TV Channels blaring that India’s inflation rate slipped into the negative for the first time in 30 odd years. What does it really mean? It really means nothing to the common man!

Prices are still soaring or at least stable at their peak - and why is this not reflected in the Inflation numbers?

This is because India calculates Inflation differently than other countries

• India uses something called the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy.
• Most other developed and developing countries use the Consumer Price Index (CPI) to calculate inflation.

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Recently, there was a news story about 70+ cricketers abandoning the ICL 20/20 league and going back to the fold of BCCI (or IPL?). I read this news on at least 15+ sites (news sites and blogs). In all these publications, I could not find any blog post or news report that points to the fact that ICL losing sheen is lost opportunity from the perspective of economy, opportunity, employment, and many more. Perhaps, it reflects the state of our media. There is more focus on re-running the same news again and again. It’s a “me too world”, but we forget that in “me too world”, we as individuals also become “one of those”…..

I believe that ICL losing steam is a great lost opportunity. This was an opportunity that would have unleashed the economic power of sport to the wider mass of India’s population. (more…)

An asset or investment for which the future return is know with certainty and therefore which carries no risk. Theoretically there is no such thing as a totally risk free asset, however many government securities and deposits with financially secure banks are taken as the benchmark for the rate of return on a risk free asset

Although domestic news remains dominated by the election, a brief look at the overseas news media shows that there is a new global story on everyone’s minds. Swine flu is admittedly not as dramatic a sounding a story as some. However, it has many people very worried and is already impacting global markets.

Currently cases of the new strain of Swine flu have been confirmed in Mexico, the US, Canada, Israel, New Zealand Spain and the UK. Also there are suspected cases under investigation in Korea and many countries in South America and Continental Europe. Although approximately 150 people have died so far, the World Health Organisation (WHO) has stated publically that this has the potential to become a world-wide pandemic. 

Like Avian flu before it, this may turn out to be an exaggerated threat. The scale of the potential disaster is however enormous and markets are, as the are prone to do, pricing in some of the downside. Global markets corrected yesterday and today, airlines and travel companies being amongst those hit the hardest. 

The social disruption witnessed in Mexico has highlighted not only the personal but also the potential economic costs of the disease. Mobility of people has to be restricted to prevent the spread of the virus and many activities simply grind to a halt. The potential cost of large scale infection and therefore immobilisation in the US would be serious for the global economy and this does not consider the real possibility of an outbreak in India itself. 

With more countries reporting cases of Swine flu by the hour, global market sentiment has reversed and fear is showing signs of return. This could well be the trigger for a serious correction of the rally that indices have seen in recent weeks, particularly if the pace at which the disease is spreading continues to grow.

How long the current rally will continue and whether this really is the start of the next bull run are questions which everyone is mulling over. What we should also be asking is what changed in the last 5 weeks to justifiy a 30% rally?

For all the talk of global cues and increased risk appetite, no one has convinced me that this rapid advance  isn’t irrational and therefore likely to correct itself. Now obviously this is part of a global rally just like it was a global crash. This just begs the question of whether the the global rally is sustainable or can be justified logically? 

I think not and I say  this because 18 months of absorbing bad news seems to have made markets all over the world, and particularly in India, immune to it. Bad news is no longer newsworthy but good news is trumpetted from the rooftops.  For example; March YoY export decline was the worst on record (India), motors sales last month were the worst on record (UK), recent unemployment figures were the worst for 6 years (US). All these stories demonstrate a continuing global decline but had minimal impact on the markets. However, the same markets rallied when the G20 re-announced existing IMF funding plans.

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Those people with a closer ear to the ground may have got wind of it but I was quite shocked to read that the RBI has been printing so much money, approximatlely 1.5 lakh cr.  At 45% of the 2009FYE fiscal deficit the action certainly solves, or helps to solve, one problem. Unfortnately creating so much cash out of thin air undoubtedly creates problems as well.

It is easy to see why the action was taken. Recent stimuls packages and other subsidy programs have put a massive strain on the government budget. There is increasing concern about the markets capacity to absorb large issues of government debt without crowding out interest rates. Tax rises are obviously out of the question. So where was the Centre supposed to get money from other than printing it?

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The unemployment rate in the world’s largest economy the US touched a 26-year-high of 8.5 per cent in March, pushing the total number of job losses since the recession began in December 2007 to 5.1 million.

The data released by the US Department of Labor showed that a staggering 6,63,000 jobs were lost in March.

During the same period, the jobless rate soared to a 26-year-high of 8.5 per cent from 8.1 per cent. Officially, America entered into recession in December 2007.

Much of the Media coverage of the G20 agreement has pitched it as a compromise; the US and the UK got the spending they wanted and the French and Germans got the tougher regulation they were after. In fact there is no stimulus spending, just another trillion dollars of debt, and although statements about better regulation may sound good, there is very little meat to them. So if a ‘new Bretton Woods’ was what Gordon Brown was really aiming for, he fell a little short.

In terms of regulation the good news is the extension of regulatory oversight to hedge funds and credit rating agencies, something which should have been done a long time ago. However a disproportionate amount of attention seems to be being given to ‘tax havens’. This may be politically expedient but it’s not as if the Swiss were the ones who brought the world to the edge of ruin.

Also in the regulatory area the G20 agreed to create a global Financial Stabilty Board to replace the Financial Stability Forum, I can see the headlines now… “dramatic name change saves global banking system”.

In all seriousness the summit was never going to redraw the regulatory map because for all the talk of togetherness, people are still very nationalistic about banking. There is zero chance the US, the UK, the French, the Chinese… well anyone really, will give up control of their domestic banking system to an international regulator, so ‘transparency and cooperation’ was about all we could hope for. (more…)

In what seems to be news in only the loosest sense of the definition, this week saw speculation that GM and Chrysler face bankruptcy. I say this because GM at least has been going bankrupt for as long as I can remember.  For anyone unconvinced the firm was doomed before the phrase “credit crunch” was ever spoken, consider 2005 and 2006 which saw GM post a combined loss of 12 billion dollars, hardly a sustainable financial performance.

The painful fact for American policymakers, who have already handed over several billion dollars to Detriote’s big 3 car makers, is that all three firms make a product which no one wants, large inefficient American cars. (more…)

Having spent 2 weeks horizontal and out of touch with financial news due to a misguided interaction with a street vendor and a glass of pineapple juice, I was recently released back into the wild to find that a very different world has emerged. No longer the doom and gloom of global depression or the anguish of multi-year lows being tested time and time again. Now we live in a world of bullish optimism and dramatic rallies.

The question which immediately sprung to my mind is “what changed?” The answer I found out was not a great deal. (more…)

This week saw a heavy correction in the equity markets, not just in India but arround the world, as concerns lingered about the depth and length of recessions in consumer nations and the knock-on effect they would have on global trade levels. In India 7% of market capitalsisation was lost in the first two sessions of the week with a further significant decline on Friday. At the close on Friday the Sensex stood at 8,843, following a weekly decline of 792 points or 8.2%. This level is just 4% above the previous closing low of this downturn, with many analysts now forecasting new lows to be reached by early March. The Nify ended the week on 2,736, down 7.2%.

The intial sell-off was caused by two factors; firstly the US markets fell on concerns surrounding the Obama banking bailout; secondly, the interim budget was released and found to contain very little to cheer the markets. These two factors resulted in heavy selling of Banking, Realty Metals and Auto stocks (amongst others) which dragged the markets down on Monday and Tuesday. After stabilising somewhat mid-week, the markets took another hit on Friday after global indices declined on news that the Dow Jones had broken through the psychologically important low of this bear market to touch levels not seen since 2002. Although the S&P 500 and the NASDAQ remain above the previous lows of this cycle, the symbolism of this event sent global markets into the red and sparked another day of heavy selling. (more…)

Despite a mid-week wobble as global markets reacted with scepticism to the latest US financial support package, this week saw some healthy gains for the benchmark indices. The Sensex flirted with 9,700 in Friday trading and closed at 9,635, a gain of 3.6% from last Friday. The Nifty also gained ground, ending the week 3.7% up to close at 2,948.

Although being heavily influenced by global cues, domestic factors have provided some support for the markets this week. Expectations regarding sector specific fiscal stimuli in the April budget have restored a degree of confidence in certain sectors, while the rail budget announced on Friday provided some good news for metals and infrastructure stocks hoping to benefit from the announced investment. Alongside expectations of fiscal support, weak IIP and inflation numbers have also increased the likelihood of interest rate cuts in the near future. The excpectation of these cuts helped to firm some of the more rate sensitive sectors like banking, auto and real estate and this trend is likely to continue. (more…)

That we will see a further cut in interest rates either with or before the Interim Budget seems increasingly likely as recent data indicates both an increasing need and an increasing capacity for it.

The recently released IIP (Index of Industrial Production) figures for December painted a gloomy picture of contracting activity in the non-service sectors of the economy. Dramatic contractions in the levels of manufacturing output, consumer durables and intermediate goods have taken many analysts by surprise and highlight a downside risk to the recent forecasts of 7.1% annual GDP growth.

While the call for lower rates is growing louder, the RBI’s capacity to accommodate the demand is also increasing. Recent data has confirmed a continuing decline in inflation from the heights of last August. Week ending Jan 31 saw WoW figures of 4.39% and many people are forecasting it to fall below 3% by the middle of the year.

With this in mind, a cut in Repo and Reverse Repo rates of at least 0.5% seems innevitable before quarter end and further cuts later in the year should also be expected. In many ways it looks like the markets have already started to price in the first cut and will continue to do so over the coming weeks. Interest sensitive stocks such as Auto, Banking and Realty may see some support as expectations firm, but significant advances are unlikely due to other fundamental concerns in these sectors. What is certain is that if the rate cuts do not materialise soon the markets will suffer.

The US markets today reacted with scepticism as President Obama’s latest efforts to resucitate the banking system were released by new Treasury Secretary Timothy Geithner. The Dow jones fell nearly 5%, indicating a lack of confidence that proposed measures would de-clog the financial system, increase lending and stop the housing market free fall. Not suprisingly European and Asian indices followed suit and fell into the red.

Although some elements of the plan remain unclear, what is clear is that to significantly increase lending the critical step is kick-starting activity in “shadow banknig system”; a network of hedge funds, investment banks, SIVs and private equity houses which have grown to gargantuan proportions in recent years. In fact as William Patalon of MoneyMorning points out, assets in this shadow system oustripped those of actual banks as early as 2007 and by 2006 the volume of lending from securitisation was double that of traditional deposit based lending.   (more…)

Trading this week was marked by a bad day on Monday, a good day on Friday and 3 quite forgettable days in between, with the majority of activity being driven by global cues.

Both the Sensex and the Nifty fell around 3.7% in Monday trading as weak US economic data sent the major European and Asian indices downwards. Tuesday, Wednesday and Thursday all followed very similar patterns with high price volatility being coupled with low trading volumes and mainly sideways movement. Friday then saw the markets recover some of their Monday losses as both the Sensex and Nifty closed up around 2.3% for the day and every sector ended in profit.

The Sensex closed on Friday at 9,301 which despite the heathly rise for the day was still 1.3% below last Firday’s close. The Nifty closed at 2,843, a loss of around 1.1% for the week.

The Rupee hit a two week high against the Dollar on Tuesday as expectations of continued withdrawals of foreign funds from India was challenged by data showing foreign investors as net purchasers of stocks the previous week. After falling back slightly, the Rupee then rose to its strongest close in a month, as the Dollar lost ground against other currencies and Indian stocks advanced on Friday.

Looking forwards, the next 2-3 weeks will be crucial in determining whether the markets can sustain another bear market rally in the run up to the election and next quarterly reporting period in April. As per this week the majority of the cues will be global.

Early next week, all eyes will be on the US and their $800bn stimulus package. If the bill is passed we could see a global upswing in sentiment building on Friday’s gains and driving the Indian markets up. If this happens and the markets can break out of their current trading range then significant gains could be made. However, if the bill is not passed and there is further deprressing data from the US, China and the major Europenan economies then a breakout on the downside does remain a posssibilty.

The Rupee gained 0.2% against to dollar to hit a 2 week high as speculation that oversees investors would continue to sell Indian equities was dampened by data showing foreign institutions as net buyers of Indian stocks last week. This followed a masive outlfow of funds the week before.

With the Rupee having suffered at the hands of the dollar in 2008, there is some evidence (or belief) that this scenario may be changing. Now that the global financial crisis has evolved into a global economic crisis, many analysts believe (and I agree) that foreign investors’ atitudes towards countries such as India will improve in 2009, as investors with liquid funds move away from extreme risk aversion in search of economic growth.

With India expected to be the second fastest growing economy in 2009 (behind China) a net inflow of foreign investmet is becoming increasingly likley. This is despite the risk premium which India carries due to persistant corporate governance concerns, so dramatically highlighted by the recent Satyam scandal.

Whilst recent history may suggest that the world has turned its back on India, the simple logic is that if you have funds to invest you would rather invest in growing economies than contracting ones. Luckily for the Rupee there aren’t going to be many expanding economies to choose from this year. 

The Beatles once sang that ‘all you need is love’. Worryingly the strongest message to come out of Davos, where the great and the good of economic policy have been gathered at the World Economic Forum, is that ‘all we need is confidence’. Well actually the phrases ‘crisis’ and ‘recession’ are probably eminating more strongly but the optomistic message is defintiely all about ‘confidence’.

Where exactly we this confidence is supposed to come from is unclear but the message has highlighted an uncomfortable truth; the economic system has always contained among other things, a large amount of smoke and a reasonable number of mirrors. Now I imagine that in America there about the same number of houses as there were 2 years ago, so where’s the crisis? OK nobody thinks that they’re worth as much as they were, but surely a little “confidence” should fix that. And OK none of the world’s banks or stockmarkets contain as much value as we thought they did 18 months ago but a little “confidence” should sort that out.

Sadly the message from Davos is accurate if not optomistic. The global recovery will be contingent on two things; banks having the confidence to lend to businesses and consumers having the confidence to spend money. The problem is that confidence, like trust is hard to recover once it’s gone, and it does seem to be gone. It’s a bit like the world has run off the edge of a cartoon cliff and made the fatal mistake of looking down, thus dooming itself to a fall which would have been avoided if we’d just kept our legs pumping and our eyes (confidence) up.

Incidentally the other consensus view from Davos is that the devloping economies with large populations and therefore significant momentum of deomestic demand will recover soonest. So maybe we in India at least, should be a little bit more “confident” after all.

The figures show that China’s GDP growth fell to 6.8% in the fourth quarter, down from 9% in the third quarter and is half of 13% growth rate in 2007. This implies that growth was virtually zero on a seasonally adjusted basis in the fourth quarter.

Industrial production has slowed even more sharply, growing by only 5.7% in the 12 months to December, compared with an 18% growth rate in last quarter of 2007. Chinese exports are likely to drop further in coming months as world demand shrinks. 2009 is expected to see first y-o-y decline in exports in past 25 years.

While forecasting GDP growth for any country economists take help from various criteria. One of the criteria is electricity output which is leads GDP growth as more electricity consumption eventually leads to higher GDP and decline in electricity output may mean that GDP is falling, In the graph, percentage growth in GDP and electricity output is shown. It can be easily seen that electricity output leads the GDP but magnifies rise of fall in GDP growth. By taking help of regression, economists have estimated that a negative 6 % growth in electricity output could convert to GDP growth in the range of 0-1 %.

Though this is not the only criteria, other criteria sush as export growth and its weight in the GDP, Housing growth indicator (which suffered a collapse due to slump in housing construction, caused by the government’s efforts to deflate a potential bubble) point even worse situation for China.

Measures taken by China

• On January 21st it announced extra spending of 850 billion Yuan over three years to improve health care and Infrastructure.
• From February, rural residents will get a 13% rebate on purchases of goods such as refrigerators, TVs and washing machines.
• Interest rates have also been cut five times between September and January
• Controls on bank lending have been scrapped. To help the property sector, minimum down-payments have been reduced from 30-40% of a home’s value to 20%, the transaction tax has been waived for properties held for at least two years, and more public housing is to be built.

Total asset size of Indian banking sector is approximately US$ 335 billion with total deposits of about US$279 billion. There are over 290 scheduled banks in the country. 

They are as follows:

• Public Sector: 27
• Private sector: new – 8; old – 22
• Foreign: 40
• Over 190 regional rural banks

There are over 66000 branches.

• Public sector: 46000
• Private sector: 5500
• Foreign: 190
• Regional Rural: 14400

Following indicators are used to analyze the performance of banks:

Ratios for evaluating operating performance

Net interest margin (NIM): For banks, interest expenses are their core costs (similar to manufacturing cost for companies) and interest income is their core revenue source. The difference between interest income and expense is known as net interest income. It is the income, which the bank earns from its core business of lending. Net interest margin is the net interest income earned by the bank on its average earning assets. These assets comprises of advances, investments, balance with the RBI and money at call.

NIM = (Interest income – Interest expenses)/Average earning Assets

Operating profit margins (OPM): Banks operating profit is calculated after deducting administrative expenses, which mainly include salary cost and network expansion cost. Operating margins are profits earned by the bank on its total interest income. For some private sector banks the ratio is negative on account of their large IT and network expansion spending (capex).

OPM = (Net interest income (NII) – operating expenses)/ Total interest income. Other income to total income: Fee based income account for a major portion of the bank’s other income. The bank generates higher fee income through innovative products and adapting the technology for sustained service levels. This stream of revenues is not depended on the bank’s capital adequacy and consequently, potential to generate the income is immense. The higher ratio indicates increasing proportion of fee-based income. (more…)

Efficient-market theory (or Efficient Market Hypothesis EMH) argues that in the long run it is impossible to “beat the market” because the current price of a stock always factors in all available information.

According to the theory, stocks always trade at fair value and it is impossible to buy undervalued stocks or sell stocks for inflated prices. Therefore it is impossible to outperform the market by stock picking or market timing; the only way to earn higher returns is to buy riskier investments. The theory gained prominence in the mid-1960s and in 1970 Eugene Fama refined it into three distinct forms: weak, semi-strong and strong. (more…)

 As with most sectors, Indian pharmaceutical companies have had a tough year. Rising raw material and energy costs squeezed margins for everyone but  this was accentuated in the pharmaceutical sector as China halted production of intermediate drugs in the run up to the Olympics. The depreciation of the Rupee also hit many of the bigger players who booked large mark-to-market losses on FX hedges and saw their interest outgoings on foreign currency loans rocket.

The net outcome of these factors was an aggregate 7% reduction in PBT for domestic pharma companies, despite a respectable 24% increase in top line revenue, resulting unsurprisingly in significant market sell-offs. The BSE Healthcare Index is 29% down over the last 12 months with some of the larger pharma stocks such as Ranbaxy and Dr Reddy’s Laboratories being heavily sold (50% and 35% respective YTD fall in share price). However, despite this backdrop the future outlook gives some cause for optimism.

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Its not really news when I say that we’re in a bear market (the widely accepted definition for western equity markets is a sustained 20% drop is much smaller than the 50% drop of the Nifty from our January high of 6357). But the question on everybody’s mind is - where are we in this bear market? The beginning, the middle, or at the end (the bottom)? Let’s have a look at the past three Indian bear markets and see if we can get some clues (data below sourced from Morgan Stanley Report, “India Strategy: How to Cope with a Bear Market”, published on 13 March 2008):

First: 2 April 1992 (top) - 26 April 1993 (bottom)

• Tipping point: Harshad Mehta
• Lasted for 56 weeks (just over a year)
• Sensex Peak at 4547
• Sensex Bottom at 2073
• Decline of 55%
• Time taken in days to cross previous high: 881 (2.5 years)
• 6 months return from the bottom: 34%

• Tipping point: Dot-com bubble bursts / Ketan Parekh scandal comes to the fore
• Lasted for 84 weeks (around 1 year 7 months)
• Sensex Peak at 6151
• Sensex Bottom at 2627
• Decline of 57%
• 12 months trailing PE at the Bull market peak: 33.9
• At the Bear market bottom: 13.6
• Decline of 60%
• Time taken in days to cross the previous high: 1425 (4 years)
• 6 months return from the bottom: 34%

• A bear market leads to an average decline of 51% of the index, and upto 60% decline in PE ratios
• If you managed to invest at the bottom, 6 months down the line you’d have made an average of 35% return (although spotting the bottom is near impossible - so this is rather misleading)
• It lasts anywhere between 1-2 years
• It takes anywhere between 2.5 to 5 years for the market to ‘recover fully’ to its previous peak - therefore the bear market is accompanied by a considerable ‘horizontal’ market
• The bull market peak is over 32x earnings (PE ratio), and tends to more than halve at the bottom.

While the market has rallied considerably since Diwali, with the Fed cutting rates to 1% and the RBI slashing repo, CRR, and SLR, the Nifty is trading at a PE of 13.76. This is by no means cheap, but considerably below historical PE levels of 17.83. 

Monday last week saw the Nifty touching its lowest PE level since Jan 99 at 10.68, with the market closing at 2524. My guess is that ‘around now’ is a great time to invest, but not exactly now. I have a feeling that the 600+ point rally that we’ve seen is just a relief rally, and once participants start profit booking, the over-reaction to the positive measure subside, and as earnings continue to disappoint, we’ll soon be back in the 9000 region. When that happens, make sure you’re ready with your money, and clear on where you want to put it!

Historical PE Chart - NSE Nifty

Source: NSEIndia.com

The crash of the Indian Stock Market since January 2008 has been widely attributed to FIIs pulling their money out to meet liabilities and redemptions. According to this article, however, FIIs have only pulled out $12.7bn and still have another $53.7bn, or almost Rs. 270,000 Cr. left in the market. 

A lot of market experts are talking about the market being near the bottom (”Valuations just cannot get any cheaper! The Indian growth story is sound, even at 7%!”) Let’s be clear on this: these falling prices are not about fundamentals - its simply about lack of liquidity. FIIs are not exiting the market because they want to, but because they are being forced to - nobody wants to book such massive losses, and nobody would argue against the fact that as an emerging market India is looking pretty cheap.

The fact that there’s so much FII money still in the market - 80% - is quite scary (more…)

One of the most elegant applications of mathematics to finance has been in the field of portfolio theory. Active portfolio management requires investors to not only select risky securities, but also decide the appropriate weightage to ascribe to each security in the portfolio.

Developed by Markowitz and Sharpe in the early 1960’s, modern portfolio theory defines portfolio risk and return in precise terms: portfolio return is the weighted average of the expected return of individual securities while portfolio risk, is the weighted sum of individual asset covariances. This simple insight allows us to determine the condition for the efficient frontier – a set of portfolios that combine various risky assets in proportions that yield maximum return for a given level of risk.

Applying the fundamental intuition behind the Markowitz / Sharpe framework, PortfolioEdge has been built keeping in mind the practical investment behaviour of traders, investors and portfolio managers. It is a rebalancing tool for equity portfolios, but can be used for any risky asset-class, provided that it is possible to specify the returns on an NAV basis. By risky, it is meant that the asset class should have a positive standard deviation and it should thus be possible to estimate a distinct higher and lower value for its Upside potential and Downside risk, respectively.

The PortfolioEdge algorithm uses an innovative methodology to estimate the model weightage of stocks in your portfolio. The fundamental intuition behind the allocation mechanism is the Reward-to-Risk ratio (R2R), which is analogous to the Sharpe Ratio under modern portfolio theory. However, unlike the Sharpe Ratio, the measure of risk is not volatility (standard deviation), but expected capital loss.

Salient Features:

• Uses an intuitive and practical approach to portfolio rebalancing, based on parameters than can be easily understood and estimated.
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• Allows you to perform various kinds of portfolio analytics and generate customized report

Screenshots

You can download a free trial version of PortfolioEdge from www.portfolioedge.net

For further details about the product contact k.v.mehta@gmail.com

There’s been so much change in the global banking landscape, with banks going bankrupt, being nationalised, and being bought over by others that its become quite difficult to keep track.

Check out this excellent interactive by FT that takes you though a 10,000 feet chronological walk though a Global ‘Bank Street’, telling you which banks have been nationalized, bought over, expanding, or have a new business model. Sigh I still cannot get over the fact that we’ll soon be able to get a Goldman Sachs Debit Card.

Here’s what the FT interactive looks like:

I read an article in the Mint this morning about the fact that an (unnamed) a major Indian commercial bank has borrowed a massive Rs. 1000 Cr. from another domestistic bank at 20% interest, a rate which reportedly the highest charged by any Indian bank in over a decade. The article goes on to say:

In this particular case, the borrower of the money was desperately looking for funds to tide over short-term asset-liability mismatches in its overseas operations.

There have been a bunch of rumours going about ICICI being badly hit, indeed threatening to collapse under the weight of losses from the subprime crisis. These rumours are of course very unlikely to be true - there’s no chance that ICICI bank could ever go under. At the same time, I wouldn’t blame people for thinking ‘ICICI’ the moment they read this article in the Mint. Bearing in mind this very issue, the author didn’t waste time in including a caveat:

Most of the large Indian banks, both state-run as well as private ones, have overseas presence. The aggressive ones have been building assets overseas by rolling over their liabilities, raised from the inter-bank market.

I had earlier written a brief article on the unilikely rumours that were floating around about ICICI Bank collapsing. I received a promt reply from ICICI bank to the post and I wrote a counter to it. I do wish, however, that rather than send generic responses they would just come clean and say - ‘Hey, look, guys honestly this is the exact extent of Mark to Market losses we’re expecting from our exposure to credit derivatives’. The only issue here may be, they themselves may not know know the true extent of their losses.

If you are a shareholder of ICICI Bank, and if there is more bad news regarding ICICI’s MTM losses, its obviously going to be bad for the stock. However, if you hold an account with ICICI bank, I think it would be a gross overreaction to start pulling out your money from your checking account.

Disclaimer: This, or anything else on the blog is not investment advice, and should not be treated as such. Do not make trades on the basis of what you read on this blog - I’m not liable for any gains / losses. All views presented here are solely the opinion of the author’s.

Disclosure: I don’t hold any positions in ICICI Bank.

So this is what happened in the US. Banks started giving mortgages to people who had a poor credit record (sub-prime), and clearly couldn’t afford to pay back the loans. They knew this but thought that since house prices would always go up, borrowers could always refinance their loans against the additional equity due to appreciated house prices. Alternatively, banks thought that they could take over the defaulter’s home and sell it for higher than the original loan amount. Of course, what brought the house of cards down was the fact that of course house prices didn’t continue to go up: borrowers defaulted en masse so banks were stuck with a ton of houses (increase in supply of houses), and since they now stopped lending to people who couldn’t afford to pay, demand for houses fell. Falling house prices lead to more defaulting, which lead to a further fall in house prices and so on.

Why wouldn’ this happen in India? Two words: Black money. Property in India is purchased using both declared income, on which taxes have been paid (white money) and undeclared income, on which taxes haven’t been paid (black money). When a borrower takes out a mortgage in India, he’ll obviously only get the loan for the amount paid in ‘white’. However, if he defaults, the bank will take possession of the entire house, which is probably much higher in value because of the ‘black’ component. Only if there is an extremely aggressively fall in real estate prices - so much so that the black component is wiped out (which given our fairly strong domestic economy, is unlikely), do we have something to worry about. 

So black money serves as a protective cushion - who would have though it?