Contributing To The Unsettled Conditions In Capital Markets

Published Date: 02 Nov 2017

The global financial started from 2007 and the markets were severely affected in 2008. The impact of the global crisis can be analyzed by the fact that stock markets have fallen throughout the world, many financial institutions (like AIG) have collapsed and many governments have to come forward with bailout packages to save the industries and business by injecting liquidity in the financial markets. The impact of the financial crisis has not only limited to the financial markets but has affected all the market driven activities and hence increased the unemployment rates in many counties, US is still fighting against the unemployment rate as high as 10% as in November, 2010. The collapse of United States subprime mortgage and decline in the prices of real estate had a "ripple effect" which affected the capital markets around the world.

Introduction to Global Crisis

The global crisis started with subprime crisis in US. The most badly hit, were the financial instruments mainly securities where banks have pooled different loans into sellable assets and thus they have transferred the risk to the third parties which have given insurance for these securities. These security buyers were paid for covering the risk. This method of pooling loans and using them as security was known as "securitization".

Banks started borrowed more money so as to lend to people so that more and more securities can be created. No one has ever thought that bad loans can create the problem for the buyers of these securities.

Companies like Lehman brothers got in the business of buying the securities and selling them out.

Loans were given by banks to people whether validating their credit worthiness that will they be able to pay the loan or not. Assumption was made that any bad debt can be recovered by repossessing the high valued housing property since real estate was on the boom and housing prices were tremendously increasing.

CDS and CDOs worsened the situation.

When the number of defaults started increasing, confidence among investors decreased. Lending slowed down and investors with banks withdrew their money. Thus banks which cannot return the money because they have little deposits with them, collapsed. Thus when the chain of collapses continued and companies like Lehman brothers and AIG collapsed US government has to come forward with a bailout of $2.8 trillion.

Since US was the world economic power in 2007, its failure has affected a large amount of markets worldwide. Because of globalization, and each economy being affected by the other the financial crisis turned out to be global economic crisis.

Role and Impact of US financial crisis on Capital markets of various countries

Asian Counties are largely dependent on imports of technologies from US and exports of its services to US. After the subprime crisis the GDP growth rate of US fall down below zero and country became more protectionist in its approach. Asian countries stock markets collapsed and the currency values also declined. More over the exports to US severely reduced hence the industrial output of Asian industries reduced hence impacting the overall GDP of the country and increasing the unemployment rate.

India: India’s stock market collapsed badly. In Jan 2008, Sensex touched the mark of 21,000 but by the end of the year Sensex flunked to 9000 mark. The GDP of India reduced to around 5% which was once growing above 7%. The capital inflow in Indian stock market reduced to US$ 13.2 billion in April-June 2008 as compare to the cash inflows in April-June 2007 which was US$ 17.3 billion. FDI’s and FII’s inflows were reduced while their outflow was increased.

External Commercial Borrowings of the corporate sector reduced to $1.6 billion in 2008 as compared to $ 7 billion in 2007. Trade deficit increased to 7.7% of GDP in 2008. The real exchange rate appreciated from an index of 104.9 (base 1993-94=100) (US$1 = Rs. 46.12) in September 2006 to 115.0 (US$ 1 = Rs. 40.34) in September 2007, it depreciated to a level of 101.5 (US $ 1 = Rs. 48.74) as on October 8, 2008. The bond markets and insurance sector is still tightened because of lack of confidence of the investors.

Trends in Capital inflows in Indian Capital market

(US $ million)

Component

Period

2007-08

FDIs

April –August

8536

FIIS

April – September

15508

External Commercial borrowings

April – June

6990

Short term Trade credits

April – June

1804

ECB Approvals

April – August

13375

Foreign Exchange reserves

April – September

48583

Source: Global Financial Crisis and Key Risks: Impact on India and Asia by Rakesh Mohan

China: China also faced a sharp decline in the growth which fell below 8% as compared to above 9% growth in 2007. China also faced job losses and reduction in industrial output. The major impact on China’s capital market was because of upward pressure on its currency, Yuan. China. China called for replacement of dollar by a world currency reserve run by IMF so that dependency on dollar can be reduced. China’s capital market suffered with non-availability of funds. Thus China fostered ties with its neighboring countries like Taiwan to meet its capital requirements.

Japan: Japan is largely export centric country. US is one of the major exporters of Japan. Heavy dependency of Japan on US made Japan to suffer during the global crises. Japan’s industrial output fell by around 10% in 2008-09 because the demand in US markets was reduced because of extremely slow growth rate and increasing unemployment rate. Thus unemployment rate in Japan also increased.

Europe: Even in Europe a number of financial institutions collapsed and some needed rescuing. Iceland which is very much dependent on finance sector faced a lot of economic problem and finally decided to take IMF funding. Later on the unrest in public lead to fall of Iceland’s government. Members of European Union increased their government spending and tax cuts to around 200 billion euro.

United Kingdom: Equity market – FTSE-100 and DataStream Indices have fallen by 31% between 2007 and 2008. Equity implied volatility has risen by 34% between 2007 and 2008. Bond market’s yield curve fall for short and mid terms in 2007-08. Pound sterling exchange rates against dollar and euro have fallen. Sterling swaption implied volatilities have gone up between June 2008 and December 2008.

Africa: Impact of global crisis on Africa was both direct and indirect. The direct impact was seen in the financial markets of Africa. Stock markets have shown volatility and stock exchanges have tremendously suffered. In Nigeria and Egypt the stock market almost collapsed by 67% between 2008 and 2009. The same was observed in Kenya, Zambia and Botswana. The collapse of financial sector adversely affected the aggregate demand and the number of defaults in the banking sector. The number of non performing loans increased challenging the stability of financial sector in Africa. For e.g. Ratio of nonperforming loans increased to 8.7% in 2008 from 7.9% in 2006 and same in Lesotho where it increased from 2% to 3.5% between 2006 and 2008. Africa suffered because its banking sector is largely controlled by foreign banks which were in turn affected by subprime crisis. The countries which have high control of foreign banks in banking sector include Botswana, Cape Verde, Chad, Guinea, Lesotho and Zambia.

Even the foreign exchange markets of Africa suffered because of subprime crisis.

Ghanaian Cedi depreciated against dollar by 14%

Zambian Kwacha depreciated by 13% against US$

Uganda – 22%

Nigeria – 27%

Since the African countries have high foreign debts, the depreciation in its currency severely increased its debt burdens. The unemployment raised, output reduced and imports become.

GCC countries (Gulf Cooperation Council): GCC countries have strong policy framework and regulations which has stimulated it towards a healthy economy improving its account balance, reserves and overall financial systems. But these GCC countries are susceptible to oil shocks: oil is a tradable commodity with fluctuating prices. The impact of financial crisis was on 2 sectors of GCC countries one oil sector and other real estate sector especially Dubai. Bond markets for the GCC countries started to decline in 2007 and the major impact was on UAE and Bahrain. The stock prices in GCC fall rapidly and stock market indices showed decline.

GCC stock market index

Jan 1 to Oct 20 , 2008

Bahrain (BSE)

-16

Kuwait (KSE)

-14

Oman (MSM)

-21

Qatar (DSM)

-17

Saudi Arabia (Tadawul)

-41

Dubai (DFM)

-44

Abu Dhabi (ADSM)

-23

Source: The Global Financial Crisis: Economic Impact on GCC Countries and Policy Implications by Shereef Ellaboudy, 2010

GCC stock market capitalization declined by about $320 billion in 2008 within two months, which is about 38% f GCC’s 2007 GDP. Since global financial liquidity reduced the cost f borrowings increased moreover credit lending practices by financial institutions was also curbed.

Response from Regulators

The global crisis reduced financial liquidity in the markets, thus various governments and regulators had to come forward to inject liquidity in the system. The steps taken by different governments and regulators are as follows

US government gave a bailout package of US$ 2.8 trillion dollar to inject liquidity. Government of India provided $75 billion additional liquidity. Russian government channelized funds from energy sectors to revive the financial systems. Iceland government took IMF funding of around $200 billion to support its financial system.

Governments raised their spending, guaranteed funds for infrastructure projects, farm loan waiver.

Cut in indirect tax rates and reduction in Repo rates and Cash Reserve Ratio so as to make funds available with banks

Fostering economic development, like China entered into ties with Taiwan. US President Mr. Barack Obama visited several nations to promote trade across borders.

Controlled lending practices by increasing lending rates and motivating people to save more by increasing saving rates

Regulations have moved from traditional factor based approaches to solvency towards Risk based regimes.

Raising caps from different sectors and inviting FDIs and FIIs like Exploration and Production of energy sector in India invites 100% FDI

Raising caps from bond and security markets so as to motivate companies and general public to make investments (both short term and long term)

Since availability of capital has become an issue since investors had lost confidence in private players, a number of government companies have come forward by listing their IPOs (initial public offerings) on stock markets so as to foster investment practices among general public.

Post era session of recession has been marked by a number of Mergers and Acquisitions and Joint Ventures so as to revive the collapsed companies with best management practices.

Response from Users

The Post Era session of recession is marked with conservative approach not only by capital markets but also by the governments of different countries. Countries markets have become protectionist in their approach and trying to increase the industrial output of the country, increase GDP and job creation within the country. MNCs have adopted capital and risk management practices with the help of credit rating agencies like CRISIL, CARE, and PROTIVITY. The markets are more inclined towards domestic investors by promoting them to invest in various schemes. Investors are investing more in government bonds and securities as well as publicly listed IPOs from credible companies. Hence the economies are recovering back India and China are again back on track with Stock market indices touching new heights and GDP rate well above 8% for both of them. Russia is developing at a pace of 6%. US And Euro zone are growing but the pace is slow and it will take some more time to bring back the confidence in the investors. The only predictable statement that could be made is that the world power has shifted from West to East.