , 1.37 and 1.36 respectively.Thus Indian 0.93 Russia 1.82 banks are relatively safe when compared to other - countries. 0.99 Contributed by: Vivek Ganatra

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Disclaimer: This magazine is a compilation of articles from various sources. Thus, readers are expected to crosscheck the facts before relying upon them. Though much care has been taken to present the facts without error, still if errors creep in, necessary feed backs will be always welcomed. Editors will not be responsible for any undertakings. The magazine is not meant for sale and hence, no part of the it should be used without the prior permission of the editorial team.

Sources: The Economics Times, Business Line, Business Standard, Financial Express, Financial Times, Wall Street Journal, DNA, The Deccan Chronicle, The Times of India, The Hindu, The Telegraph, Business Week, Business World, Business Today, India Today, The Economist, Forbes, Bloomberg, Reuters, Investopedia.com, Wikipedia.com, Moneycontrol.com, Vccircle.com, yahoofinance.com. VOLUME 1, ISSUE 1

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