Monday, June 29, 2015

Global financial crisis: Isn’t it over yet?

In the famous Hindi movie ‘Darr’ there is a scene in which Shah Rukh Khan walks on the edge of a tall building with a flower in a hand and taking out a petal from it at a time and uttering in a staggered manner – “Kiran, tum meri ho (you are mine)” and “Kiran, tum meri nahin (you are not)”. Greece did the exact same thing with Euro zone but unlike in the movie scene, it ended with up with a different choice. Will it be out of Euro and does that mean a steep fall for them? Its banks are already closed for the week and all emergency funding seems to be drying up.  ‘Oh Greece, You are not alone!’ So says Puerto Rico as it is unable to service its debt. ( That means what we are seeing now would be tip of iceberg and it is difficult to size what is below the water.

While Greece is set to pay the price for its mistakes, what will happen to those who lent the money? They will have to take a haircut and write-off the loans as bad debt that causes their balance sheets to shrink too. So both Greece and the countries which lent to them will to have embrace austerity – cut in public spending. Since no economy operates in a silo, economic contraction will spread and it would affect global GDP too.

What is happening in China? Its stock markets are falling sharply. Its central bank reduced rates but it did not help to prevent the fall. If you look at last 20 days chart, you will see Shanghai Composite Index has fallen by 20%. Shanghai Composite Index Yes, it is significant. But if you see the yearly chart, you will notice that it had gone up from 2,000 levels to 5,000 in a relatively short period so a correction was due. But you should not fail to notice that interest rates set by its central bank are the lowest in the last 20 years.

All major economies US, European countries, Japan and now, China are at the mercy of their central banks for their economic revival. But going by history, it seems Central Banks can avert a crisis by choosing to spread the losses over a long term but it takes its own course of time for economic cycle to turn-up.

Japan lost a decade and now some of European countries are going that way. China is slipping into slow growth despite lower rates. Will it be India next? Probably not in immediate future, if we become disciplined with debt and monetary policy. We have the right man in RBI. But will he last? Rajan stays or not, going by global trend, economic contraction leads to inflation in India to slow down as well, triggering RBI to reduce rates again and again.

When the rates are low, savers lose. Borrowers who can use it productively stand to gain (at the expense of savers). If you can find avenues to borrow and use it productively, be ready as a lifetime opportunity is on your way in the coming year. Otherwise get into loans with floating rates now as doing so would become difficult next year. And do your math enough before jumping in as no asset class would hold water when deflation looms.