January 2009 YEAR END REVIEW
FINANCIAL MARKETS UNDER STRESS An Update
“At the end of the year, we saw some light at the end of the tunnel. Unfortunately, we found out that the light at the end of the tunnel was a train.”
— Art Hogan, Chief Market Strategist, Jefferies & Company
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Contents Page 1.
Stress in Financial Institutions
Support and Stimulus
Slowdown in Stock Markets
Outlook and Prospects in 2009
Annexure Recommendations of the Group of Thirty Timeline of Major Events
“The best way to get out of trouble is not to get into it in the first place.” — Ben Bernanke, Chairman, Federal Reserve, US
FINANCIAL MARKETS UNDER STRESS An Update
No News Is Good News It appears that no news is good, at least when it comes to enthuse markets. On the muchawaited Inauguration Day of the new president of the United States on January 20, 2009, the Dow Jones fell by 4%, S & P by 5.28%, and Nasdaq Composite by 5.78%. The fear of recession further spread on the eve of the Inauguration with Citi dropping by 20%, Bank of America by 29%, and State Street by 59%. Financial stocks in the US lost more than 15%, making it one of the biggest drops in two decades. Art Hogan, Chief Market Strategist at Jefferies & Company, described the present predicament more aptly, “At the end of the year, we saw some light at the end of the tunnel. Unfortunately, we found out that the light at the end of the tunnel was a train.” The Year of Fear The year 2008 proved to be an exceptionally challenging year for the global economy and finance. From the peak of growth and activity witnessed in 2007, the year 2008 experienced a series of setbacks and slowdown, which many analysts described as a major meltdown that could happen once in a century. This short note provides an update on the financial situation and presents some important aspects of the developments in global finance in 2008 with possible implications in 2009.
THE SLOWDOWN A large part of the global economy is in the midst of a recession in 2009 following the steep fall in the growth of real Gross Domestic Product in many major economies. According to the estimates by JP Morgan, the growth of global real GDP showed a rapid fall from 3.5% in 2007 to 1.8% in 2008, which is expected to reach negative growth territory in 2009 with a contraction of 0.9%. The slowdown is mostly borne by the developed markets in which the growth of real GDP fell from 2.4% in 2007 to 0.8% in 2008 to register a negative growth of 1.9% in 2009. The growth in the emerging markets has subdued the severity of the decline in the global economy to some extent, though the emerging markets too are experiencing the pain of slowdown, causing concerns on their stability.
1. THE SLOWDOWN Global real GDP, which was in the positive range in the third quarter of 2008, suffered a steep fall in the fourth quarter by showing a decline of 4.1%. It is expected that global real GDP may remain in the negative range in the first quarter of 2009 and thereafter move upwards. However, developed markets are likely to experience an economic contraction in the first half of 2009, with recovery appearing from the third quarter onwards. The emerging markets have been projected to experience a contraction of about 1% in the fourth quarter of 2008 and then move into positive territory, with growth gradually picking up in the first quarter of 2009 and then gaining ground in a gradual manner. Industrial production in a large number of countries showed rapid decline. The world economy continues to experience pressure of no growth, which is evident from the slowdown in global manufacturing. A recent survey published in the Wall Street Journal highlights the following details on the slowdown in the global manufacturing sector: t
Fig 1 GDP Growth (Percent change) 9 Emerging and developing economies
New orders, a gauge of future industrial activity, sank to the lowest index level since the US records began 60 years ago. Exports and production also sank, and employment levels declined.
Source: IMF staff estimates
JP Morgan’s global manufacturing index, released in the first week of January 2009, compiled from surveys in 19 countries, reached a new low in December 2008; consistent with a severe 17% annualized contraction in global activity.
The downturn in demand for manufactured goods is prompting the US companies of all sizes to lay off workers, shut down plants, and reduce production of machinery, steel, plastics, and other basic components.
Manufacturing activity contracted in Germany, France, Italy, and Spain, pushing the Markit Economics Survey of euro-zone manufacturing in December 2008 to the lowest level in its 11-year history.
In Russia, the VTB Bank Europe manufacturing index fell to its lowest level since it began in September 1997.
The US shed some 1.9 million jobs in 2008, till November, and the unemployment rate, which was 6.7% when the November 2008 figures were released, is expected to rise.
Unemployment across the euro zone hit 7.7% in October 2008, its highest level in nearly two years. The rate is expected to rise further in 2009. Fig 2 Cumulative Output Loss Relative to In China, manufacturing activity fell for the fifth Potential during Global Downturns month as the global financial crisis reduced demand (Percent) for exports. Factories in China’s manufacturing sector, 2 2 which accounts for 43% of the economy, contracted 0 0 for the fifth straight month in December 2008.
South Korea warned that exports growth in 2009 may be 1%, the weakest since 2001. Exports in December 2008 dropped 17.4% from a year earlier, more than what economists had expected. Brazil’s manufacturing index dropped sharply to a new low.
World -‐6 Advanced economies Emerging and developing economies -‐8 2008–10 1990–93 2001–03
Source: IMF staff estimates
Table 1: Overview of the World Economic Outlook Projections (% change, unless otherwise noted) Year Over Year Projections 2007
Other advanced economies
Newly Industrialized Asian economies
Emerging and developing economies2
Central and Eastern Europe
Commonwealth of Independent States
World growth based on market exchange rates
World trade volume (goods & services)
Imports Advanced economies
Emerging and developing economies
Emerging and developing economies
Emerging and developing economies2
Commodity prices (US dollars) Oil
Non-‐fuel (average based on world commdity export weights) Consumer prices
London interbank offered rate (%)4 On US dollar deposits
On euro deposits
On Japanese yen deposits
Source: IMF Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during December 08, 2008-‐January 05, 2009. Country weights used to construct aggregate growth rates for groups of countries were revised. 1. The quarterly estimates and projections account for 90 % of the world purchasing-‐power-‐parity weights. 2. The quarterly estimates and projections account for approximately 76 % of the emerging and developing economies. 3. Simple average of prices of UK Brent, Dubai, and West Texas Intermediate crude oil. The average price of oil in US dollars a barrel was $97.03 in 2008;the assumed price based on future markets is $50.00 in 2009 and $60.00 in 2010. 4.
Six-‐month rate for the United States and Japan. Three-‐month rate for the euro area.
The size and significance of the recession this time is expected to be quite severe as compared to the recent episodes of economic contraction. The current global economic recession has similar intensity to that of the early 1980s and with the way the contraction is taking place, it is feared that it may even surpass it.
Major Recessions 13months and
*Dec 2007 -‐ present March 2001-‐ Nov '01
July 1990 -‐ March '91
July 1981 -‐ Nov '82 6
Jan 1980 -‐ July '80
Nov 1973 -‐ Mar '75 11
Dec 1969 -‐ Nov '70
April 1960 -‐ Feb '61 8
Aug 1957 -‐ Apr '58
July 1953 -‐ May '54
Nov 1948 -‐ Oct '49 8
Feb 1945 -‐ Oct '45
May 1937 -‐ June '38
Aug 1929 -‐ Mar '33 * The US officially reported to have entered into recession in December 2007 Source: The Wall Street Journal
Fig 5 Gross Domestic Product -‐ Q3 2008 % change on year ago
Industrial Production -‐ Q3 2008 % change on year ago -‐1.6
1.5 3.7 France Germany 7.5
Japan United Kingdom United States 0.0
Source: The Economist, London
International Monetary Fund, in its recent update of World Economic Outlook (January 28, 2009) observed that the output in advanced economies is now expected to contract by 2% in 2009, which makes it the first such annual contraction during the post war period. However output growth is likely to recover from the later part of the year and could show a rise of 1% in 2010. Growth in emerging markets too has suffered steep erosion in the recent months and is likely to fall to 3.25% in 2009 from 6.25% in 2008. Falling export demand, lower commodity prices and tighter external financing constraints could accentuate the problems faced by the emerging markets. The economic pressures have dampened the external investments from the Middle East. In 2008, the value of the external portfolios of the Gulf Cooperation Council states fell to $1.2 trillion from $1.3 trillion in the previous year, with the largest losses reported to have been incurred by entities from the United Arab Emirates, Kuwait, and Qatar.
Table 2 India - Total GDP at factor cost constant (1999-00) prices 2000-01 4.4 2001-02 5.8 2002-03 3.8 2003-04 8.5 2004-05 7.5 2005-06 9.5 2006-07* 9.7 2007-08** 9.0
India’s Economic Growth at 9 % in FY08 The quick estimates of the Central Statistical Organisation (CSO), Ministry of Statistics and Programme Implementation, released on January 30, 2009, showed that Gross Domestic Product (GDP) at factor cost at constant (1999-2000) prices in 2007-08 is estimated at Rs 31,29,717 crore as against Rs 28,71,118 crore in 2006-07, registering a growth of 9.0% during the year as against the growth rate of 9.7% during the previous year. At current prices, GDP in 2007-08 is estimated at Rs 43,20,892 crore as against Rs 37,79,385 crore in 2006-07, showing an increase of 14.3% during the year. At constant (1999-00) prices, the national income (i.e., net national product at factor cost) in 2007-08 is estimated at Rs 27,64,795 crore *provisional estimates ** quick estimates as against Rs 25,33,450 crore in 2006-07 showing a rise of 9.1% during the year. Source : CSO At current prices, the national income in 2007-08 is estimated at Rs 37,87,596 crore as compared to Rs 33,12,569 crore in 2006-07, showing a rise of 14.3% during the year.The growth rate of 9.0% in the GDP during 2007-08 has been achieved due to high growth in agriculture, forestry and fishing (4.9%), manufacturing (8.2%), electricity, gas & water supply (5.3%), construction (10.1 %), trade, hotels & restaurants (10.1%), transport, storage and communication (15.5%), financing, insurance, real estate & business services (11.7%), and community, social and personal services (6.8%).
2. STRESS IN FINANCIAL INSTITUTIONS Financial institutions in mature economies suffered severe downturn with number of failures growing sizably in 2008. Credit conditions tightened across the world, despite a wide range of measures of central bank support and fiscal stimulus announced in a large number of countries. A spate of stressful events and institutional failures dominated the financial sector in 2008. These included the sale of Bear Sterns to JP Morgan Chase, collapse of Lehman Brothers, merger of Merrill Lynch with Bank of America, run on Northern Rock in the UK, conversion of Morgan Stanley and Goldman Sachs into commercial banks, subjecting themselves to greater regulation from the Federal Reserve, etc. Some emerging markets too witnessed pressure on banks. Fig 6
Number of Failed Banks in USA since October 2000 25
Banking fallout -‐ Assets in liquidation accumulated by FDIC
2000 2001 2002 2003 2004 2005 2006 2007 2008
Writedowns of Financial Institutions
Erosion in Market Capitalisation
$8540bn $7320bn *Dec 2007 -‐ present
July 1990 -‐ March '91
July 1981 -‐ Nov '82
Jan 1980 -‐ July '80
Nov 1973 -‐ Mar '75
Aug 2007 Source: Financial Times
March 2001-‐ Nov '01
Aug 2007Dec 1969 Mar -‐ Nov 2008 '70
Sept 2008 11 10
April 1960 -‐ Feb '61 Aug 1957 -‐ Apr '58 July 1953 -‐ May '54
Corporate performance in most of the markets were under intense pressure. S & P estimates that 60-75 European companies from its speculative grade category could default on a total €20 billion - 25 billion of debt in each of 2009 and 2010, taking the overall default rate up as high as 11% as against 3.2% for the past 15 years. Fitch Ratings downgraded the credit ratings of 88 emerging market companies in the fourth quarter of 2008, the most in at least seven years. According to an estimate of JP Morgan Chase, companies in the emerging markets need more than $200 billion to refinance external debt with largest borrowing needs coming from Russia, Turkey, Mexico, South Korea and the UAE. The current pressures have slowed down the pace and intensity of the mergers and acquisitions in developed markets. US companies spent $188.6 billion on acquisitions of non–US companies, down 26% from 2007, whereas those in the UK spent $101 billion, down 67%. It is only Japan that showed a surge in regard to global acquisitions. Japanese companies spent $78 billion on acquisitions outside Japan more than triple the amount spent in 2007 and exceeding the previous annual record of $52 billion set in 2006. Bankruptcy filings by US businesses rose 67% (September 2008) from a year earlier. Bankruptcy filings among publicly traded companies in the US surged 74% in 2008. According to the data released by BankruptcyData.com, 136 publicly traded companies filed for bankruptcy in 2008, as compared to 78 in 2007. Though in 2001 the total number of filings were a record 263.The 136 companies seeking bankruptcy protection in 2008 had about $1.16 trillion in assets, compared with $70.5 billion of assets in 2007. Overall, 12 publicly traded financial firms with $1.09 trillion in assets have filed for bankruptcy in the US. Among the largest financial firms filing for bankruptcy include Lehman Brothers Holdings Inc., Washington Mutual Inc. and IndyMac Bancorp Inc. Box 1
Chapters 11 and 15 These are the two chapters that are in great use and visibility in the US in the recent period in the light of the financial crisis. A primer on these two: Chapter 11 refers to a section of the US Bankruptcy Code. It is a voluntary step taken by financially troubled companies to reduce or eliminate their debt under the supervision of a US court. Unlike a Chapter 7 filing, where the company goes under liquidation, in Chapter 11, companies continue to operate and their stocks and bonds continue to trade. However, bondholders and stockholders of the company stop receiving interest-principal and dividend payments respectively, and debt payments are suspended to give companies time to develop a reorganization plan. Bankruptcies can take anywhere from three months to more than a year to complete. Chapter 15, another part of the US bankruptcy code, provides effective mechanisms for dealing with cross-border insolvency cases of multinationals and usually accompanies bankruptcy proceedings in the debtor’s home country. The main purpose of Chapter 15 is to promote cooperation between the United States courts and their foreign counterparts involved in crossborder cases as well as to provide for their fair and efficient administration so that the interests of all creditors and other interested entities, including the debtor, are protected.
A study of 500 corporate bankruptcies filed in the US courts over a 14-year period, with an average asset size of $250 million, showed that bankruptcy reorganization can rehabilitate financially distressed firms (inability to pay off debts) where as economically distressed firms (negative operating performance and unviable businesses) are likely to refile for bankruptcy within three years. Table 3 Cross-border M&A deals in 2008 done by companies in major nations Top 10 acquirers US France
No of deals
2008 value, in $ billions
Change from ‘07
3. SUPPORT AND STIMULUS With the severe slowdown in growth, governments all over the world have been concerned with evolving policy initiatives that could help rebound the economy. As a measure of reviving the economy, a wide range of policy measures, including reduction in interest rates and launching of fiscal stimulus packages, were initiated by many countries across the world. India too launched two rounds of fiscal stimulus packages combining interest rate changes and creating enabling conditions for banks to lend more. Fig 10 Interest Rates in Selected Countries Change from Aug-‐07 (Dec-‐08) (Basis Points) -‐113
Philippines -‐25 Malaysia -‐125
Hong Kong -‐20 Japan New Zealand
Switzerland South Africa
150 Slovak Republic
Czech Republic 0
Sweden United Kingdom
Interest Rate Change (Basis Points) Source: JP Morgan
Rates are country-specific; for instance, the Federal funds rate in the US, the Repo rate in the UK, the Overnight call rate in Japan, Cash rate in Australia, and the Repo rate in India.
Fig 11 Interest Rate Change from Aug-‐07 till Dec-‐08 (Basis Points) 0
-‐200 -‐300 -‐400
UK US India China Euro
Changes in Key Policy Rates Since Jan 08(%) Jan-08 Jan-09 5.50 1.50 3.50 0-0.25 7.75 5.50 7.47 5.31 4.00 2.50
Change -4.00 -3.25 -2.25 -2.16 -1.50
Source: JP Morgan
Fig 13 General Government Fiscal Balances
Fig12 Fiscal stimulus
(% of GDP)
% GDP; JPMorgan estimate for 2009 7 6 5 4 3 2 1 0
Emerging and developing economies
an Jap an Ge rm a ny Au stra lia UK Sw ede n Me xic o Kor e Tha a ilan d Ru ss Ma ia lay sia F ra nce US N. Zea Ho land ng Kon g S. Afr ica Sp ain Ind ia Ch ina
Source: IMF staff estimates
The rate cuts were most intense in the US, followed by Europe and the Asia Pacific. Co-ordination of central banks, consultations of the Group of 20 countries, and country-specific stimulus packages were major initiatives that dominated the policy area in the recent period. Japan decided to lend $100 billion to emerging markets facing crisis. International Monetary Fund extended lines of credit and assistance to a number of smaller countries adversely affected by the crisis, including Iceland, Hungary, Pakistan, and Latvia.
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Emergency Economic Stabilisation Act The United States announced Emergency Economic Stabilization Act (EESA) in which Troubled Assets Reconstruction Programme (TARP) that envisaged capital support to banks to the tune of $700 billion. The transactions conducted under TARP for the period ended January 23, 2009, is given below. Capital Purchase Programme (around 300 banks) Systematically Significant Failing Institutions (AIG) Automative Industry Financing Programme (GMAC, GM, Chrysler, Chrysler Financial Services) Targeted Investment Programme (Citi/Bank of America) Asset Guarantee Programme (Citigroup)
: $194 : $40 :$20 :$40 :$5
Though banks are provided with the capital support in developed economies, the outcome appears to be not so encouraging. Despite provision of $148 billion in capital to 13 major US banks from the Troubled Asset Relief Programme, total loans of these banks fell by nearly $46 billion to $3.31 trillion at the end year (Dec.2008), down from $3.36 trillion as of September 30. Concerns are on the rise whether TARP could induce bank lending, since a survey of 569 US companies in December 2008 found that 59% were found to have experienced constraints regarding bank credit. New rules according to EESA: Support programme to banks and financial institutions is implemented through EESA.To ensure that the Support programme to financial institutions goes on smoothly and effectively, the Treasury Department announced the following new rules that will focus more on transparency and reduce the influence of the lobbyists. Combating lobbyist influence in the EESA process: The Treasury Department will implement safeguards to prevent lobbyist influence over the programme, including restricting contacts with lobbyists in connection with applications for, or disbursements of, EESA funds. Keeping politics out of funding decisions: The Treasury Department will ensure that political influence does not interfere with EESA decision making, using as a model for these protections the limits on political influence over tax matters. Certification to Congress on objective decision making: In reporting to Congress, the Office of Financial Stability (OFS) will certify that each investment decision is based only on investment criteria and the facts of the case. The investment process will be transparent and based on objective criteria: Only banks recommended by the primary bank regulator will be eligible for capital investments. OFS will publish a detailed description of the investment review process undertaken by the regulators and OFS. The Treasury Department will ensure adequate resources exist to process applications as quickly as possible with priority to the date of the application as received by OFS and will formulate procedures to ensure integrity and regularity in the application process. Source: US Department of the Treasury
Fiscal Policy Initiatives United States
The new administration and Congress are likely to implement new fiscal measures of $700-$900 billion. including a combination of tax cuts and expenditure increases. However, the one quarter of the plan dedicated to infrastructure spending will likely to spend out slowly.
The government-introduced economic packages include direct subsidies to the household sector (2 trillion yen), tax incentive for business investment, housing, and security investment, and subsidies for industries beleaguered by higher input costs in 2008. Two supplementary budgets to fund these packages amount to 1.1% of GDP.
The combination of discretionary fiscal expansion and automatic stabilizers should add 2.6 percentage points to the area’s fiscal deficit this year and another 0.4 percentage points in 2010. Announced plans include support to households and companies through tax and subsidy changes, as well as increased investment.
The government approved a second stimulus package for 2009 and 2010 (worth around 1% of GDP per year) including additional public investment and reductions in taxes and social contributions for households and companies. This should push the deficit to 3.1% of GDP in 2009 and 4.4% of GDP in 2010.
With a deficit-to-GDP ratio of more than 3% in 2008, the fiscal easing measures by the French government for 2009 and 2010 are moderate. However, in combination with the deep recession, the deficit-to-GDP ratio is likely to surpass 5% in 2009 and 2010.
A fiscal package worth around €5 billion (0.3% of GDP) has been approved, two-thirds of which should be directed to households via tax cuts and benefits for the poorest. A capping to 4% on mortgage rates is also included. The rest should benefit corporates via more tax rebates. These measures are supposed to be entirely financed, so their impact on the budget balance should be roughly neutral.
The UK government will provide a fiscal stimulus of roughly 1% of GDP for 2009 via cut in VAT. Fiscal tightening of about 3% of GDP cumulative was announced for 2010-13, but it is unclear if this actually will happen.
The 2008/09 budget surplus projection of 1.8% of GDP has been cut to a balanced position, via direct fiscal stimulus to families, pensioners, first home buyers, increased payments to the states, and a focus on infrastructure. Further stimulus is expected in 2009/10, most likely a bring forward of income tax cuts planned for July 1, 2009, and July 1, 2010, pushing the budget balance from a projected surplus of 1.5% of GDP to a deficit of 1.0% — that is, a 2.5% of GDP stimulus.
The government of Canada is likely to run large budget deficits over the next two to four fiscal years. Some estimates anticipate an additional 4% of GDP over that time from a combination of infrastructure spending, tax cuts, increased unemployment benefits, and back-stopping of key industries, including the auto manufacturing, telecommunications, forestry, and aerospace sectors.
The State Council announced a RMB4 trillion stimulus package in early November 2008 for 20092010, with more than three-quarters to be spent on investment projects such as infrastructure development and earthquake reconstruction. The provincial governments have since put together investment proposals of more than RMB25 trillion, equivalent to 100% of 2007 GDP, for the coming two years. The State Council announced a RMB4 trillion stimulus package in early November 2008 for 20092010, with more than three-quarters to be spent on investment projects such as infrastructure development and earthquake reconstruction. The provincial governments have since put together investment proposals of more than RMB25 trillion, equivalent to 100% of 2007 GDP, for the coming two years.
A 35.6 trillion won (3.7% of GDP) total fiscal package in Korea was approved last year. 9.0 trillion won was spent in 2008, leaving 26.6 trillion won (2.7% of GDP) for 2009. Households and corporations will gain from tax cuts, while SMEs and construction firms will gain from higher direct subsidies and greater infrastructure spending.
Source: Citi Asia Economic Outlook and Strategy. January 2009
Box 4 Selected Government Support Packages (a) Country
United Kingdom United States
Guarantee of banks' wholesale liabilities (b) (billions)
Capital Injection (billions)
Euro area (g) Austria Belgium
Pre-Oct. 2009 debt
Banks' wholesale debt
Italy Netherlands Portugal
Pre-Dec. 2009 debt
Banks' wholesale debt(q)
US$60(p) CAD $25
Banks' wholesale debt
Nationalisation of Glitnir, Landsbanki and Kaupthing
Banks' wholesale debt
South Korea Total ( £ billions)
Source: Bank of England
Sources: Press releases a. Table includes government announcements up to October 24, 2008. b. These guarantees may cover (i) money market borrowing and (ii) term debt. c. Bank of England is making at least £200 billion available under the Special Liquidity Scheme. d. £99 billion Northern Rock and £50 billion Bradford & Bingley. e. The United States has also announced other packages to finance purchases of commercial paper and assets held by money market mutual funds. f. Term Securities Lending Facility, outstanding to date. g. All euro-area bank guarantees cover debt issued until end-2009. Maturity of debt guaranteed ranges from three to five years depending on the country. Details for Spain are known for 2008 only. h. €2 billion Dexia and €2.4 billion Fortis. i. 24% stake in a portfolio of structured products arising from the restructuring of Fortis. j. €1 billion Dexia and €40 billion other. k. France is offering €320 billion of collateralised lending to its banking system. l. €50 billion Hypo and €80 billion other. m. The Italian Ministry of the Economy and Finance has been authorised to subscribe to or guarantee capital raising decided by banks incorporated in Italy. n. €16.8 billion Fortis, €10 billion ING and €20 billion available for other banks. o. Fund established with an initial endowment of €30 billion extendable to €50 billion. p. A special purpose vehicle (SPV) will be set up to purchase up to US$60 billion of illiquid assets. The Swiss National Bank will loan this SPV US$54 billion and UBS will provide US$6 billion. UBS will bear the first US$6 billion of losses. q. The maximum amount of insurance available to an eligible financial institution will be greater of 125% of the contractual maturities of wholesale debt instruments for that institution during the six-month period beginning November 1, 2008, or 20% of deposits as of October 1, 2008. r. Bank of England estimates. Guarantees for Australia, Belgium, Canada, Denmark, Ireland and Italy have been estimated on the basis of existing banks’ wholesale debt. Totals computed using foreign exchange rates as of October 22, 2008.
4. SLOWDOWN IN STOCK MARKETS It was a crunch time for stock markets, with global markets collectively witnessing erosion of personal wealth to the tune of US$ 30 trillion. Following the revival of the stock markets from the second half of 2003, it is the first time that most of the stock markets in the developed and the developing world showed a steep fall in market values, which has adversely affected the investor interest as well as plans for new issuances by several corporates. The MSCI Emerging Markets Index comprising 746 companies in developing nations declined by 54% in 2008, considered as the worst annual performance since the index was initiated in 1987. Equity investors in emerging markets withdrew a record $48.3 billion from their funds in 2008, according to the data from EPRF Global. Most of the major emerging markets witnessed withdrawal of foreign institutional investors. Korea, Taiwan, Brazil, and India experienced significant outflows. Table 5 NET FOREIGN INVESTMENT (USD mn) Japan (1wk lag)
South Africa Brazil
Source: Bloomberg, JP Morgan, I:Net, MKK, AMG Data Services, MSCI, Datastream
One of the main reasons for the decline of the stock markets in the emerging economies is the withdrawal of foreign institutional investors (FIIs). However, in the developed countries, massive retrenchment of institutional and individual investors has led to huge losses in the stock markets. All the major developed markets showed huge losses. In 2007, only Sweden and Japan showed decline in stock prices, whereas in 2008 all the developed markets reported huge falls ranging from 39% in the US to 52% in Australia. Table 6 MSCI Index - Returns as of December 31st Developed Markets-Country Performance Countries France Germany Italy Spain Sweden United Kingdom Australia Hong Kong Japan Singapore Canada USA Source: MSCI Barra
2004 16.3% 14.4% 28.6% 25.4% 34.0% 15.5% 26.7% 20.8% 14.7% 18.8% 20.5% 8.8%
2005 7.8% 7.7% -1.3% 1.6% 8.1% 3.7% 12.5% 4.8% 24.1% 10.8% 26.7% 3.8%
2006 31.7% 33.0% 28.1% 44.8% 40.5% 26.2% 27.1% 26.3% 5.1% 41.9% 16.2% 13.2%
2007 10.9% 32.5% 2.7% 20.7% -1.4% 4.7% 25.0% 37.5% -5.4% 23.9% 27.6% 4.1%
2008 -44.9% -47.2% -52.1% -43.0% -51.4% -50.6% -52.3% -52.9% -30.5% -49.6% -46.6% -38.6%
Table 7 MSCI Index - Returns as of December 31st Emerging Markets (EM)-Country Performance Countries China India Indonesia Korea Malaysia Pakistan Philippines Taiwan Thailand Brazil Mexico Peru Russia Turkey Egypt South Africa EM Asia EM Far East EM Latin America EM Europe & Middle East EM Europe EM Eastern Europe EM (Emerging Markets)
2004 2005 -0.8% 15.9% 16.5% 35.4% 44.5% 12.6% 20.0% 54.3% 11.8% -1.5% 8.6% 56.5% 24.1% 19.9% 6.5% 3.3% -4.0% 4.9% 30.5% 50.0% 45.0% 45.2% -0.2% 28.5% 4.1% 69.5% 38.5% 51.6% 118.8% 154.5% 40.7% 24.0% 12.2% 23.5% 11.8% 22.1% 34.8% 44.9% 28.8% 41.7% 33.4% 47.2% 32.1% 46.1% 22.5% 30.3%
2006 78.1% 49.0% 69.6% 11.2% 33.1% -1.7% 55.4% 16.3% 6.8% 40.5% 39.0% 52.1% 53.7% -9.2% 14.8% 17.3% 29.8% 27.6% 39.3% 23.9% 33.6% 43.6% 29.2%
2007 63.1% 71.2% 50.8% 30.0% 41.5% 32.5% 38.0% 5.4% 40.9% 75.4% 9.3% 86.0% 22.9% 70.0% 54.9% 14.7% 38.3% 33.7% 46.9% 28.9% 27.8% 23.7% 36.5%
2008 -51.9% -65.1% -57.6% -55.9% -43.4% -75.4% -53.8% -48.7% -50.3% -57.6% -44.0% -42.4% -74.2% -63.4% -53.9% -40.0% -54.1% -52.0% -52.8% -63.9% -68.6% -69.6% -54.5%
Amongst the emerging markets, the loss is much more severe, ranging from 40% in South Africa to 75% in Pakistan. As against only three countries showing decline in stock prices in 2004, one in 2005, two in 2006, and none in 2007, all major emerging markets experienced a steep fall in market prices in 2008. The exchange industry also faced severe pressures. Except a handful, most of the exchanges experienced decline in market capitalization and value of share trading. The exchanges that topped erosion in their market capitalization include the Bombay Stock Exchange (64.4%), National Stock Exchange (India) (63.8%), Shanghai Stock Exchange (61.4%), Korea Exchange (58.1%), and the Indonesia Stock Exchange (53.3%). The exchanges that led in loss of value of share trading include the Bursa Malaysia (44.1%), Philippine Stock Exchange (41.1%), Shenzen Stock Exchange (40.9%), London Stock Exchange (37.3%) and the Shanghai Stock Exchange (36.4%). The global stock market value plunged to $42.21 trillion on September 30, 2008, from a high of $62.57 trillion on October 31, 2007, losing almost $20.36 trillion in market capitalization. Fig 14 Variations in Domestic Market Capitalisation-‐in USD (comparison of Dec 2008 with Dec 2007) JSE Egyptian Exchange Mexican Exchange BM&F Bovespa The Stock Exchange of Thailand Taiwan SE Corp Philippine SE Bursa Malaysia Korea Exchange Indonesia SE National Stock Exchange Bombay SE Shenzen SE Shanghai SE NYSE Group Nasdaq American SE Singapore Exchange Osaka SE Tokyo SE Hong Kong Exchanges Australian SE London SE BME Spanish Exchanges Borsa Italiana Deutsche Borse Euronext -‐65% -‐60% -‐55% -‐50% -‐45% -‐40% -‐35% -‐30% -‐25% -‐20% -‐15% -‐10% -‐5%
Source: World Federation of Exchanges
% Change in Value of Share Trading -‐ in USD (comparison of 2008 with 2007 )
The January Effect The first month of the year may have a great significance for the rest of the year in regard to the stock markets. The Wall Street Journal recently carried out an interesting article on this. Historically, January often augurs how the rest of the year will go. Although this is hardly a perfect potent, over the past 10 years, January correctly predicted the future seven times. When S & P falls in January, the index loses an average of 2.4% in the next 11 months, according to data going back to 1950 from Ned Davis Research. When the S & P rises, the index posts an average gain of 12.3% throughout the rest of the year. A positive January for Dow Jones led to an increase of 9.8% over the rest of the year. A negative January led to gains that averaged just 1.6%. However, in 2003, when the stock markets began to recover after the technology bubble burst in 2001, there could be some surprises too. After falling in January, the Dow and S & P rose about 30% in the next eleven months, which is making some optimists to look for a better year in 2009. Some say that the bear market is still not complete since they might often include sharp but temporary rallies that appear to mark the end of the pain, but fizzle out and lead to new lows. Ordinarily, a 20% gain from a low would signal that a bear market is over and new bull market has begun. The S & P 500 stock index surged more than 20% from November 20, 2008, through early January 2009. The Dow Jones rose as much as 19.6% over that period. However, there are exceptions. From November 13, 1929. through April 17, 1930, following the 1929 crash, the Dow Jones surged 48% causing elation on the Wall Street. Then as the Great Depression set in, stocks gave back all those gains. Recovery came only after 1932.
JSE Egyptian Exchange Mexican Exchange BM&F Bovespa The Stock Exchange of Thailand Taiwan SE Corp Philippine SE Bursa Malaysia Korea Exchange Indonesia SE National Stock Exchange Bombay SE Shenzen SE Shanghai SE NYSE Group Nasdaq American SE Singapore Exchange Osaka SE Tokyo SE Hong Kong Exchanges Australian SE London SE BME Spanish Exchanges Borsa Italiana Deutsche Borse Euronext -‐50%
Source: World Federation of Exchanges
Source: The Wall Street Journal.
Stock Index Returns in 2008 -‐ % change over a year ago BME Spanish Exchanges (IBEX 35) Bursa Malaysia (KLCI) London SE (FTSE 100) JSE (FTSE/JSE All Share) Euronext Paris (CAC 40) Egyptian Exchange (CASE 30 Price Index) Deutsche Borse (CDAX Price) Borsa Italiana (Historic MIB) Tokyo SE (TOPIX) The Stock Exchange of Thailand (SET Index) Singapore Exchange (Straits Times) Shenzen SE (SZSE Composite Index) Shanghai SE (SSE Composite Index) Philippine SE (PSE Index) Osaka SE (300 Common) National Stock Exchange (India) (S&P CNX 500) Korea Exchange (KOSPI) Jasdaq (JASDAQ Index) Indonesia SE (JSX Composite Index) Hong Kong Exchanges (Hang Seng) Bombay SE (SENSEX) Australian SE (All Ordinary Price) TSX Group (S&P/TSX Composite) NYSE Group (Composite) Nasdaq (Composite) Mexican Exchange (IPC) BM&F Bovespa (Ibovespa)
Source: World Federation of Exchanges
Among the top 10 performing stock exchanges in 2008 were the Mexican Exchange (-24.2%), the JSE (-25.7%), the London Stock Exchange (-32.8%), and the Jasdaq (-33.2%)
Fig 17 Average Stock Index Performance in 2008 (in USD) The Americas
Europe/Africa/ Middle East
-‐45.50% Source: World Federation of Exchanges
Business of Stock Exchanges Stock Exchange
Market Capitalisation (USD billions) 31-‐Dec-‐08
Value of ShareTrading (USD billions) 2008
Borsa Italiana BME Spanish Exchanges London SE Australian SE
New Capital Raised (USD billions)
National Stock Exchange
Hong Kong Exchanges Jasdaq
356.71 103.13 591.96 234.05 85.98 482.70
837.77 116.97 750.25 112.8 93.47 400.76
11 18 na 31 na 37
30 13 na 63 na 62
18 11 3 39 3 0
21.13 39.73 na 10.38 32.53 128.23
21.16 9.39 na 36.98 32.32 178.53
13.68 2.73 28.83 2.63 3.47 9.45
Philippine SE Taiwan SE Corp The Stock Exchange of Thailand BM&F Bovespa Mexican Exchange Egyptian Exchange JSE Source: World Federation of Exchanges
CAPITAL ISSUANCE Fig 18 The year 2008 was stressful for the IPO market. Global IPO Activity by Year According to a survey by Ernst & Young, global IPO bn activity has fallen volume-wise to a 13-year low. The $400 2500 first 11 months of 2008 recorded only about 745 IPOs $350 2000 $300 worldwide, raising $95.3 billion in capital as compared $250 1500 to 1,790 IPOs over the same period a year ago, which $200 1000 $150 raised $256.9 billion in capital. That’s a clear 58 % drop $100 500 $50 in the number of IPO deals since 2007 and a 63 % 0 $0 plunge in global proceeds. The IPO window has been slammed shut by the capital crisis. Surveys showed Capital Raised (bn) Number of deals that 298 IPOs have been postponed or withdrawn in 2008, compared with 167 in 2007. And those companies that went through with their offerings didn’t fare so well. The most established IPO markets, the US and Europe, were hit particularly hard. By funds raised, the top three exchanges in 2008 were the New York Stock Exchange, which accounted for 26.3 % of capital raised ($25.1 billion) and was buoyed by the Visa Inc. listing; London Stock Exchange (5.8 % capital raised, $5.5 billion); and Hong Kong Stock Exchange (5.0 %, $4.8 billion). The top three exchanges by number of deals were the Australian Stock Exchange (65 IPOs), AIM London (27), and Hong Kong Stock Exchange (23). Sectoral Performance Sectorwise, industries accounted for 105 new issuances and high technology, 81. The top three sectors by total capital raised were financials ($26.2 billion), energy and power ($18.3 billion), and materials ($16 billion).
Regional Performance According to a study by E&Y, IPO activity has also fallen in the emerging markets. However, of the top 20 IPOs, 15 have been from the emerging markets. BRIC markets recorded 163 deals and $28.0 billion in capital raised in the first 11 months of 2008, compared with $106.8 billion and 365 deals over the same period in 2007.
Largest Exchanges by Capital Raised (IPOs & Secondary Market Issues) in 2008 and 2007 Exchange USD bn 2008 USD bn 2007 % Change in USD Euronext * 156.7 * NA -
2 3 4 5 6 7 8 9 10
NYSE Group London Stock Exchange Hong Kong Exchanges Australian Securities Exchange BME Spanish Exchanges BM&F Bovespa Shanghai Stock Exchange National Stock Exchange of India Shenzhen Stock Exchange
151.2 124.6 51.9 50.4 32.2 28.8 27.6 27.0 17.4
137.0 82.8 74.0 69.3 116.7 41.8 87.2 33.3 13.0
10.4% 50.5% -29.8% -27.3% -72.4% -31.1% -68.3% -18.9% 33.8%
Source : World Federation of Exchanges
5. HEDGE FUNDS The hedge fund industry has just endured their worst year ever. The industry was down 18.5 % in November 2008 after an unprecedented six-month streak of losses. The amount of money the hedge funds had to invest, which peaked at almost $1.9 trillion in June 2007, shrank by almost one-fifth by October 2008. The state of the market has led nervous investors to pull out billions of dollars out of these funds in order to park their money in safer alternatives or meet other investment obligations. The capital base of the hedge fund industry hit an all-time high of $1.93 trillion in June 2007, according to the estimates by Hedge Fund Research, which tracks self-reported data from 7,800 funds. By October 2008, that base had declined to $1.56 trillion, with investors withdrawing $70 billion and performance losses accounting for $300 billion. This has also led many hedge funds to wind up their operations. The number of hedge funds worldwide, growing every year for the past 18 years, has taken a hit due to the financial crisis and has actually seen a decline in 2008. According to a recent report, investors pulled out of hedge funds for four consecutive months to extend the total net outflow for 2008 to $200 billion.The size of the once lucrative industry has fallen almost by half in the past year, to $1 trillion under management, because of performance losses as well as investor redemptions. The average fund lost 21.7% in 2008, according to Morningstar 1000 index. That is based on the 1,000 largest funds, which account for 90% of industry assets. Fig 19
Investment in Hedge Funds $1,868.4
$1,105.4 Assets (in billions)
Net Asset Flow (in billions)
$820.0 $625.6 $456.4 $367.6
$58.4 $8.4 1991
$95.7 $167.8 $27.9
*Till October Source: The Washington Post
Fig 21 Number of Hedge Funds in thousands (estimated)
Hedge Funds -‐ Net Asset Flow in 2008 (in billions) +$16.5
10 +$12.5 -‐$31.7
Q2 6 4 Q3
Source: The Washington Post
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Fig 22 Real Commodity Prices
The global financial turmoil in 2008 and the subsequent slowdown in economic growth has had a dramatic impact on commodity prices. Commodities surged during the first six months of 2008 on a combination of rising demand from growing economies, including China and India, and a huge wave of speculative trade. But in the second half of the year, futures plunged as major world economies fell into recession and speculators left the market, hoping to avoid devastating losses.
(1995 = 100) 450 400 350 Oil
200 150 100
85 90 95 2000 05 10 14 As recession was spreading around the world, stocks and 1980 Source: IMF staff estimates commodities plunged together. Demand seemed to be waning for raw materials, so did speculators’ appetite for commodities. As a result, several hedge funds that bought at the top of the market, particularly in oil, ran into trouble and were forced to close. A spiraling down in business and consumer confidence, intensifying credit crunch, sharp slowdown in global auto sales and housing as well as the significant slump in industrial activity in China contributed to the rapid deceleration.
Crude Oil The performance of crude oil was the most telling example of what happened to commodities during the past year. The first few months of 2008 saw crude oil prices breach one barrier after another. High economic growth posted over the last four years led to a rise in energy demand. Demand from China, the world’s second largest oil consumer, almost doubled in these years. Crude hit $100 (Rs 4,870) a barrel for the first time on January 2, 2008, and then soared over the next six months, hitting a once unimaginable $147.27 (Rs 6,299) on July 11, 2008.
Fig 23 NYMEX Crude
Weakness in dollar against major currencies, rise in demand and increasing geopolitical worries had also Source: Metastock supported the rally. But the situation changed dramatically, as the subprime mortgage crisis shook the US financial market and the global economic downturn set in. From its all-time high, crude was down nearly 70% by the end of December 2008.
Gold The year 2008 saw gold prices perform exceptionally well as compared to other commodities. Gold prices started the year on a positive note at around $833 an ounce and went on to reach an all-time high of $1,033.90 an ounce in the month of March. The credit crisis badly hit the financial market, leading to liquidity crunch in the global financial system. Since then gold tumbled by more than 33% to mark a low of $690 an ounce in the month of November 2008 as fall in physical demand and collapse in oil prices eased demand for gold. Gold prices managed to bounce back from $690 to $870/ounce in December 2008, as bad news for the global economy brought gold investors back to the marketplace.
Fig 24 GOLD
In 2008, India imported more than 800 tonnes of gold against the import of 754 tonnes in 2007. Gold, considered a safe haven in volatile markets, maintained that trend in 2008, although at times it did show some volatility of its own. The largest single day historical gain of $85 (10.39%) occurred on September 17, 2008, while the largest single-day loss of $64 (7%) occurred on October 10, 2008. Base Metals Base metals have been hit hard in 2008 by concerns over the impact of the global economic downturn on demand. Rise in inventories, production cuts and falling demand have been a regular feature in the Base metal sector. No metal was spared the price carnage, as is shown in the table below, which shows three-month prices at the closing evaluation of December 31, 2008, together with the percentage decline from the end of 2007. Base metals producers have been reducing output and cutting capacity in an effort to stabilise their markets but with little impact on prices. Table 9 As on Dec 31, 2008 Price(USD/tonne)
The slump in prices was accompanied by sharply rising LME inventories as surplus metal was delivered to the market as last resort. There were, however, two important exceptions to this pattern. Lead stocks ended the year virtually unchanged, and down sharply from their mid-year peak of 101,850 tonnes, while those of tin fell by 36 % over the course of 2008. The consumption of BRIC countries, that are significant metal consumers, was down by almost 50% in 2008. Demand from China continued to remain under pressure and that played a major role in the huge downturn in the price of base metals in the year 2008. Aluminium sank 36.1% in 2008, with weak demand conditions reflected in massive increases in stocks (aluminium and alloy) in the London Metal Exchange (LME) warehouses, which had reached well over 2 million tonnes at the end of 2008. Since aluminium is an energy intensive metal, fall in oil prices put downward pressure on aluminium prices Copper prices were down 54% this year after reaching a high of $4.00/lb in July as rise in construction activity supported the red metal. Zinc was trading on weak note as rising inventory and heavy surplus from the beginning of the year weighed on metal prices. Lead prices plunged by more than 75% from its highs mainly due to fall in demand for batteries as a result of the global financial turmoil. Nickel prices started the year on a positive note, but could not hold on to its gain . Fall in steel demand also put pressure on nickel prices that are currently trading at a multi-year low of $5.00/lb.
Fig 25 EURUSD
EURUSD The US dollar, which had in the last couple of years moved in the opposite direction to gold investment prices, began to strengthen in 2008 as the process of deleveraging began in earnest across the markets. This caused the dollar to rise from a low of $1.60 to around $1.23 to the euro. As 2008 came to an end, the dollar weakened sharply and fell from $1.26 to $1.41 in December, a significant decline in such a short period. Source: Metastock
GBPUSD The sterling lost about 27.3% against the US dollar in 2008 as financial markets tumbled across the world. In early 2008, the pound sterling was hovering around $1.98 levels and touched the $2.03 mark for a brief period around mid-March, after which it went back to the $1.95 level and played along those levels until July. Post July, there has been a steady decline in the GBPUSD right until the end of the year and this trend is expected to continue until the first quarter of 2009 as Bank of England is expected to continue easing monetary policy with another rate cut in the near future.
Fig 26 GBPUSD
USDINR The Indian rupee depreciated nearly 23% since the start of the year, very much following capital flow movements in and out of the country, given the financial turmoil the world economies were facing the entire year. There was tremendous pressure on the RBI to juggle between managing the rupee and maintaining liquidity in the system. This is the reason why depreciation in the rupee was so sudden. On November 19, 2008, the Indian rupee closed at an all-time low of 50.02/03 against the dollar on account of capital outflows and weak outlook on equity markets.
Fig 27 USDINR
Since 2007, the USDINR rate displayed a positive Source: Metastock correlation with equity markets. The USDINR rate and equity markets were in bull phase in 2007 as both were trading well above the 200-day moving average. It all started to change in 2008. The USDINR has been very volatile in the August–October time frame when the rupee depreciated up to 19 % from the levels of 42 to 50 in a short span of three months. It then pulled back from 50 to 47 levels and hovered around 48 in January 2009.
8. OUTLOOK AND PROSPECTS IN 2009 t t t t t t t
The US may face one of the longest and worst downturns. Japan and major European countries could be in recession. Most of the developed economies could see either a decline or negative growth in GDP. Growth in the emerging markets could be affected by decline in commodity prices. Oil and other commodity exporting countries will be under pressure. Stimulus packages from governments likely to continue. Financial institutions in developed markets could remain under pressure.
The recession in the US could well be one of the longest and worst downturns for the US economy, which is expected to shrink by at least 1.8% in the year 2009. The Japanese economy along with some European countries, which include Ireland, Italy, and Germany, is already in a recession. The other economies of the European Union are likely to follow suit. For Japan, this will be the worst recession since the Asian crisis in 1998. All economies are expected to see declines in their GDP in 2009.The developed economies in the Euro zone will see a negative growth of 1%, GDP in Japan and the United Kingdom will also fall by 1.3% and 1.8% respectively. Growth in the emerging economies will also be affected by decline in commodity prices. Countries like Russia, Iran, Venezuela, and South Africa, which are the major oil and commodity-exporting countries, are facing a decline in commodity prices. Also, Asian countries, most of them being major exporters, will be hampered as a result of decline in world trade. China, which enjoyed a robust 11.9% growth in 2007, is likely to grow only 6.9% in 2009. Latin America is also experiencing the economic storm. Weak commodity prices could push the region into running a large current-account deficit, just as capital inflows decline sharply. Oil-rich Venezuela and Equador are hurt by falling oil prices. Mexico and the Central American countries could be affected by the contraction in the US economy as their economies are directly linked to the US economy. The Mexican Central Bank estimates that the country’s GDP, which grew 3% in 2008, will grow less than 0.5% in 2009, whereas Brazil, which grew by 5.9% in 2008, is forecasted to grow by only 2.1% in 2009. The year 2009 is also going to see many countries announcing stimulus packages to revive their economies. The countries with major packages include the US (3-5% of GDP) and China (around 16% of GDP). The fiscal stimulus plans announced for other major economies ranged between 1 to 2% of their respective GDPs. India’s GDP growth is also expected to shrink from 6.8-7% in 2008 to 5.8% in 2009 (according to the World Bank estimates). A large proportion of the investment in Indian markets has been financed by overseas borrowing or new equity issuance and both seem to have shrunk in recent months. The government’s huge budget deficit also limits its room for fiscal easing. In January, India announced its second monetary and fiscal stimulus package, within a month of the first package, but the extra spending is considered rather small. Overall, the long-term prospects in developing countries remain good because of structural reforms and better macroeconomic policies over the past decade. In December, the World Bank forecast that GDP per head in poorer countries would rise at an annual pace of 4.6% during 2010-15, similar to that during the past decade, and more than twice as fast as in the 1990s. Although 2009 will be a painful year for poorer countries, Fig 28 Contribution to the Global GDP those with high savings and modest debt could recover 5.0% fairly quickly. On many measures, such as government 5.0% and external balances, emerging economies look much 4 4 sounder than the richer countries. Commodity prices 3 3 likely to remain subdubed in 2009. With the economic outlook weakening by the day, futures markets for 2 2 commodities are yet to factor in the full extent of the 1 1 fall in demand that is going to occur this year. Oil prices have already fallen below the $40 per barrel mark. On 0 0 the positive side, the drop in energy prices is going -‐1 -‐1 to act as a respite for households and businesses all -‐2 over the world. The big drop in commodity prices also -‐2 1985 1987 1989 1991 1993 1996 1997 1999 2001 2003 2005 2007 2009 signals a major shift in the terms of trade, in favour Industrial Countries Emerging Markets of the developed economies, and represents a ‘reSource: JP Morgan balancing’ of growth and current-account deficits, with commodity-importing countries being the major beneficiaries. On the currency front, the outlook for the dollar is likely to remain strong as long as the crisis continues and the US dollar will continue to retain its principal reservecurrency status. However, the downward pressures on the dollar are likely to return once the crisis is over. Moreover, the markets also seem confident that the US may be able to come out of the recession sooner and faster than other parts of the world.
Table 10 POSITIVES
Low oil and energy prices could help resistance to recession in emerging markets
The world’s largest economies in North America, Europe, and Asia in a recession
Attractive valuations in stocks could spur investment from institutions and retail investors
Slowdown in corporate earnings
Active government intervention might reduce the speed Widening spreads for corporate debt in mature and of slowdown emerging markets Greater engagement of multilateral financial institutions Commodities prices likely to be subdued with measures of financial support Fiscal stimulus packages in emerging economies could induce higher levels of spending
Rising bankruptcies in the developed world
Relatively healthier capital levels of banks in major emerging markets
Corporate balance sheets becoming more riskier than sovereigns
Relatively lower levels of household debt in major emerging markets could revive growth
Contraction in the external trade as also trade finance
A few important developments in the global markets in response to the current crisis include:
The concept of financial supermarket is under intense test with banks like Citibank planning to hive off its core banking from its related activities in the realm of insurance, brokerage, and other financial services. This move is expected to lead to banks focusing more on its core banking business rather than adding up too many activities that might increase the risk and making it difficult to manage in times of a crisis. It would be interesting to watch the shape of banking in the light of these developments.
Group of Thirty (See Box) made recommendations regarding reforms in the global finance that would have a sizeable impact on the regulatory regimes and structures in a number of countries, as also the functioning of the financial markets.
A more integrated approach to regulation and supervision is emerging. In a recent review, Angel Gurría, Secretary General, Organisation for Economic Cooperation and Developments, called for a more integrated supervision of the European financial markets. “It is essential that national differences in implementation do not lead to distortions in competition and that consideration be given to how governments exit from their commitments when the turmoil eventually dissipates,” he said. “In addressing financial market vulnerabilities, governments must be careful not to sow the seeds of future problems.”
Concerns are also expressed with regard to growing protectionist tendencies that could harm the future prospects of the global trade. Following the financial crisis, trade restrictions are taking place, leading to complaints from some countries of unfair trade practices. For global policy it is important to ensure that the growth of global trade, which contributed significantly to the growth of the world economy, should not be put to protectionist measures that could severely dent the scope of the world economic growth.
RECOMMENDATIONS OF THE GROUP OF THIRTY (Excerpts) Group of Thirty, a consultative group on International economic and monetary affairs established in 1978, and a private, nonprofit, international body composed of very senior representatives of the private and public sector and academia, on January 15, 2009, released its latest report ‘Financial Reforms: A Framework for Financial Stability’. Excerpts from the report are given below: 1.
In all countries, the activities of government-insured deposit-taking institutions should be subject to prudential regulation and supervision by a single regulator (that is, consolidated supervision). The largest and most complex banking organizations should be subject to particularly close regulation and supervision, meeting high and common international standards.
Large, systemically important banking institutions should be restricted in undertaking proprietary activities that present particularly high risks and serious conflicts of interest. Sponsorship and management of commingled private pools of capital (that is, hedge and private equity funds in which the banking institutions own capital is commingled with client funds) should ordinarily be prohibited and large proprietary trading should be limited by strict capital and liquidity requirements. Participation in packaging and sale of collective debt instruments should require the retention of a meaningful part of the credit risk.
In general, government-insured deposit-taking institutions should not be owned and controlled by unregulated non-financial organizations, and strict limits should be imposed on dealings among such banking institutions and partial non-bank owners.
To guard against excessive concentration in national banking systems, with implications for effective official oversight, management control, effective competition, nationwide limits on deposit concentration should be considered at a level appropriate to individual countries. REGULATORY STANDARDS FOR GOVERNANCE AND RISK MANAGEMENT Regulatory standards for governance and risk management should be raised with particular emphasis on: 1.
Strengthening boards of directors with greater engagement of independent members having financial industry and risk management expertise.
Coordinating board oversight of compensation and risk management policies with the aim of balancing risk taking with prudence and the long-run interests of and returns to shareholders.
Ensuring systematic board-level reviews and exercises aimed at establishing the most important parameters for setting the firm’s risk tolerance and evaluating its risk profile relative to those parameters.
Ensuring the risk management and auditing functions are fully independent and adequately resourced areas of the firm. The risk management function should report directly to the chief executive officer rather than through the head of another functional area.
Conducting periodic reviews of a firm’s potential vulnerability to risk arising from credit concentrations, excessive maturity mismatches, excessive leverage, or undue reliance on asset market liquidity.
Ensuring that all large firms have the capacity to continuously monitor, within a matter of hours, their largest counterparty credit exposures on an enterprise-wide basis and to make that information available, as appropriate, to its senior management, its board, and its prudential regulator and the central bank.
Ensuring industry-wide acceptance of and action on the many specific risk management practice improvements contained in the reports of the Counterparty Risk Management Policy Group (CRMPG) and the Institute of International Finance.
Recommendation on Fair Value Accounting 1. Fair value accounting principles and standards should be re-evaluated with a view to develop more realistic guidelines for dealing with less liquid instruments and distressed markets.
The tension between the business purpose served by regulated financial institutions that intermediate credit and liquidity risk and the interests of investors and creditors should be resolved by development of principles-based standards that better reflect the business model of these institutions, apply appropriate rigour to valuation and evaluation of intent, and require improved disclosure and transparency. These standards should also be reviewed by, and coordinated with, prudential regulators to ensure application in a fashion consistent with safe and sound operation of such institutions.
Accounting principles should also be made more flexible in regard to the prudential need for regulated institutions to maintain adequate credit loss reserves sufficient to cover expected losses across their portfolios over the life of assets in those portfolios. There should be full transparency of the manner in which reserves are determined and allocated.
As emphasized in the third report of the CRMPG, under any and all standards of accounting and under any and all market conditions, individual financial institutions must ensure that wholly adequate resources, insulated by fail-safe independent decision-making authority, are at the centre of the valuation and price verification process.
Recommendation on a Resolution Mechanism for Financial Institutions 1. In countries where this is not already the case, a legal regime should be established to provide regulators with authority to require early warning, prompt corrective actions, and orderly closings of regulated banking organizations, and other systemically significant regulated financial institutions. In the United States, legislation should establish a process for managing the resolution of failed non-depository financial institutions (including non-bank affiliates within a bank holding company structure) comparable to the process for depository institutions. 2.
The regime for non-depository financial institutions should apply only to those few organizations whose failure might reasonably be considered to pose a threat to the financial system and, therefore, subject to official regulation.
A regulatory body having powers comparable to those available for the resolution of banking institutions should be empowered to act as a receiver or conservator of a failed non-depository organization and to place the organization in liquidation or take action to restore it to a sound and solvent condition.
The special treatment accorded to various forms of financial contracts under current US law should be examined in light of recent experience, with a view toward resolving claims under these contracts in a manner least disruptive to the financial system.
Source : Group of Thirty
TIMELINE OF MAJOR EVENTS Sep 14, 2007:
Sep 30, 2007: Oct 24, 2007: Feb 17, 2008: Mar 14, 2008: Mar 16, 2008: Sep 7, 2008: Sep 14, 2008: Sep 15, 2008: Sep 17, 2008: Sep 25, 2008: Oct 6, 2008: Oct 8, 2008: Jan 8, 2009: Jan 14, 2009: Jan 15, 2009: Jan 16, 2009: Source: Financial Times
Bank of England bails out Northern Rock with emergency short-term credit, triggering a run on the bank. UBS announces $690 million loss in Q3. Merrill Lynch suffers $8.4 billion loss as a consequence of the subprime crisis. Northern Rock nationalized. US Fed and JP Morgan Chase announce emergency funding deal with Bear Stearns. JP Morgan Chase buys Bear Stearns for $2 a share. Fed buys out Fannie Mae and Freddie Mac, taking on $12,000 billion worth of debt, after their shares had collapsed. Bank of America buys out Merrill for $50 billion. Lehman Bros files for bankruptcy. Fed bails out AIG with $85 billion. Hank Paulson proposes a $700 billion bail-out plan to buy distressed assets. Fed announces a plan to make $900 billion available in short-term loans to banks. The UK government announces banking bail-out. £200 billion made available through the special liquidity scheme; £50 billion to repair bank balance sheets; £250 billion guarantee for banks refinancing. The German government injects €10 billion into Commerzbank in return for quarter of the company. Deutsche Bank announces €3.9 billion loss. Anglo-Irish bank nationalized. Bank of America posts $2.4 billion loss, while the US government agrees to $20 billion capital injection and $118 billion loss guarantee. Citigroup announces an $8.3 billion loss and confirms it will split itself into two.
Acknowledgements Ernst & Young - Growth during economic uncertainty - Global IPO trends report 2008, JP Morgan Chase Bank - Economic Research - Global Data Watch- January 2, 2009, Citi - Asia Economic Outlook and Strategy - Asia’s Disturbing GDP Trends - 23 January 2009, IMF World Economic Outlook Update - 28 January 2009, World Federation of Exchanges - Focus January 2009, MSCI Barra, Central Statistical Organisation - Government of India, Financial Times, The Washington Post, The Wall Street Journal, www.kitcometals.com
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