Artificial Liquidity Crunch ????

What cues do you draw when a top rung Bank raises capital at a huge premium ?? That :

1. it no longer is the premiere bank that it once was

2. it is in dire straits financially and needs money urgently.

3. there is an (artificially created??) liquidity crunch in the market place that is not enabling financial institutions to raise money with ease.

Take the case of Citigroup. After posting almost $16 billion in writedowns, it has just bolstered its capital by selling $6 billion of preferred shares in the bank's biggest public debt offering. The perpetual hybrid bonds pay interest of 8.4 percent for 10 years. After that, if not called after 10 years, the interest rate will convert to a floating rate and the debt will then begin to float at 4.03 percentage points more than the London interbank offered rate .

The offering adds to New York-based Citigroup's $37 billion of capital raising since November to help compensate for more than $40 billion of credit losses and writedowns since the subprime mortgage market collapsed. Citigroup in January sold $3.72 billion of perpetual preferred shares at a yield of 8.125 percent and $3.17 billion of convertible securities, according to data compiled by Bloomberg. The bank sold $3.5 billion of hybrid bonds in December at a rate of 8.3 percent and raised $20 billion in private sales to investors including the governments of Singapore and Abu Dhabi.

The good part though..... Hybrid bonds and preferred shares that have characteristics of both debt and equity count toward capital reserves, allowing the bank to replenish its coffers without diluting equity. Hybrids typically allow issuers to defer interest payments without defaulting, and credit-rating companies usually consider the bulk of the money raised as equity, meaning only a portion is counted as debt on an issuer's balance sheet.

Now look up at points 1. and 2. Citi falls exactly in the same bracket. How about 3. then?? Is there really any artificially created liquidity issue?? You can be a believer or a non believer depending upon your orientation. But just look at what happened to Bear Sterns just a few weeks ago..... The firm was doing well except for the sub prime hiccup that was prevelent across the whole financial system. It did not have any short term liquidity issues. It was sitting on a cash base of $14 billion. The only issue it had....it didnt have any backp other than this cash, save for the lines it had with various banks and FIs out of which it could draw in times of need. And here is where itfell. When it required these lines, it was denied so by the very institutions that had promised it these lines. And when investors began drawing money out of the firm, it had no other option left. And who comes for the bailout?? JP Morgan Chase. One of the institutions that Bear had drawing lines with. That it didnt surface when Bear was in a liquidity crisis was evidently to gain a) indirectly if a competitor falls or b) directly by claiming a stake in a fallen Bear by supporting it financially. After all, Bear had huge Real Estate Assets in addition to its core business assets.

Now draw a parallel on the same arguement with Citi's fate. It was the world's premier bank just a few months back. In a notrmal course, it would have then attracted capital (if it ever needed then) at far attractive rates than the 400 to 500 bp premium that it is paying now. The reason?? CREDIT CRUNCH. No money in the market. Then where did the $170 million come from that all the great Banks of the world have raised in the last few months in the subprime aftermath?? Oh yes, there is money but the market sentiment is so bad that the Investors are shying away from putting it in the market. They would rather sit on it and wait for the market to improve. As if a market with a liquidity crunch, can bounce back on its own!!! (And that is where my argument is....there is money but is being hoarded away so that the investor can extract a BETTER return when the time comes to make a kill. Nothing wrong in the Investor's thinking. But, the point is, this is what qualifies to be called an artificially created liquidity crunch. period.

Inflation and the Repo rate

The effect of inflation for a lay person is the prices of everything going up over the years, or in other words too much money chasing too few goods. For instance the cost of one loaf of bread purchased by my father was 50 paise when he was a kid, now it is worth Rs.10. Thus, inflation makes the worth of money to reduce.

There are two kinds of Inflation indices in use in India;
1. Wholesale Price index (WPI), issued by the Ministry of industry. It is the most commonly discussed index of inflation.
2. Consumer Price index (CPI), issued by the Ministry of Labour.

The composition of these indices is different, with food articles constituting 57% of weightage in CPI for industrial workers, as against 27% in WPI. A more than proportionate rise in prices of food articles leads to a higher rise in CPI as it is happening in the current scenario.

Causes of Inflation
Broadly, there are two categories of inflation:

• Demand-pull Inflation or the Demand side Inflation: caused by increase in aggregate demand due to increased Govt. and individual spending. The propensity to buy increases with an increase in wage rates.

• Cost-push Inflation or the Supply side Inflation: caused by fall in supply due to increase in supply of inputs. For example, due to a crop failure the supply of wheat in the market is reduced, the sellers will respond with a increase in prices of the existing stocks.

Money supply plays an important role in deciding the level of inflation. The Government, in a crises situation (like war) may stimulate demand by printing Currency notes (deficit financing).

Effects of Inflation on the economy
A small amount of inflation is believed to have a positive impact on the growing economy. An attempt to maintain a zero inflation level may lead to falling prices, losses and unemployment. This situation may be accompanied by downward movement in wages and output and is called ‘Deflation’. Moderate inflation also serves as an incentive for the ‘savers’.

Controlling Inflation
Central bank of the country (RBI in our case), have used several monetary policy measures to contain inflation. It is virtually impossible to achieve a zero percent inflation over sustained period of time, because it is impossible to prevent wage earners from demanding higher wages. The most common methods of controlling inflation are:
• Slow growth of money supply
• High interest rates

REPO Rates and Inflation
The hike in REPO rates by the central bank is an indication to lenders to increase their lending rates, thereby reducing the excessive demand. In addition, the central banks indulge in open market operations, ie. buying and selling Govt. securities in the market to influence short term liquidity, on a day to day basis. Sometimes, the reserve requirements are also changed to manage liquidity. In
the recent past, RBI has hiked cash reserve ratio (CRR) on three occasions to suck the excess liquidity from the system.

These are demand side factors of controlling inflation. However, in the longer run, supply side management is more effective in controlling inflation. The govt. tries to augment production, supply of the scarce commodities to have a sobering effect on their prices. For example, if the prices of cement have gone up in the past, the govt. can allow import of the commodity, and at the same time grant new licenses to enhance the capacity to produce cement in the economy.

The G7 Concern

The G7 in their meeting yesterday, raised concern on the dollar's slide and said the global economic slowdown may worsen amid an "entrenched" credit squeeze.

"Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability," the G-7's finance ministers and central bankers said in a statement after talks in Washington yesterday.

The officials downgraded their outlook for the world economy from that of two months ago, blaming the U.S. housing recession, credit-market turmoil, commodity prices and inflation pressures. The dollar has lost 8 percent against the euro and 6 percent versus the yen since the G-7 last met in Tokyo in February.

The new language was the first significant change in the G- 7's view of currencies since a February 2004 meeting in Boca Raton, Florida.

And now another bit of news.....The International Monetary Fund this week forecast a 25 percent chance of a global recession this year.

The IMPLICATIONS?? Well for one, the G7 statement itself is enough to strengthen the Dollar by 1 to 2 percent in real terms. On the psychological terms...... don't expect the Euro to break 1.60 that soon. And a similar no to the 100 mark for the Yen. Chances are, the Yen may not be able to be convincing in its march towards 100. The Euro on the other hand, should make up to the 1.60 mark despite the G7 comments, abliet a bit later than the markets were expecting.

The Flip side of the story?? The concern may all be talk and nothing else. The G7 did not move any agenda on the steps to be taken to strengthen the dollar except alleying its concerns and putting in place a timeline of 100 days towards achieving its goal. No concrete proposals nor any concrete policy statements. No willingness. And no visible interest in intervening too.

And why so?? one may ask. For, if the greenback weakens, it makes imports expensive while making exports to other nations cheaper. The net effect should be in propelling the economy up. And for the nations importing from the US, it should be a bonus, importing the same goods at a lower cost. At the same time, a stronger currency is good for a nation when it is trying to fight rising inflation and helps in fighting price hikes (Euro is a great case in point here). Thus the muted concern of the other G7 members.

So where does it lead the world economy?? Nowhere I guess. The U.S. economy it seems is weaker than its counterparts of the G7 and the other members are comfortable for the timebeing in letting it being so for a change. They infact for the first time in decades, are not bothered about the fall of the US. What a twist of fate.....

The Great Indian Tamasha

While lots has been written on the Indian stock market by a lot of people, I invite myself too into the ring. I had written a few weeks ago that the BSE had a bottom near the 14,800 to 15,200 mark (and also on the 12,000 mark nearing breakage on the Dow Jones). And was I correct!!!!!!. It bottomed at 14,803 before reserructing itself by a few hundred points. My new prediction on the BSE..... Wait for a while, maybe tommorow. It should be testing the 15,200 mark again. And in weeks to come, with the turmoil in the world economies....it may even break the bottom I predicted and go on to the 13,400 to 13,800 levels. The Dow on the other hand should take things more maturely before giving way below the 12000 mark again. Its a great psychological barrier you see. And we Indians are a "freakish" (rather than nervous if I may say so) lot when it comes to things tumbling down. You may have witnessed it in the past three months.

Though I had heard/read a few days back of the market moving to 11,000 , in my inimitable style (pun intended dear folks.....on me of course...who else????), I would say it is too premature to predict so, though not dismissing off altogether, given the shaky place the world has come to be.

Now, to test my skills further, I am trying to write a blog. You can access it at http://themarketstoday.blogspot.com/ . Hope to see you all there too. Chao.

Coming of age of the Yen

The Yen has it seems come of age. Belying market predictions of going to 92 and 80 levels(yes its true, some top shot Tokyo trader predicts so) it has sustainably kept itself above the 95 levels and now managed to jump to the 101-103 zone. Though if I were to believe my instincts, it should again test the 100 levels and possibly slide below silently in the next few weeks. Mark my words, "There is more dirt in the subprime closet than we have been told."

About the Euro, I wash my hands off. It has gone and gone and gone on to levels we had never imagined a year ago....rather few months ago too. 1.60!!! what levels to achieveif it does..... I tend to agree with people who say it may keep testing this level for some time now. 1.62 (and perhaps 1.63) is never out of range but 1.50 is history. Amen.

The INR has in the meanwhile kept its head above the 40 levels after the 3rd week surge to 40.80 that I had been talking of, since ages. I still tend to believe it will continue the good work (look out for the footnote) in the wake of the surging oil prices and despite the run on it by the exporter community which I believe may not impact it by more than 10to 20 paise in absolute terms. Though the slumping below 40 convincingly is also a certainity in the coming weeks.

In keeping with my disclosure last month on my personal interest in the Yen and the Rupee, I am glad that I made comfortable moves if not great. My covering of the USD against JPY was at just above 100 (remember I was not expecting the Yen to strengthen so much so soon!). Also, that I did not wait for better rates on the Yen had majorly to do with the fact that I had a rupee leg to cover after I covered the Yen one and the Rupee had Weakened to my desired levels. And I didnt expect it to weaken further and IT REAFFIRMED MY BELIEF IN the pair. Thus my deal on the INR against USD was done near 40.78 . So you see now, I only said (and did) things that I believed in. And in the hindsight now, I feel I got myself a good deal.