The Solvency Crisis

Includes: EEM, IFN, IPN
by: Saket Mundra

The last 45 days have been quite eventful for the Global economy and more so for India. If the global markets witnessed mixed economic data from the US and perhaps a stellar Chinese GDP number (on face value), India wasn't far behind with its budget and numbers from IT biggie Infosys (NASDAQ:INFY).

Amidst all the developments, global markets went through a slight pull-back only to gain again in the last week. China has been leading the pack and has given tremendous returns over the year. With the Chinese Government's continued thrust on public spending, many believe things will be quite rosy. Commodities across the globe have been rising due to Chinese stockpiling and huge speculation. With the Chinese Central Bank tightening, things may start to unwind. Another important factor to note is if all the monetory loosening led to real lending. I doubt that.

India markets are not far behind in their performance largely driven by hopes. The corporate numbers so far have been mixed. While Infosys was just OK, TCS did quite well. On the other hand infrastructure giant L&T disappointed with its profit from core operations quite dismal and a steep decline in the order inflow. The budget was rather disapponiting but let's be realistic, the Finance Minister didn't have much breathing space.

The monsoons in India have so far been disappointing or below average. Even if it catches up now the damage has already been already done to crops. The whole of the rural economy, which everyone is banking upon, may not deliver given the present circumstances. Moreover, the country is facing a huge deficit in hydro power generation as a consequence. The rural juggernaut may fail to impress and food inflation may hit the roof.

The bank credit growth in India is finally showing some signs of bottoming, but the truth is that banks are still parking money with the RBI and are reluctant to lend. How long can the corporates sustain without the lifeline from banks and what happens to the majority of projects is debatable. But things don't look on the ground.

It seems that the global liquidity push by Central banks have resulted in a swift rally across equities and commodities, but is the rally sustainable? With valuations already rich or no longer cheap, the slightest disappointment may lead us downward. I am no economist and still learning my lessons, but I don't quite understand how a thing - the excess money supply and leverage that got us into this situation - can help us get past it.

The Japanese crisis of the 90s offers enough evidence that quantitative and credit easing may not be the solution to the problem. What most households and corporates are facing today is not only a liquidity crisis, but a solvency crisis. We have been bitten hard due to our excessive leveraged spending and speculation. The word leverage is of utmost importance here.

In the end, I want to add a few thoughts about green shoots that people are talking about. Though we have stopped declining at a rapid pace in terms of economic numbers, it is not prudent to say that the demand has picked up or is picking up. A few facts that all of us may take with a pinch of salt and think of before talking about a recovery:

  1. The Riskbank, Sweden’s central bank and the world’s oldest central bank, effectively cut interest rates to minus 0.25% and started a program of quantitative easing, a.k.a printing money on July 5.
  2. Piles of Corporate Debt will be due for refinancing across the globe in years to come, starting from 2011 till 2014.
  3. The cut down in global liquidity, due to deleveraging, is estimated at around 15 Trillion dollars. How on earth could the combined liquidity injection, of not more than 3 trillion dollars, fill this void?