Abstract
Global Recession and Meltdown of Indian Capital Market
By: - Mayank Mittal, M. Shakir, Nihal Khurshid, Reshma Hussain and Farha Khalid1
Indian economy is integrated with the global economy and as a result it has been affected by global recession. Over the last few months we have seen that the world has gone through its worst financial crisis. The world leading investment banks have gone bankrupt.
What are the different reasons behind this global recession? Why India is affected? Why did Stock markets collapse and what are the factors behind the daily fluctuations? How can India get back its development pace again? What can be the Imperatives & Strategies for Indian Businesses to come out from these conditions?
This recessionary period has generated an environment of uncertainty in the capital market of all over the world. Although India is affected much less than expected by the global recession, almost all of the Indian business sectors are facing problem. The recession led to job lay-offs. Companies are rolling back their major projects and expansion plans. Investors are pulling their hands from Indian capital market. FDIs and FIIs are getting affected by this recession.
This paper attempts to analyze the different reasons behind the global recession. It further assesses the effects of the global recession on Indian Capital Market.
Key Words: Global Recession, Financial Crisis, Indian Capital Market, FDI, FIIs, NINJA.
1. Students: M. B. A. IInd Semester of Al-Barkaat Institute of Management Studies, Aligarh
Meltdown of Indian capital market
Introduction:-
Today we are in an era of globalization. Globalization in India has allowed companies to increase their base of operations, expand their workforce with minimal investments, and provide new services to a broad range of consumers. The process of globalization has been an integral part of the recent economic progress made by India. Over the last few months we have seen that the world has gone through its worst financial crisis. A recessionary environment is prevailing around the world and it started in US. Generally recession means a contraction phase of the business cycle. It is a condition when consumers loose confidence in growth of economy and spend less. Recession leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment. Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment. In an economy the National Bureau of Economic Research (NBER) declares that the economy is in a state of recession. NBER defines recession as a "significant decline in economic activity lasting more than a few months“, which is normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. [1]
As the fourth-largest economy in the world in PPP terms, India is a preferred destination for foreign direct investments (FDI); India has strengths in information technology and other significant areas such as auto components, chemicals, apparels, pharmaceuticals, and jewellery. Despite a surge in foreign investments, rigid FDI policies resulted in a significant hindrance. However, due to some positive economic reforms aimed at deregulating the economy and stimulating foreign investment, India has positioned itself as one of the front-runners of the rapidly growing Asia Pacific Region. India has a large pool of skilled managerial and technical expertise. The size of the middle-class population stands at 50 million and represents a growing consumer market. [2]
India's recently liberalized FDI policy (2005) allows up to a 100% FDI stake in ventures. Industrial policy reforms have substantially reduced industrial licensing requirements, removed restrictions on expansion and facilitated easy access to foreign technology and foreign direct investment FDI. The upward moving growth curve of the real-estate sector owes some credit to a booming economy and liberalized FDI regime. In March 2005, the government amended the rules to allow 100 per cent FDI in the construction business. This automatic route has been permitted in townships, housing, built-up infrastructure and construction development projects including housing, commercial premises, hotels, resorts, hospitals, educational institutions, recreational facilities, and city- and regional-level infrastructure. [2]
A number of changes were approved on the FDI policy to remove the caps in most sectors. Fields which require relaxation in FDI restrictions include civil aviation, construction development, industrial parks, petroleum and natural gas, commodity exchanges, credit-information services and mining. But this still leaves an unfinished agenda of permitting greater foreign investment in politically sensitive areas such as insurance and retailing. FDI inflows into India reached a record US$19.5bn in fiscal year 2006/07 (April-March), according to the government's Secretariat for Industrial Assistance. This was more than double the total of US$7.8bn in the previous fiscal year. The FDI inflow for 2007-08 has been reported as $24bn and for 2008-09, it is expected to be above $35 billion. A critical factor in determining India's continued economic growth and realizing the potential to be an economic superpower is going to depend on how the government can create incentives for FDI flow across a large number of sectors in India. [2]
Since the meltdown began in September 2008, the US economy has seen the loss, on average of around 17,000 jobs a day. Move the base line to November 1, 2008 and job loses averaged more than 19,000 a day and the trend is getting worse. Close to 20.6 million jobs have been lost since just September 2008. Over 1.7 million of those have vanished over the last three months. January 2009, saw the loss on average of more than 800 jobs every hour. But many find it amusing that it took officials 11 months to declare “Recession” in the United States. During this period more than 22,000 employees have been thrown out by the California Administration and pay cheques of 55,000 employees affected in Kansas in the United States.
Recession in the US may be considered as the epicenter of global recession. The United Arab Emirates sovereign wealth fund – once said to be $ 1 trillion has taken a hit in the global recession, while the lifeblood of the economy, the price of oil is down by more than 60%.[3] The public sector is facing the heat of global meltdown, causing the number of unemployed to rise to 7.9% in France. Chinese exports have got hit as US consumers are checking spending causing millions of jobs being lost.
The new industrial policy of 1991 brainchild by Dr. Manmohan Singh worked as the life belt to Indian economy. MNCs from all over the world started to pour capital through the way of FDI into the Indian economy.
As of now, India is facing heat mainly on three grounds
1. Share market is falling everyday
2. Rupee is weakening against Dollar
3. Banks are facing severe cash crunch resulting in shortage of liquidity in the market.
This paper is our humble attempt to bring out the various reasons behind the global recession and for the sudden rise and collapse of the Indian stock market. Best efforts have been made to our research as updated and extensive as possible within the given time constraints. However it might be possible that some vital information might have been skipped erroneously. We highly regret for this.
Objectives of the paper:-
The objectives of this research paper are:
To analyze the different reasons behind the global recession.
To assesses the effects of the global recession on Indian Capital Market.
Reasons behind the global recession:
Basically the current financial crisis or the global recession’s epicenter is situated in United States. For the past many years the housing sector was booming in USA due to a combination of
Low interest rate
Large inflow of foreign funds.
It was quite easy for people to take home loans. As more & more people took home loans, demands for property increased and fueled the home prices further.
Since this sector was bringing in huge profits thus loan agents were asked to find more potential home buyers. Their only aim was to give loans to as many potential customers as possible. As a result the common sense practice checking customer’s repaying capacity was also ignored. Thus many people who come under the NINJA (No Income, No Job, No Assets) category were giving housing loans in disregards to all principles of financial prudence. These loans were called sub prime loans as they were not a part of prime loans market.
Besides this since it was a boom period for housing sectors, many home owners used the increased property value to refinance their homes and took out second mortgage against the added value (of home) to use the funds for consumers spending. Adding to the complexity of this problem was the negligence that people showed regarding the interest rate. Though they knew that initial interest rate were low, they would increase after an initial period. [4]
The plight of American loan market & its impact on rest of the world:
As soon as the USA came to terms that the housing bubble had fizzled out, it realized that home prices had started declining by summer 2006. An overbuilding of houses of during this period had led to surplus inventory of homes.
Once housing prices started depreciating in US, refinancing became more difficult. Home owners found themselves unable to refinance and began to default on loans as their loans reset to high interest rate.
Eventually over 8.8 million home owners in US, had zero or negative equity as of march 2008, meaning their homes are worth less then their mortgages, as a result they began to walk away from the homes rather then paying their mortgages.
Foreclosures (Legal proceeding initiated by a creditor to repossess the property for loan that is in default) increased along with unwillingness of many home owners to sell their homes at reduced market price. This caused an excess supply of home inventory to arise. Whereby nearly 2.9 million homes remain vacant and this led to a further reduction in home prices. [4]
Complications of American housing woes:
Unfortunately this problem was not as small as it appeared. These sub prime loans which were offered to unreliable borrowers had about 2% higher interest rate then the interest on prime loans.
Secondly, since these sub prime loans appeared very lucrative and thee stock market was booming with liquidity, many big fund investors like hedge funds, mutual funds saw sub prime loans portfolios as an attractive investment opportunities. Thus they bought these portfolios from original money lenders. The sub prime loan market thus became a fast growing segment.
Thirdly, major investment banks bought these loans (known as mortgage backed securities, MBS) to diversify their portfolios. Most of these loans were bought as part of CDOs (Collateralized Debt Obligations). CDOs are just like mutual funds with two significant differences
o Unlike mutual funds, in CDOs all investors do not assumes the risk equally and each participatory group has different risk profiles.
o Secondly, CDOs buy securities that are backed by loans.
Owing to heavy buying of MBS and sub prime loans by major American and European Banks, thee problem which was to remain in US propagated to world’s financial market
As the home prices decline in us, sub prime borrowers found themselves in a messy situation. The house prices were declining and loan interest on these houses was soaring. As they could not afford to take a second mortgage to their home, it became difficult for them to pay thee higher interest rate. Eventually there remained no option except to write off losses on these loans.
The problem multiplied many folds owing to falling prices of CDOs. These dented banks investment portfolios and these losses destroyed banks capital. [4]
The debacles of major banks:
The global banks have written off an estimated $ 512 billion in sub prime losses so far, with the largest in Citigroup ($ 55.1 billion) and Merrilll Lynch ($ 52.2 billion). Despite efforts by US Federal Reserve to offer financial assistance, it has led to collapse of bears terns, one of the largest investment bank in the world.
The crisis has also seen Lehman Brothers – forth largest investment bank in the US which has survived for the past 158 years – file for bankruptcy.
From this point, a chain reaction of panic started. Since bank are like backbone for other major industries and provide them with investment capital and major loans, a loss of net capital to banks acts as a deterrent to various industries and business. What is worse is actually the fact that losses suffered by banks in the sub prime mess have directly affected their money market world over. [4]
Impact on money market:
Money market is actually an inter bank market where banks borrow and lend money among themselves to meet short term need for funds. Causes of its failure are as follow:-
The interbank market performs the critical role of bringing cash surplus and cash deficit. Bank together lubricates the process of credit delivery to companies (for working capital and capacity creation) and consumers for buying cards etc.
As housing loans crisis intensified, banks grew increasingly suspicious about each other is solvency and ability to honour commitments.
As a result panic began encircling all sectors and it sucked other market into its centrifuge.
Liquidity crunch resulted in a tight situation for top companies to take loans for their needs.
A sense of disbelief and extreme precaution is prevailing in banking sector where they are trying to move away from assets which are considered win remotely risky.
None of the efforts have so far stabilized global market but it is hoped that with proper monitoring and controlling of money market situation will eventually get in control. [4]
Global recession and India:
Under this era of globalization no country can remain isolated from the troughs & crests of world economy, it revolutionized the economic system all over the world, therefore recession in west is the bad news for our country. Globalization emphasized on market forces, private sector, increased mergers and acquisitions. Since firms & industries interlinked with other countries as companies in India have more outsourcing from US and our export to US have increased over the years, export have declined due to recession as a result of this downfall in employment market is seen. US account for only 16% of India’s total exports thus impact on domestic demand is minimal. Some companies have laid-off their employees and there have been cuts in promotions and compensations of the employees. Companies are hesitant to take up new projects; industries are confronting heavy loss due to the fall down of global economy inventories industries like garment, gems, and textile had cut down production by 10 percent to 50 percent. [5]
Although United States is a big consumer of goods produced by developing countries yet consumption pattern in US economy is going down. Due to recession the demand for the goods produced by these countries decreased in domestic industries which have a basis of export trade also lost their roots in foreign market, impact of which have to be faced by the common man or employee in the form of cut down in salaries or lay-offs in their jobs. But crisis is not seen on the balance sheet of Indian companies. At the same time MNC’s and BPO sector are on the job cut sphere.
During last two years our stock market was touching new heights of Sensex due to heavy investment of foreign investors but when the financial crisis occurred, the parent companies of these investors found themselves in capital crisis. They had to withdraw their money back from Indian capital market. As foreign investors laid out their money from stock market by selling their stock in India, the domestic investors on the foot step of foreign investors also laid out their money from Indian capital market with the feeling of insecurity regarding investment to which demand becomes less than the supply of shares in the market. That’s why Sensex touched lows and lows.
FII hold well over equity in form American depository receipts and global depository receipt. FDI plays a significant role in the process of economic development and reflects the objective of a resident entity in one economy obtaining a lasting interest which implies the long term relationship between a direct investor and the enterprise. FDI flows are in equity capital mainly. In the last fiscal year alone, India borrowed $29 billion from foreign lenders and got $34 billion of foreign direct investment. A global recession has hurt external demand. A international lenders who have become extremely risk aversive can limit access to international capital. The investors of FDI, due to credit crunch in US, laid out their money back form capital market. Share price suffered a down fall. Even domestic investors were not ready to buy the shares in the possibility of loss more than the profit from share market. [5]
At the time of recession when FIIs and FDI were busy in selling their stocks, they need to convert the amount in Dollar ($) so to sent back to US. With this demand of dollar increased as much as it supplied to US, more and more were bought by FIIs and FDIs. Rupee displaced its position by loosing its strength in the market as the demand of dollar was more as well as dollar in our country got reduced day by day with this the cost of dollar increased in the same way rupee lost its position. Now we can list out the effect of global financial crisis in India as follows:
Share Market
More people have sold the shares in the Indian share market than they bought in the recent weeks. This has added to the fall of Sensex to lower points.
Foreign investors have pulled out from stock markets leading to heavy losses in stocks and mutual funds
Stock broking houses are laying-off people
Because of such uncertainty many people have started saving money in banks rather than investing [1]
IT and Real Estate Sector
The key challenges faced by the industry now are inflation and the psychological impact of the US crisis, leading the companies to hit the panic button.
Bonuses, perks, lavish parties, and many other benefits are missing as companies look to cut cost.
India's IT export growth is also showering down
One of the casualties this time are real estate, where building projects are half-done all over the country and in this tight liquidity situation developers find it difficult to raise finances.
Layoffs and Unemployment
Hundreds of workers have lost jobs in diamond jewellery, textiles and leather industry.
Companies in IT industry have stopped hiring and projected lower manpower need.
Firms attached to the capital market are laying-off people and large companies are putting their future expansion plans on hold.
Industrial sector
Government and other private companies are reluctant in starting new ventures and starting new projects.
Projects that are halfway to completion, or companies that are stuck with cash flow issues on businesses that are yet to reach break even, will run out of cash.
Car, bike & truck sales down
Steel plants are cutting production
Hospitality and airlines are hit by poor demand
Reasons behind the daily fluctuation behind the daily fluctuation of share market:
We see the indices of stock market fluctuate all the time. There are different reasons behind the daily fluctuation of indices of stock market. The most dominant reasons are as follows-
Demand and supply
In stock market investing, the stock price falls if sellers overrule the buyers. Conversely, if there are more investors who want to buy the stock than the number of shareholders who are willing to sell their holdings, the price will go up, and up, and up…. As a result, stock prices fluctuate daily. [6]
Market psychological effect
Demand and supply for the available shares to be traded is due to market sentiment effect. Every time investors feel that the stock will not able to meet their expectation, they sell their equities and leave the company.
On the other hand, if they are optimistic of its future growth, they will buy more shares of that stock to get better return on investment. [6]
Individual investor needs
This is the most difficult one to identify but is the most reason why stock prices fluctuate daily. Look, every now and then, investors who buy the stock can have variety of reasons, and that reasons won’t be the same from one investor to another.
They buy and sell stocks according to their strategy and needs on daily basis. The fact is there are traders who make living out of stock trading. Therefore, the price will fluctuate based on their trading activities. [6]
Strategies in recessionary period:
The monetarists argue that income growth can be fully regulated by controlling the money supply. As such a contractionary money policy by decelerating the income growth may let loose the forces of demand recession. A sudden increase in the bank rate it the statutory liquidity ratio or the reserve ratio, or the open market operations like the sale of government securities by the central bank, all such measures can put a brake on the generation of money supply in the economy and thereby the national purchasing power may get reduced. That is how demand recession results when the credit squeeze measure are adopted by the central bank.
Also, if the people are subject to high income tax rate then their disposable income is likely to fall in this may reduce the demand for consumption goods. In the same way if there is a sudden cut in the public investment program or a sudden shift of expenditure from development towards defense, some sort of dislocation of demand takes place in the process of which some sectors in the economy may face recession. It follows that the anti inflationary policies, either monetary or fiscal, if overplayed, can be a potential source of recessionary pressure generated in the economy.
With new uncertainties raised by the attacks and many economists forecasting a deep and prolonged recession, businesses will have to do everything within their power to brace for the coming storm and survive the bad times-predicted by some to be bigger and more devastating than the Great Depression of 1929. Use these surefire strategies to immediately recession, but you'll come out on top of your competitors when the economic tide reverses.
Diversify
In a weak economy, diversification may be a businessman’s best friend. The more services one can offer, the more clients one will be able to find. For example, if one primarily creates business plans or marketing collateral for big name clients, one can expand one’s services to include press releases, sales letters, web content, or other business-related products and services. And one can diversify even further by repackaging one’s product and selling it to a different clientele. For example, one can host a seminar or workshop on writing business plans. Each person who attends may not be able to pay one’s normal fee, but combined not only will a businessman earn more, one can also score a few new clients. No matter what service one offers, with a little innovative thinking one can develop several "new" offers. All of which will help keep him/her ahead. Of the competition while the competitors shall bite the dust. [7]
Offer outstanding customer service
It has become conventional to talk only demand recession. But demand recession itself may be a reflection of over production resulting in excess supply. Such situations result from inaccurate forecasting, lack of sufficient planning inadequate control and inappropriate management of production. The point remains that recession may result from mismanagement of not only demand but also supply. Once a business starts attracting customers, one has to worry about retaining them, and in a stagnating economy that may be even more difficult. One must provide not only a high quality product, but also exceptional customer service. When money's tight, clients expect more for their dollar. If one wants to keep business alive, one must keep them happy. Refining one’s customer service strategy to insure that every step from taking the order to delivering the product is client-focused and effective. One may want to conduct a customer satisfaction survey or two in order to make sure his/her customers' needs are being met. Also one should consider making one’s service more valuable to clients with faster delivery times, wider selections, or more flexible payment terms. [7]
Intensify marketing
One of the biggest mistakes business owners make during periods of economic slowdown is to cut back on marketing and advertising, doing this could be most detrimental to one’s business. Instead, marketing needs to be more aggressive and more comprehensive than ever. This can be done by contacting past clients and simply touching base. Chances are a good number of them will have projects or assignments for which services may be required
Offering discounts, freebies, or other extras act as incentives. One may also wants to set up a referral reward program for clients as part of one’s marketing efforts. One may also need to re-evaluate One’s current marketing methods. If one is not seeing some increase in sales from every dollar one spends on promotions, then one is wasting valuable revenue. Whether one uses billboard ads, direct mailings, or the yellow pages now is the time to make sure one’s current marketing is cost-effective and efficient.
Positioning oneself as a Market Leader requires stepping outside of one’s comfort zone and daring to lead than to follow. Setting oneself apart from the competition by developing one’s own USP-unique selling position sometimes also referred to as ESA (Essential Selling Advantage) is also required. What is a companies’ USP? It doesn't really matter 'what' one’s USP is as much as it matters that one may have one. Prospective customers MUST have a good reason to do business with a company rather than competition. It can be a superior customer service, lifetime refund policy, best prices or the outstanding quality of companies’ products. One may absolutely have no reason to worry about the economic slowdown or competition once companies’ customers 'experience' its USP. In fact, a company can use its USP to ruthlessly eliminate its competitors. [7]
Adopt cutting edge technologies
One of the best ways to stay ahead of the competitors is by keeping up with current technology. So if a company isn't familiar with customer relation management, software or even e-mail marketing now is the time to do so. One can put one’s business online, advertise with well-placed banner ads, send out information to potential clients via e-mail, outsource some of his/her administrative duties, manage his/her payroll, or establish an affiliate program all on the Internet. Current technology can help a company run more efficiently and more cost effectively, plus it can open access to clients in the next city, in another state, or even enable one to compete in the global marketplace. One will have the potential to contact millions of people who would otherwise have never heard of that companies’ product and in a slow economy it will need all the exposure it can get. [7]
Stay focused
Nothing will damage a business more than business myopia or short sightedness. In order to stay successful, one must always keep an eye on one’s long term goals and objectives. One will hit rough spots but should not get bogged down in the present. One should not make this mistake. Instead one should keep one’s eyes on one’s target. One should stay focused. Every decision, every cutback, every improvement one makes now must be beneficial not only in the present but more importantly in the future. Thinking about this before one slashes prices, fires employees, cuts overhead, or lowers one’s standards.
Conclusion:
As we know that whole world is suffering from recession, India is also affected by global recession. The economic growth, stock market, real GDP, employment and demand of goods and services are decreasing due to global financial crisis.
Our suggestions for having stability and growth in stock market are:
1. An awareness of stock market among the retail investors must be there. Generally retail investors trade their stock on the recommendation of broker.
2. Brokers should be well trained. They should have adequate knowledge about the share market because they influence retail investors and their trading.
3. Government should ensure that all the listed companies are showing “true and fair” financial statement because these things affect the share market. Recently “Satyam scandal” is a witness of effects of these kinds of things on the share market.
4. Retail investors should not adopt share trading as their prime business. They should adopt it as a side business.
5. Investors should believe in long term investment. If they will do short term investing and trade their stocks very frequently for short term profit then it will affect the share market’s indices and resulted in instable market price.
6. Big player should be more ethical and try not to influence the share market in negative manner.
7. The growth rate of stock market, we have seen in last two years was unhealthy. Investors should not expect so much growth in capital market. They should have positive attitude towards Indian capital market. This will help a lot to keep market stable and growing.
8. Stock market also depends upon the business performed by companies. If companies will perform well then stock market will also improve and become more stable.
Our suggestions for recuperating from this recession are-
9. Tax cuts up to the possible extent are the first step to be taken by the government.
10. The government should also hike its spending to create more jobs and boost the manufacturing and services sectors and to prop up the economy.
11. The government is coming up with some boosting packages. It should come up with some more packages to help the private sector to come out from the crisis.
12. The regulatory bank in India, i.e. RBI (Reserve Bank of India), also needs to relax the rate of interest up to a possible extent in both public as well as private sector.
13. Provision of comfortable liquidity to meet the required credit growth consistent with the overall projection of economic growth.
14. Respond swiftly and effectively with all possible measures as warranted by the evolving global and domestic situation impinging on growth and financial stability.
15. Ensure a monetary and interest rate environment consistent with price stability, well-anchored inflation expectations and orderly conditions in financial markets.
References:
1. http://www.prochow.blogspot.com/
2. http://en.wikipedia.org/wiki/Economy_of_India
3. The Hindu – feb 16, 2009
4. http://www.theindianblogger.com/problems/reasons-for-global-recession-in-plain-simple-english/
5. http://www.economicrecession.in/effect-of-global-recession.htm
6. http://www.stock-investment-made-easy.com/stock-prices-fluctuate-daily.html
7. M. Adhikary - Economic environment of business – pg. 165-201
8. http://www.nrimutualfunds.com/sensex_movement_frame.htm
9. http://www.fairloanrate.com/2008/12/02/the-reasons-behind-global-economic-crisis/
10. Francia Cherunilam - Business environment text & cases – pg. 389-394
