Can you believe it ? People who have defaulted on their home loan in America are making Indian economy stronger. Can there be any relation between a guy who could not pay his loan on time in US and the booming stock markets of India?
Indeed it’s true no matter how incredible it seems. Read on..
In just 4 working days the Sensex (Sensitive Index of Indian Stock Market) achieved it’s fastest 1000 points run and gone from 18,000 to 19,000. Over the last month, it has gained 3,500 points. And during this period, four of its five all-time highs were achieved.
The common investors in India are a bit confused. The question, whether they should sell their stocks or wait for it’s further appreciation, is making the confused. If you are one of them, then before taking a decision you should understand what exactly is driving this boom.
A major portion of all the money, being pumped into Indian Share market, is coming from FIIs(Foreign Institutional Investors). These FIIs are very big investment groups, which keep studying the world markets to identify the best markets with potential of maximum returns. They are not ordinary investors, but very big corporates with trillions of dollars in their kitty and a huge army of experts to advice them on emerging world markets. In the eyes of these FIIs, India has become one of the hottest destination for investment and so there is a frenzy among these FIIs to brought as much stocks of Indian companies as they can.
Now why India has become such a hot favorite of these FIIs ?
The first reason is that returns from India remain among the best in the world; and there is a very positive expectation that in future also, the Indian economy and corporates will continue to do well. As you may be aware, the Nuclear deal with US is off for the present, but it has ensured that the Government will not fall soon. So a better environment of trust is there.
However, the second and most immediate reason for this huge rush for Indian Stocks actually started on 19th September after Ben Bernanke, chief of the US Federal Reserve, cut key interest rates in an attempt to save the world’s largest economy from dipping into a recession.
He cut interest rates due to the sub-prime mortgage mess in the US. Let me explain what this is all about.
In US there are people who are rich, not so rich and those who come under low-income groups. The people from low-income group are not given priority while sanctioning loans. As their income is neither high nor steady, they comes under the category of potential defaulters. So, lending institutions are not much interested in giving loans to them for the fear of default. These people collectively constitutes what is known as sub-prime markets . In recent years, however, a trend of providing loans to sub-prime markets was going on in the US.
Sub-prime loans were extended to these people with low income and high default risk. Despite their having a bad credit history, they were granted loans by lending institution on the premise that economy was quite strong and it was assumed that with a certain degree of controls, they wouldn’t default. Further these lending institutions were brimming with huge surplus of dollars and it was a good calculated move to invest them in the sub-prime markets. However, it didn’t turn out to be that way. High interest rates in the US started pushing up the numbers of people who couldn’t repay the loans. Slowly but consistently the numbers of defaulters started piling up. Soon it comes out that this situation was not limited only to these local defaulters and their lending institutions. These sub-prime loans were already resold by these lending institutions to other big investors as part of various investment products. As these major investments products have a huge customer base, the entire profit from them became quite vulnerable and risky.
As it turned out, American banks had a huge exposure to this segment of borrowers (of sub-prime markets) and many started reeling under the weight of defaults. The problem had reached proportions that threatened to derail the American economy in view of the inclusion of these local loans with big investment products. US Federal Reserve reckoned that if it cut interest rates, it would be easier for people (who are on the verge of defaulting) to service their loans and the financial services sector could withstand this storm.
However, most things in life have two facets – good and bad. A reduction in interest rate, though has made the repayment of loan easy for the defaulters, it has also made the investment scenario in US a bit unattractive. People, who were getting good return on their investment in US, will now get lesser returns as the interest rate has been lowered. From an individual’s perspective, this lesser return may not be a significant amount, however, for big Institutional investors, this lowering of interest rate can mean a huge loss on their expected rate of return. It made sense, therefore, to look at safer markets that offered better returns. Like India.
So, as of now, all investment fund managers are heading for India. There is a rush among them and almost every fund manager wants India to be in his investment portfolio. As a result the stock market is booming here. In the last month itself, a $7.2 billion of net inflows have been pumped into the Indian Share market by these FIIs. If you think this figure is not very large, let me tell you that in the entire 2006, the total investment from them was $8 billions. As a result the share market is booming. Apart from FIIs, who are here for long term investments, there are many hedge funds also which are investing money in the market for a short period to make quick profit. They may sell their shares in the days to come. However, for the time being they are in a buying frenzy and are helping the market touch new heights everyday.
This is truly the magic of globalization. The economies of various countries have become so much inter-dependent that a little change in the local economic scenario of one country can deeply impact the economy of a distant country. The present boom in India is a classical example of this. Some guys took loans and failed to repay it in time. Since the repayment of their loans was connected with the profit margin of big players, the entire economy panicked thus triggering the reduction in interest rate. This reduction made return on investment less attractive and the money starts moving to a better investment destination. Wow ! Truly the world is becoming a global village.
In my next article I will write about what can be the effect of this stock market boom in India.
{ 4 comments… read them below or add one }
In this blog/article you have described how defaulters are fuelling indian economy. In one way i can say US went in recession because of these defaulters only. These defaulters were the people who took sub prime loans but were not able to repay leading to backrupcy of many financial institutions and thus meltdown of US economy. But in one of your blogs “Reasons behind Recession”, you described how indian economy was affected by US recession. I am just pasting a few lines from your blog —————-
“For the last two years, our stock market was touching new heights thanks to heavy investments by Foreign Institutional Investors (FIIs). However, when the parent companies of these investors (based mainly in US and Europe) found themselves in a severe credit crunch as a result of sub-prime mess, the only option left with these investors was to withdraw their money from Indian Stock Markets to meet liabilities at home. FIIs were the main buyers of Indian Stocks and their exit from the market is certain to wreak havoc in the market”.———-
Here you are telling that to meet the liabilities at home FIIs are withdrawing money from our stocks.
Don’t you think in both of these blogs you have talked just the opposite.
@ Shashank shekhar
No I don’t think there is any contradiction in these two posts. If you read them carefully, you will find that at the point when FIIs were heavily buying Indian Stocks, they were not facing a serious credit crunch problem at home. The crisis was looming large at them but not in such dangerous proportion. They were still in a position to make decision based on lower/higher rate of return. However, as the sub-prime crisis deepened, their investments in US started turning into losses and there was no option left but to withdraw money from other markets (like India and meet liabilities at home). I hope this will clear your doubts.
Well, when the sub-prime crisis worsened, the investors started pulling out their money from indian stocks to meet liabilities at home. Right? Why sub-prime crisis worsened is because there were some people(defaulters) who took loans and were unable to repay it. So to compensate the losses which these investors suffered in US, they started pulling out their money from indian stocks to meet liabilities at home. This is not fuelling our economy but adversely affecting it. This is the sole reason why sensex crashed from 21000 to 8000 just in few months.
@Shashank
You are giving opinion on an article which I wrote 15 months ago (17th Oct, 2007). Since then a lot of things have changed and it is futile comparing two articles written in different circumstances. Both articles are true in their respective time frame and comparing them will confuse you more.
{ 1 trackback }