Last fortnight, the Bank for International Settlements (BIS), an international organization that serves as a bank for central banks, released its comprehensive set of data for the second half of 2008.

The data showed that the world had begun to shun speculation, which was reflected in the contraction of credit default swaps (CDS). Even commodity derivatives declined to one-third between July and December, from its earlier level between January and June last year. Foreign exchange contracts dipped by 25% and equity-linked contracts fell by 40% during the same period.

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But a closer look at the data reveals several disturbing facts.

*Although volumes of the derivatives markets declined from a peak in June 2008, they are nowhere close to levels of June 2007.

*The total volume of CDS registered a decline to below June 2007 levels, indicating that the market’s appetite for such instruments was on the wane. But the number of unreconciled CDS soared. Obviously, more counterparties have defaulted.

The volume had jumped from $721 billion in June 2007 to $2 trillion in December 2007 and further to $3.1 trillion in June 2008. It stood at a frightening $5.7 trillion by December 2008. This could mean that more banks, hedge funds and other fund managers may go belly up.

That could also probably explain why the stress tests norms for US banks were diluted and some of the accounting norms were reinterpreted when it came to mark-to-market procedures. In other words, be prepared for more bad news.

*Interest rate contracts continued to soar but dipped inexplicably in the second quarter of 2008. Was it because of contraction of money supply, which is inconceivable given the US bailout packages, or just a desire to stick to cash? How does one explain the doubling of gross market values in the same period? The debt market could hold out some nasty surprises.

*The market for foreign exchange contracts shrank. It was presumably because all currencies began to be perceived as being highly risky. Or it could have been on account on the way global trade contracted. Either way, gross market values soared 73% over June 2008, even though notional amounts registered a decline. Could it have been a result of more defaults on the trade front? Or, was this on account of pure speculation on currencies? Could it also have been a result of the increase in interest rates on sticky exposures?

This column has already reported how reinsurance rates have begun to climb. The divergence between notional amounts and gross market values in respect of foreign exchange contracts underlines the fragility of the financial markets and the enormous risks they bear. Collectively, the liabilities stand at $34 trillion—half the entire world’s gross domestic product.

Understandably, there are more questions than answers. But the underlying message is clear: Be careful. Be very very careful.


An expensive proposition

Exorbitant cost: A Mumbai Metro rail construction site. Phase two of the project raises a serious question with a high average price of Rs257 crore per km against Rs214 crore per km in the first phase. Prasad Gori / HT

The second phase of Mumbai’s Metro railway has moved yet another pace with the Mumbai Metropolitan Region Development Authority (MMRDA) finally accepting the bid by Anil Ambani’s Reliance Infrastructure Ltd, the sole bidder for the project.

Other parties who had been shortlisted by MMRDA, including Pioneer Infratech with Mutsubishi Corp. and Tata Power Co. Ltd as partners, Reliance Industries Ltd with Siemens and Gammon India Ltd, and Essar with Alsthom and Lanco, failed to submit bids.

This phase is 32km long and covers the route from Charkop in north-west Mumbai to Mankhurd in the city’s north-east. The project is estimated to cost Rs8,250 crore, of which Reliance Infra will ask the government for a viability gap funding support of Rs2,298 crore.

Although the formal award of the contract has yet to take place, the bid does raise a very serious question. It arrives at an average cost of Rs257 crore per km, which is exorbitant compared with the cost of Rs161.5 crore for the Delhi Metro. This is despite the fact that steel, cement and labour costs are at least 40% lower than those prevailing when the Delhi Metro was built. Thus, the cost should have been lower, not higher.

What is worse is that these costs put to shame even the earlier expensive cost for the first phase of the project involving just 11km at a cost of Rs2,356 crore, which translates into a cost of Rs214 crore per km.

It remains to be seen whether normative costs are taken into account before awarding the project to any party.

R.N. Bhaskar runs a company with significant interests in distance learning and examination certification and writes on corporate and business policy issues. Comments on this column are welcome at