| INDIA AND SUBPRIME CRISIS | |

INDIA AND SUB-PRIME CRISIS

Sub-prime, as the word suggests, is something that is not prime. In the Sub-prime crisis context it simply means lending money to Sub-prime borrowers i.e. lending to people with low or poor credit worthiness. Sub-prime crisis was caused because the lending norms in the USA were very lax. It is joked about in the academic circles that any man who was not on a respirator was given a loan without any regard to his or her creditworthiness. This was brought about by the “Spend yourself out of the post dot com bust recession” policy of the American government at that time. The end result of the Sub-prime crisis is manifesting itself in myriad ways. There are direct and indirect implications not only for the United States but for the entire world. The Sub-prime that was brought upon by the American financial system upon itself is spreading its tentacles around the world. People who were not even remotely connected with the Sub-prime crisis are being adversely affected.
National Bureau of Economic Research (NBER)
National Bureau of Economic Research (NBER) is the official agency in charge of declaring that the economy is in a state of recession.
They define recession as: “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”.
BUSINESS CYCLE
The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession).
Business cycles are usually measured by considering the growth rate of real gross domestic product. Despite being termed cycles, these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern.

CAUSES OF RECESSION I. Currency crisis II. War III. Under consumption IV. Overproduction V. Financial crisis VI. Price of Fuels

EFFECTS OF RECESSION I. Bankruptcies II. Credit crunches III. Deflation (or disinflation) IV. Foreclosures V. Unemployment

MAJOR SECTORS AFFECTED BY RECESSION I. Indian Stock Market II. IT and BPO III. Banking IV. Real State V. Textile VI. Automobile

EFFECT ON INDIAN TEXTILE INDUSTRY
Indian textile industry has gone through the metamorphosis from being a 'cottage industry' to the state of supremacy. The industry is the second largest employer in India, next to agriculture. It generates employment opportunities for approximately 33.17 million workers directly, and 54.85 million workers indirectly, making a massive total of 88.02 million. Until the clutch of recession took over, it was a doorsill of growth. Indian textile industry was one of the world's best performing industries, during the past few years, but now there is a downtrend in the industry graph. Industry analysts predict that by the end of April 2009, approximately half a million direct workers from textile, garment and handicraft sectors will lose their jobs. Considering the other people who are indirectly associated with the textile industries, total direct and indirect job losses are expected to reach 6 million.
Approximately, 60% of the total garments manufactured in India are exported to foreign markets like EU, US, and Japan, generating revenue of up to US$ 52 billion. Textile export houses are one of the biggest employers in the country. Economic slowdown in the US and EU has affected the textile business in India, resulting in a drastic decline in the country's garment exports. As meltdown diminishes the garment sales in US, Indian suppliers are beginning to feel the pinch. Food is the first preference over clothing. As the customers of the Western countries, curtail their expenses to fight slowdown, export market of apparels in countries like India began shrinking. To sustain themselves in the market, apparel manufacturers chose to go in for cost cutting; thereby opting for lay-offs. An estimate states that during 2008, almost 8, 00,000 garment and textile employees had lost their jobs.
During October 2008, as economic slowdown branched out, the total output of the textile sector came down by 10%. Simultaneously, investments in textiles were also decreasing, ultimately affecting the profitability of the industry. Some biggest apparel companies in India, which are mainly located in Ludhiana in Punjab generating employment for 4,00,000 jobs has suffered a 50% loss in sales; especially the exports during 2008. This has affected 20 to 30% of jobs. Gujarat and Tamil Nadu, the two largest textile manufacturing states of India have been knocked by the sag in garment exports. This has ultimately resulted in retrenchments and layoffs. Majority of the layoffs target the daily-wagers, who comprise 25-30% of a company's workforce. Textile industries are running on 75% of their capacities, or have reduced their three shifts into one.

EFFECTS ON BANKING SECTOR
The economic development of any country to the large extend depend upon healthy and wealthy banking system. They are the driving engine for the development. They play an important role in economy like the role of blood vessels. Actually banks are like backbone for industries. They provide loans and capital to the business, industry, agriculture etc. Loss of profit and Capital of these banks bring serious threat to the economic development of that country. It effects on capital market and money market which provide long term and short term lending economy.
The present world recession has its roots in sub- prime crises. Greedy, uncontrolled and mighty banks and financial institutions provided loans to those borrowers who were not eligible for the same. The construction industry saw its highest booming. But trouble started when the second class of borrowers failed to refund their loans. The whole banking industry came in to danger. The global banks and brokerages have had to write off estimated $ 512 billion in sub-prime losses. City group suffered a loss of $55 billion and Merril Lynch about $52.2 billion.
Indian banks and financial institutions exhibited resilience in the midst of a severe global financial crisis. Now withstanding the growing financial integration and globalization, the banking system in India had no direct exposure to the subprime assets that triggered the crisis in the advanced economies. The direct exposure of banks in this regard was also insignificant. Much before the crisis started in the advanced economies, the Reserve Bank had taken a number of measures which contributed to strengthening the resilience in the Indian banking system. Some banks, however, had indirect exposure through their overseas branches and subsidiaries to the US sub-prime markets in the form of structured products, such as collateralized debt obligations and other investments. Banks have suffered losses, including some public sector banks like Punjab National Bank, Bank of India, State Bank of India and Bank of Baroda as they had an exposure to the instruments issued by Lehman and Merrill Lynch. It wasn’t just the private bank ICICI, although the latter posted the maximum losses due to their exposure.
However, if we take the overall the Banking sector in India, there is nothing to worry as heavy regulation coupled with the tendency of banks to be cautious (more than regulations stipulated) has protected the Indian banking industry. Even ICICI can easily handle the loss it has suffered. What it might impact is ICICI’s future plans to expand, but deposits are safe
Despite the fact that Indian banking system suffered a lot during recession, it however managed to control. The reasons are: * In the period of globalization also Indian banking working is not deviated from its customary working. Indian banks are risk avoiders. They take calculated risk. They are very cautious in lending loans. They give a lot of importance to the repayment capacity and state of affairs of the borrowers. So their recovery rate is high as compared to banks operating in advanced countries. * The nationalization of 20 major commercial banks in the year 1969 and 1980 has proved a boon for Indian banking. They are under close control of central government. Today major parts of the deposits are with these banks. They are prevented from greedy thrust of profit. Their earning capability and sound economic position have not affected in the present age of global recession. The principal object of nationalization is to safeguard the interest of the economy and not their own. * In this period of liberalization also, RBI has succeeded to keep the Indian banking system under control. Banks in India operate as per the guidelines and direction of RBI. They have to follow statutory obligations like Bank rate, Cash Credit Ration, liquidity Ratio etc. Right from the beginning or recession, RBI has made necessary changes to keep banking industry on right track. It has reduced bank rate, CRR and SLR to overcome the problem of liquidity crunch. * Indian Finance Ministry has taken effective steps to face the issue of global recession. It has been issuing guide lines to RBI and commercial Banks time to tackle the recession. Because of good combination between Finance Ministry and RBI efforts are being made to keep the losses of banking industry to minimum. Fiscal policies of the government have been effective in such critical times.

EFFECTS ON STOCK MARKET
The economy and the stock market are closely related. The stock markets reflect the buoyancy of the economy. In the US, a recession is yet to be declared by the Bureau of Economic Analysis, but investors are a worried lot. The Indian stock markets also crashed due to a slowdown in the US economy.
The Sensex crashed by nearly 13 per cent in just two trading sessions in January. The markets bounced back after the US Fed cut interest rates. However, stock prices are now at a low ebb in India with little cheer coming to investors. The rise and fall of the Sensex has been dizzying. The markets are back to the point it scaled three years ago. The BSE Sensex on Friday crashed by 1,071 points to close at 8,701 points. This has been an incredible year for the markets, after scaling the 21,000 peak in January 2008; the markets are at 8,000 now.
The Reserve Bank of India gave the markets its biggest blow as it left key interest rates unchanged and lowered the GDP target to 7.5-8% for 2008-09.
The worst hit stocks were DLF, Ranbaxy Laboratories, Hindalco Industries, Tata Motors, Reliance Industries and Mahindra & Mahindra.
Stock markets plunged following sustained capital outflows, shaky global markets, poor company results, and the International Monetary Fund's warning that economic growth in advanced nations will be close to zero. The BSE Sensex fell by 398.20 points, or 3.92%, to fall to 9,771.70.
January 21, 2008: The Sensex saw it’s highest ever loss of 1,408 points at the end of the session on Monday. The Sensex recovered to close at 17,605.40 after it tumbled to the day's low of 16,963.96, on high volatility as investors panicked following weak global cues amid fears of the US recession.
January 22, 2008: The Sensex saw its biggest intra-day fall on Tuesday when it hit a low of 15,332, down 2,273 points. However, it recovered losses and closed at a loss of 875 points at 16,730. The Nifty closed at 4,899 at a loss of 310 points. Trading was suspended for one hour at the Bombay Stock Exchange after the benchmark Sensex crashed to a low of 15,576.30 within minutes of opening, crossing the circuit limit of 10 per cent.
March 3, 2008: The Bombay Stock Exchange benchmark Sensex witnessed its second-largest fall ever losing 900.84 points to close at 16,677.88 on frantic selling by funds, triggered by deepening concern over United States recession and some Budget-related concerns.
March 17, 2008: The Bombay Stock Exchange benchmark Sensex crashed by 951 points to close at 14,809 on weak cues from the overseas markets. Unabated selling saw the index slip below the 15,000-mark.
10 October 2008: The markets crashed by 801 points to close at a low of 10,528. The crisis in the global markets, a fall in the rupee and poor IIP numbers led to the fall.
EFFECTS ON AUTOMOBILE INDUSTRY
Indian car industry is one of the most promising car industries across the globe. It has gradually strengthened its foothold in the international arena as well. The country is dealing with many car manufacturers, dealers, and associations in various different countries including U.S. From some countries, India imports cars and car components and to some India exports. With this, the global recession is obvious to have its impact on the Indian car industry.
Though India has witnessed a growing customer base, it has not inoculated them from the global crisis. The crippling liquidity and high interest rates have slowed down the vehicle demand. However, the fall down started in July with a decline of 1.9% and thereafter the industry saw a major slowdown in October 2008.
Business Analysts reported that Indian car market had recorded a continuous growth of about 17.2% over the last few years but this year the recession has brought the growth to about 7-8%. Be it Tata Motors or Maruti Suzuki the car market has gone down to a tremendously negative terrain.
Tata has reported that its profit fell from 34.1 percent to 3.47 billion rupees because of the slower growth in the industrial production. Further, the company has also recorded a 20% decline in the sales as compared to last year. And with its Nano making a big impact before the downturn as such, but after the downturn may hold a bleak future for the world's cheapest car, because the consumer spending has gone very low.
Maruti Suzuki reported a 7% decline in sales due to rising cost of the materials and a falling rupee value.
Mahindra & Mahindra, the India's largest SUV and tractor manufacturer, is not immunized, showing profit fall of 20.6%. The famous SUV of Mahindra & Mahindra are Scorpio , Bolero, Sedan which are showing less sales value at that time.

EFFECTS IN REAL ESTATE SECTOR a. Contribution to GDP of about 7% b. Second largest employment generator in the country c. Real estate growth gives boost to steel and cement sectors d. Real estate is a growth engine for development of over 269 allied industries e. Retail sector had created a very fast pace of demand in Indian real estate sector which have gain a very high impact image of investing in India. Till October 2008 the real estate sector was a very booming sector in India.
The impact of recession in US economy has badly hit Indian real estate market along with sectors like retail, steel, cement, hospitality and logistics. Because of lack of uniformity of land laws, slowdown and approval delays, the developers missed to complete their projects within the boom period. The banking sector had not reduced interest rates sufficiently. Banks rates were 10% to 12%.Increase in the price of cement, steel, sand, labor has affected the real estate sector. Volatile foreign investments
Indian real estate sector has been affected by the global financial turmoil for projects dependent on foreign investments. Also, additional investments in this sector have taken a hit. Foreign investments were mostly in the form of short term debts and equity exposures.
FDI inflows with long lock-in periods have escaped the downward market trend. The vulnerability of this sector is therefore due to its linkages to PE investments. Any panic selling by foreign investors takes the toll on the ‘value’ of realty funds in BSE and NSE, frontline trading exchanges of India.

Realty index was the biggest loser at 7.65 per cent, followed by IT index at 5.51 per cent. The IT and ITES sector has been the prime demand driver of the market, mainly for commercial and residential properties. The recent slowdown also has a lot to do with the slowdown in the IT sector.

Stagnation in prices

Due to the debt crises investors stayed away from risky assets which unfortunately initially includes real estate. This had led to stagnation in prices. Rising inflation coupled with high labour costs and negative investor sentiment lead to price stagnation for a while. But price of the real estate never went down and stagnation of price remains only for a short while.
For instance, Mumbai market had shown resilience but sprang back at a surprisingly quick pace. National Capital Region faced with an oversupply increasing the negative impact. Bangalore continued to find demand due the information technology sector growth. Hyderabad negatively impacted on account of the unrest due to the Telangana issue. Chennai had been a stable market with fundamentals for demand being strong. The impact is not that much as compared to international markets.
Thus there wasn’t any decrease in the prices of quality housing or in prime localities. Yes, the rate of capital appreciation had come down of late and transaction time had gone up.
FINAL OUTCOME I. The market rates in India were dropped by 10 to 30% in most of prominent as well as upcoming cities. II. Real estate slowdown affects revenue generation in country. III. Progress of ongoing project was very slow and the future project has been postponed. IV. Owner want to sell their properties in any cost as a result bargaining power of costumers increased.
OVERALL RESULT I. DLF – 79 % decline in profits & 57 % slide in sales II. Unitech 63 % decline in profits & 50 % slide in sales. III. Parsavanath, India bulls, HDIL, Akruti, Shobha, Purvankara have reported decline in profits upto 95 %. IV. Overall 76 % dip in profits & 57 % fall in sales in First Quarter of FY 09-10 over First Quarter of FY 08-09.

EFFECT ON INDIAN BPO IT INDUSTRY
The changing economic scenario and the unprecedented restructuring in the global financial services sector is raising concerns about the impact of a potential recession on the global outsourcing industry.
As corporations across the world put expansion plans and discretionary spending temporally on hold, large transformational outsourcing contracts may be postponed for at least six to nine months. Current slowdown in US will make the Indian IT and BPO companies to reduce their dependency to US and start marketing their services to other countries like ASIA PACIFIC and Latin America. At this time, it is not clear how long it will take for Indian companies to penetrate into those markets, but the current US market will force them to act quickly. Tier II IT and BPO companies in India may not withstand the US slowdown so they might consider merging with larger IT and BPO companies for their survival. This is specifically true for companies those who are doing outsource work for BFSI companies in US and UK.
As the global demand for outsourcing decreases, Indian outsource vendors will reduce hiring new employees and they may lay-off bottom performers. In the medium to long-term, 12-36 months and beyond–cost efficiencies and business transformation in companies will likely gain greater precedence than ever. The more resilient vendors can anticipate future opportunity areas and build new and differentiated offerings for companies emerging from the turmoil.
As newer ways to cut costs are explored, off-shoring of higher value adding, knowledge-based work to lower cost locations is likely. Established destinations such as India may benefit due to higher experience and maturity in these areas. As cash-starved companies focus on survival, they may look to monetize their investments in captive operations. The larger third party vendors can gain by acquiring such operations at modest valuations, and secure the parent company's business through long-term deals. A spate of M&A activity will bring its share of legalities and will provide a fillip to legal outsourcing. Some HR outsourcing deals may be in order, aiming to provide remediation to some of the staff post.
Existing contracts and outsourcing in conventional areas such as routine F&A or technical support will continue, but growth in the hard-hit sectors (especially BFSI) has been limited. In sectors, which are not seeing as much slowdown, competition for the few available outsourcing contracts will be strong. The labor-arbitrage-driven offshore model has become a standard expectation for buyers who are now looking to achieve business and strategic impact beyond cost savings. To achieve this, suppliers will need to continue to innovate and invest in technology, delivery footprint, and domain and process expertise. Additionally, suppliers will need to identify key focus segments to create successful differentiation in the market.
The current global economic slowdown has made it a roller coaster ride for the world economies. Asia / Pacific is experiencing a deferred impact due to the “domino effect” of the current crisis. With the expectations of a sluggish GDP growth and consequent reduction in IT spending, countries / markets which have a higher dependency on the export markets are expected to be affected more than other countries / markets with stronger domestic demand.

INDIA’S ESCAPE STORY
India, being a free market economy itself, wasn’t insulated from this turmoil. It was evident in the sharp depreciation of rupee against the dollar and the fall in BSE sensex. FIIs pulled out their money in huge numbers. Companies which had exposure to risks associated with Lehmann or Meryl faced losses. Thousands of jobs were lost and pay cuts and pink slips were order of the day.
Despite all this, India was able to avert a major disaster. And this was only because of those very regulations which we denounced as being anti-liberal. RBI policies helped in thwarting the crisis. For instance, the unsecured loans in India weren’t easy to get. And these loans were the possible trigger of sub-prime crisis in the US.
Dr. Y. V. Reddy ex-chairman of RBI was the person whose policies saved India from the crisis. He anticipated the problem lot before others. The steps taken by him were :
a) Lending was based on cash flows as against the assets which was done in USA. – Loan was not given to buy land it was given only for construction purpose. Loan for land was given only by foreign banks. Loan was given against cash flows.
b) Indian Culture and mindset – Spend only what you earn.
c) Curtailing use of securitization. – Bank was forced to monitor the borrowers.
d) Increasing the risk weights. – Risk weight for real estate made to 120% up from 100%
e) Increasing the rate of interest. – RBI started increasing the rates early on.

References

* http://en.wikipedia.org * http://rajyasabha.nic.in/rsnew/publication_electronic/glob_eco_crisis2009.pdf * http://advances.mse.ac.in/making/Sp%20and%20India_Anand.pdf by Anand Shankar * http://www.indiabroadband.net/news-views-business-world/14169-effect-financial-crisis-india.html * http://www.indianrealestateforum.com/chennai/t-sub-prime-crisis-possible-india-5207.html - blog post by saurav_k * http://www.bis.org/publ/bppdf/bispap54m.pdf by Anand Sinha * http://www.financialexpress.com/news/us-subprime-crisis-may-affect-india-in-many-rways-parekh/260484 * http://www.domain-b.com/economy/general/2007/20071006_analysts.htm * http://www.igidr.ac.in/money/mfc-11/Mody_Kashmira.pdf by Kashmira Mody * http://www.business-standard.com/india/news/alok-sheel-sub-prime-impactindia/335200/ by alok sheel