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INDIA BUSINESS WORLD - October 1st October 15th 2008
FED, ECB & OTHER MAJOR CENTRAL BANKS CUT RATES, INDIAN MARKETS FEEL GLOBAL CREDIT FREEZE; WOBBLY SENSEX HITS 26-MONTH LOW, BUT RECOVERS
The world’s top central banks have put their cards on the table. In a dramatic joint action, the US Federal Reserve, Bank of England, European Central Bank and monetary authorities of Sweden, Switzerland, Canada and United Arab Emirates have all cut interest rates by 0.5 percentage point to revive the comatose loan market. The Chinese central bank also announced a 0.27 percentage point cut in rates and a 0.5 percentage point cut in reserve requirements for commercial banks.
It was the strongest signal they could have sent to turbulent financial markets, which, after the subprime fiasco, is now haunted by the spectre of global recession. But the impact was limited.
Overnight lending rates softened, but the cost of borrowing long term was still expensive. The US market was choppy in early trades and European shares were in the red. It was evident that cheaper money cannot be an instant solution in a nervous market rattled by defaults, collapse and mistrust.
Back home, the carnage in Asian markets—with Japan dropping 9%—had bulls scurrying for cover. It did look at one stage that the Sensex and Nifty would breach the first level of the intra-day circuit filter, causing trading to be temporarily halted. Late buying by domestic institutions and some short covering of positions by traders, however helped reduce losses significantly.
As FIIs net sold over Rs 1,000 crore, the 30-share Sensex slumped to a 26-month low of 10,740.76, before climbing to 11,328.36 at close, a loss of 366.88 points, or 3.1%, over the previous close. The 50-share Nifty touched a 25-month low of 3329.45, before closing at 3513.65, down 92.95 points, or 2.6%, over the previous close. Elsewhere, Russia, Indonesia, Ukraine and Romania halted trading at stock exchanges as share prices continued their free fall.
Meanwhile, the freeze in global credit markets is slowly working its way into the Indian financial system as well. Many small and medium enterprises are said to be struggling to fund their working capital needs due to the tight liquidity in the system. Many retail brokerages are on a cost-cutting spree by downsizing their staff and branches.
Global markets were unprepared for the sudden rescue operation announced by the UK government, which will invest $87 billion to avert a collapse of its banking system. As part of the plan, the government will buy preference shares and provide a guarantee to help refinance debt. The Bank of England will make funds available for banks to borrow under the so-called special liquidity plan.
Complex inter-linkages between asset classes are undermining central banks and regulators’ efforts to restore normalcy. The co-ordinated rate cut caused the dollar to weaken against the euro, with the US greenback losing its appeal as a safe haven. The Japanese yen soared to a six-month high against the dollar, as investors cut back on carry trades due to the slide in global stock markets. In a carry trade, investors borrow in yen and deploy the proceeds in securities promising better returns, like emerging market equities for one. Strengthening of the yen is expected to further choke money flow into emerging markets like India, which have benefited from carry trades over the last few years.
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