The Unexpected Dilemma

With the oil prices shooting up in the world market, the least thing one would expect to happen is the food prices to follow them.

The urgent and frantic need to search and develop an alternative environment-friendly bio-fuel has started having its impact on the food production. All the grains and other bio-fuel feedstocks are being excessively used for the production of ethanol and bio-diesel leading to a tightening of supply in the food market. The impact of this raise in food prices already made food-importing countries like china ban the diversion of grains meant for food production to bio-fuels. With growing inflation concerns around the world, countries like India and China are in big dilemma now of having to chose between Food and Fuel.

More the increase in crude oil prices more is the demand for bio-fuels; more are the food prices.

Well, to gain something, you lose something; but does it always have to be like that?

IT

The IT stocks behavior in the recent turmoil of the sensex have been very interesting. Before getting into the discussion I want to expand on few terms here

Rupee appreciation: In the recent times the huge amounts capital inflows into our country in the form of FDI and FII have led to an excess demand of the rupee in the exchange market. This led to the appreciation of rupee. If a currency appreciates its purchasing power increases and so our imports become cheaper, but at the same time exports become more costly.

Exchange market intervention: Countries like china and India which depend a lot on its exports wouldn’t want its currency appreciation to affect the exports. So, the central bank of India would sell more rupees in the foreign exchange market and buy dollars. This increase in supply of rupees will negate the increase in demand for the rupee keeping the currency stable.

But, because of inflation concerns in the recent times the central bank of India stopped intervening(stopped buying dollars) in the exchange market letting the rupee appreciate based on market forces.

Appreciation of rupee will affect domestic industries which solely depend on their exports like textile industries, IT and other service industries. The revenue earned by the IT industries will decrease when converted to rupees. Simple example, suppose a company X normally earns 50$ per project and say the exchange rate is 50 rupees per dollar today. So the income for the company is 2500 rupees per project. Now, the currency has appreciated to 40 rupees per dollar, the income of the company will decrease to 2000 rupees per project. So, the profit margins of IT companies come down and based on these concerns their market price in the stock market will decrease.

The behavior of IT stocks with respect to the sensex recently was affected by some of these factors, more and more foreign institutional investors (FIIs) started investing in the Indian stock markets leading to more demand of rupee in the exchange market. So, rupee started appreciating.

Now the sensex was soaring up because huge amounts of FIIs being invested. But the rupee appreciating led concerns have affected the IT stocks.

More FIIs = Sensex soaring high = more of rupee appreciation = IT stocks not performing well.

Everything was going fine until the sub prime mortgage crisis started raising concerns throughout the world markets. So, FIIs started pulling back all their money from Indian markets, so naturally the rupee has to now depreciate. And a normal guess would be the Sensex goes down and IT stocks go up. But, this is not completely true; instead IT stocks also started plunging down along with Sensex. The reason is simple, people expected the US to go into an economic recession after the sub prime crisis. And 50% of the projects of the Indian IT companies come from US. The economic recession in US, if happens, will have much more devastating effect on the Indian IT industries.

A few days back on 18^th September the discount rates in US were cut down by good enough margins to mitigate the concerns over mortgage crisis. So, naturally FIIs started flowing into upcoming Asian markets like India again. On 19^th September you saw the Sensex reaching an all time high. Again more FIIs will lead to appreciation of rupee. So, on 20^th September rupee reached a nine year high value. Even though the Sensex has been reaching new heights the IT stocks are not the major gainers in this race. The reason being simple, Rupee appreciation.

So the IT stocks after the long bull run in the past years have come to a stop regardless of whether the Sensex is on a bull run or bear one.

sub prime what?

After the recent mortgage episode now all eyes are on America and Fed (Federal Reserve the central banking system in the Unites States like the RBI in India) and how are they going to wade across this mess.

Most economists say the genesis of the current crisis was some where near 1990.When all the Asian countries started joining the world economy leading to what in known as liberalization and globalization. But it was in the year 2000 when the dot-com bubble crashed it became quite clear that another crisis was imminent. Any big stock market bubble crash will lead to bankruptcy of some companies and investors in the market. This in turn leads to an economic recession.

In an effort to get out of the recession The Fed led by Alan Greenspan used the weapon famously known as “the Greenspan put” which is a way of ensuring liquidity in capital markets by lowering interest rates if necessary. Lowering the interest rates and relaxing the lending standards makes it is easy for people to borrow and companies to invest more and more in new projects (in this case avoiding a recession).

In 2003 the interest rates in US went as low as 1%. Every one started borrowing as the interest to be paid on them is almost negligible. Now, when there is so much liquidity in the market people want to invest somewhere and after the dot com crash no one was willing to look at stock options. So, other investment like real estate is where all the liquidity started flowing into. All of you know that more demand on a good will increase the price of it and so cost of house properties started insanely shooting up. Now that real estate properties are defying the laws of gravity and just going up and up, banks started give housing loans to everyone. After all if a person with bad credit history (mostly poor and other low income people) defaults there is always the house which can be sold at a very high price. And the banks can charge more interest rate to some one with a bad credit record because no one else was willing to give them that money. But these rates were just marginally high compared to others because the banks thought the risk involved in mortgage loans was very low, since the real estate prices have always been going up.

Now, this started spreading like an epidemic, every one is willing to buy a house. There was so much money involved in this market and the investment banks started jumping in too. They provided all the necessary money to the small banks and the small banks with their excellent network especially in rural areas and which can reach ordinary man quite easily provided all the necessary mortgage loans. Simply, now every one can buy a house. It’s not about every one owning a house, it’s about cashing out in this boom.

The interest cannot be so low always, lower interest rates have their own consequences if they go beyond a limit. Lower the interest rates higher the liquidity in the market, more the liquidity; more the liquidity i.e. more the money and the supply not matching up will lead to inflation. So The Fed got panicky because of incipient inflation and started raising the interest rates. The interest rates went as high as 6% within no time. From 1% to 6%, it is easy imagine the raise in the interest one has to pay on a loan. Plus every one entered the housing market and it reached a saturation limit. So people suddenly realize they cannot pay the interest on loans any more and they try selling their houses (which now every one is doing, so again do the demand supply thingy; more sellers less buyers) the price plunge down. The smart investment banks coerced the small banks for their money; small banks foreclosed all the defaulted loans only to realize that the houses are not that worthy any more. Every one was just trying to sell their houses. And so, we have a crisis. Every one is in a loss now. Banks decide to stop lending because of the existing uncertainty, not just mortgage debt but other forms of debt as well. This led to the credit crunch which most of us would have heard of recently. When investment banks are in loss and interest rates are high, story is back to square one, stock market crashes.

The sub prime market was worth in trillions; the losses involved are still being estimated.

Fed wakes up, Greenspan put, exactly what is happening right now, Fed has decreased the discount rates and is expected to decrease even more. Most importantly elections coming, the Republicans and the Democratic party, everyone starts thinking on how to rescue the affected leading to more pressure on The Fed. Because of which, now the markets are recovering but all these efforts to rescue will just lead to a postponement of this crisis some time soon but definitely not before the elections of course.

A dot-com bubble bursts, interest rates go down leading to housing market bubble burst.

If The Fed opts to cut down the interest rates again what is going to be the next bubble to burst?

Expectations from St.Petersburg

I have created this space for the sole purpose to vent out my views on the various events taking place around the world, especially in the economic and political world.
The G8 summit taking place in St.Petersburg is grabbing all the headlines world over. The world is looking at the G8 for answers on a number of issues ranging from tackling pakistan and dealing of terrorists to the future of soaring oil prices, and a solution to the ongoing battle in the middle east between the Hezbollah and Israel. It is quite astonishing that,America, which panics , when North korea test fires missiles, is staying absolutely calm and is turning the other to the Israeli aggression.The Israeli attack is cause a chain reaction which is sending shockwaves around the world. Oil prices have touched $78 a barrel with fears of fall in supplies and with OPEC not willing to increase production. I think its time the United Nations, steps in and takes some action to counter Israel's kneejerk reaction.