How vulnerable is India?

Recent declines in share prices have almost ended all talk of India being insulated from the financial crisis buffeting the world. A look at the stark numbers tells us that India has been one of the worst casualties of the market meltdown.

India, along with China, has witnessed the steepest market declines between December 2007 and September 2008. Both countries have lost almost 51% of market capitalization, or m-cap, and this figure could be much higher if the declines of the last fortnight are taken into account.

Also seeM-Caps in world’s free-float markets(graphic)

A closer scrutiny of the figures shows that the climb of India’s market capitalization last year was much steeper than China’s. In September, India’s market capitalization was just 10% higher than in March 2007. China, on the other hand, had a (significantly larger) capitalization that was almost 30% higher in September compared with March 2007 levels.

Easy money creates asset bubbles. Unfortunately, it will be easy money again—the bailout of $700 billion (nearly Rs34 trillion) and the more than $1 trillion kept ready by the EU—that will be bailing out the markets. Such easy money, unless regulated, will lead to another asset bubble, larger than the one confronting banks right now. And thanks to the analysis done by researchers at ‘Fortune’, it is possible to have an idea of the size of the funds involved. For instance, it is estimated that the total US exposure to credit default swap (CDS), a double derivative not dissimilar to a gambling ticket, is estimated to involve some $54.6 trillion, well above the world’s GDP of $54.3 trillion. While it is true that some of these CDS “commitments" could be cancelled against each other, even a fraction of this amount is staggering. Those “debts" will have to be reckoned with.

Also, the asset write-downs in the US have already reached $515 billion, and could increase to anywhere in the region of $1-1.7 trillion. According to the data released by the US Federal Reserve, there is also the additional $20.4 trillion of consumer and corporate debt, and $2.7 trillion in municipal securities. All this will have to get factored in during the next few years. And these deficits could have a toll on the strength of the US dollar.

The one silver lining for India could lie in falling commodity prices which could allow it to focus on infrastructure during the next couple of years and get the economy ready for the inevitable upswing by that time.

But, this benefit could get neutralized if the Reserve Bank of India does not allow the rupee to strengthen against other foreign currencies. A weakening currency will only stoke further inflation, make lowered commodity prices that much more expensive in rupee terms, and also frighten foreign capital away.

Present indications are that—notwithstanding the dip in the Index of Industrial Production, which could have been the result of an inaccurate calculation of industrial growth—corporate investments continued to remain strong, at least till the end of September. But that is a subject for next week’s column.

ICICI and media?

Last week, ICICI Bank Ltd announced an unusual arrangement—that it was tying up with Dish TV India Ltd, one of the major direct-to-home (DTH) broadcasters in India.

ICICI Bank wants to create an exclusive channel where its customers can study the status of their respective accounts, since the set-top box and the VSat allow for a very secure communication channel—far more secure than the Internet and the telephone network.

While Dish TV customers, who also have accounts with ICICI Bank, will not be able to transact through this medium—DTH dishes allow for just one-way communication—they can send their requests (for any additional information) through SMS, and the information can be beamed back to the specific set-top box. Dish TV will also benefit by being able to send its promotional literature (and possibly targetted discounts) to the 25 million customers of the bank.

But, what is more interesting are ICICI Bank’s plans to use this special channel on Dish TV to give out investment advisories, interest rates on various schemes, and information on mutual fund opportunities. While nobody is willing to say whether this would be merely text or will involve video as well, there is a good possibility that the bank will create a separate financial channel starting with ICICI Bank’s promos and gradually moving on to detailed analysis of the capital markets and commodity markets.

Moreover, as there is no exclusivity clause that binds either partner, ICICI Bank could actually allow this channel to be beamed through other networks too in the not-too-distant future. Will that make ICICI Bank a media company as well? Given the beating ICICI’s shares have taken of late and with the bank pointing fingers at rumours, a separate channel and confidence building might be what ICICI needs.

India’s own financial bubbles

India could well be sitting on its own financial bubbles waiting to burst, though they may not be even a fraction of what the US has notched up.

First, there are the participatory notes (PNs) which have witnessed a series of policy flip-flops.

They were introduced by the finance ministry in defiance of the fact that they made a public mockery of the know your customer (KYC) norms that are so strictly adhered to in the banking and the mutual funds industry.

When India’s stock market regulator, Sebi, put restrictions on PNs last year, almost every banker heaved a sigh of relief as it would put a stop to very large unregulated financial inflows and outflows.

Last week, Sebi removed these restrictions, obviously on directions from the finance ministry, and this could complicate matters further. Nobody knows how these funds will be used—and what speculative forces they could unleash.

Then, there are the fixed-maturity plans (FMPs) of mutual funds. As of the first week of October, most mutual funds were willing to mop up short-term money for periods as short as 30 days and going up to 375 days and at rates of 11-12%. Much of this money was generally loaned out to corporates as loans for much longer periods. It was the same story of borrowing short and lending long. New investors were constantly roped in to expand the pool of available funds.

Also seeWooing investors (graphic)

Unfortunately, some of the companies who have borrowed money from some of these mutual funds have begun defaulting on repayments, and some of the mutual funds are desperately wooing investors to roll over their FMPs.

What is perplexing is that nobody knows for sure whether RBI or Sebi have been monitoring the money garnered and used by FMPs. Some people believe that neither regulator has taken a serious look at them as yet.

Not surprisingly, large companies and high networth investors have begun pulling out their money from FMPs. Current estimates indicate that as much as Rs30,000 crore have been pulled out from FMPs in the first fortnight of October alone.

To meet these redemption demands, some mutual funds have been borrowing money at rates as high as 20%. That could explain why the mutual funds industry is in a flap.