Greater clarity on meltdown making investors jitteryOctober 10th, 2008 - 7:17 pm ICT by IANS
New Delhi, Oct 10 (IANS) Investors around the world are getting increasingly jittery each passing day as they are gaining greater clarity on the repercussions and side effects of the financial tsunami that began in the US and has now engulfed almost every economy in the world.”Each passing day investors are gaining clarity on the side-effects of the financial tsunami and they are getting more and more nervous,” analyst Jagannadham Thunuguntla told the IANS.
Thunuguntla is the head of the capital markets arm of India’s fourth largest share brokerage firm, the Delhi-based SMC Group.
The latest development that has left investors shivering is the collapse of what is called the ‘yen carry trade’.
Owing to deflationary conditions in the Japanese economy, the interest rate there has come down to just 0.5 percent.
Taking advantage of this, foreign institutional investors (FIIs) and hedge funds borrowed yen denominated loans from Japanese banks and reinvested these funds after conversion into other currencies.
As the cost of these funds was only 0.5 percent, FIIs and hedge funds often invested in assets where the return was sometimes as low as 2-3 percent as these still enjoyed a spread.
Over the last few days, however, the yen has been strengthening against the dollar because of the financial crisis in the US. Just a few days back, the conversion rate was 106 yen to a dollar, but Friday the rate rose to 98 yen to a dollar.
“This means that now FIIs and hedge funds have to repay a lot more dollars for every yen that they had borrowed and the cost of their yen-denominated loans has actually gone up from 0.5 percent to as much as 5-6 percent,” Thunuguntla said.
“This means, with more and more FIIs and hedge funds now being forced to repay what has become high-cost yen-denominated loans, their losses too are climbing,” he added.
Consequently, they are getting into fire sale situations in most global markets to raise money to repay these yen-denominated loans, besides being already under redemption pressure, he said.
In the Indian markets too, FIIs and hedge funds are selling indiscriminately and that is one of the major reasons why the market is crashing.
“The ill-effects of over-leveraging are also becoming clearer and clearer,” said portfolio strategist and US-trained chartered financial analyst Manoj Krishnan of Delhi-based Price Investment Management and Research Services.
Analysts said Iceland is an excellent case study in over-leveraging because the story is the same for all troubled investment banks and financial institutions.
Iceland has nationalised all its three banks and the country’s entire banking system has collapsed. Yet, in the four years - 2004 to 2008 - their bank assets grew five times through excessive borrowing, analysts said.
Now the total debt of these banks at $61 billion is five times the country’s GDP and the per capita debt of each Icelander is a whopping $276,000.
Their currency krona has also crashed. One month back, the conversion rate was 120 krona to an euro. Now it is 330 krona.
“That means the currency value has eroded by three times, and this will lead to runaway inflation because final consumption will not come down, imports will be costlier while GDP growth will be negative,” Thunuguntla told IANS.
“The real problem is that the crises in the financial markets are now creeping into the real economy,” Krishnan told IANS.
German bank Hypo Real Estate is another example. Hypo has a banking unit called Depsta. It used to stand guarantor to infrastructure projects so that these projects could get financing at rates that made them viable and take a commission in return.
Owing to Depsta’s guarantee, these projects could get funds at 5-6 percent instead of 10 percent and above. With Hypo Real Estate now getting into trouble, the Depsta guarantees have become meaningless.
Now all those projects that were viable due to cheaper funds by courtesy of the Depsta guarantee have suddenly become all unviable and promoters are being forced to stop work on them, the analysts said.
“This will inevitably impact the real economy in an adverse way,” said Naresh Pachisia, managing director of Kolkata-based SKP Securities, a leading distributor of financial products and services in eastern India.
The decision by the Reserve Bank of India (RBI) to cut the cash reserve ratio is also not cutting much ice with investors mainly because such measures too can lead to repercussions on the real economy, Pachisia told IANS.
“Moreover, India has so far followed a conservative policy regime with regard to banks and that’s why they are better off than US or European banks as they are well capitalised and not over-leveraged,” said Thunuguntla.
“But now if the RBI opts for a more liberalised policy then Indian banks too will go in for over-leveraging and then the repercussions here will be much more severe,” he added.
These are only some of the side effects that are making investors so nervous and there are many more, the analysts said.