Expert Zone

Straight from the Specialists

Too many questions, no convincing answers

October 11, 2011

(Nipun Mehta is an award-winning private banker with many years of experience across Asia. The views expressed in the column are his own and not those of Reuters)

If one were to evaluate global events of the last four years dispassionately, the subprime mess in the U.S. and the imminent debt default by Greece (and four other countries to a lesser extent) and the resultant crisis in the euro zone have virtually held the global economy to ransom.

This generation of bankers, analysts, bureaucrats, politicians or even economists, has not been witness to the kind of convolutions that governments and markets are passing through. All this has also led to credit rating agencies taking some surprising and some highly inexplicable decisions.

The outcome of this extraordinary, though not entirely unexpected, chain of events has been various out-of-the-box decisions and/or suggestions like introduction of a new tax on the rich called the ‘Buffet Tax’, an offer by Brazil to start funding the euro zone deficit (much like the tail wagging the dog), of breaking up of the EU, of easing Greece out of the EU, of issuing a new layer of ‘Euro Zone Bonds’, tranches of quantitative easing by the Federal Reserve, etc. The pendulum of risk aversion has swung so sharply that gold and more recently the dollar are the only asset classes that have performed in the last few quarters.

The uncertainty created by persistent delays in a clear decision within the euro zone has created a lot of volatility across markets and asset classes. The latest potential solution of investors taking a 50 pct cut in their investment in Greek bonds will shave off billions of dollars of assets from a few European Banks’ books and impair their balance sheets by raising a serious question mark on their overall asset quality.

Bank rating downgrades have already happened in Europe and unless governments capitalise some of them soon, an impending banking crisis is brewing in some European countries. Due to their huge exposure to Greek bonds, two of the largest French banks have already been forced to announce a 110 bln euro asset liquidation over the next few years to strengthen their balance sheets. Can you imagine the impact of such a measure on global businesses in various countries?

The kind of volatility across bond, forex, commodity and equity markets that we have seen globally over the last few months has been immense, and unknown to many, with far reaching implications. If a close to 9 pct rupee devaluation (vis-à-vis the dollar) over the last three months can create havoc amongst businesses, imagine the kind of impact on P&L a/cs, of bond price movements on profitability of some global banks, of importer or exporter revenues in case of adverse forex movement. The fact that company budgets have gone awry or government fiscal deficits estimates have increased will be apparent only after a lag. It’s best to be prepared.

Amidst all this mayhem in the bond markets, there has been an interesting fight for market capitalisation leadership in equity markets in certain countries. Let us take the case of the U.S. and India. Over the last few months, at above $400 bln, Apple overtook Exxon Mobil as the world’s most valuable company in terms of market capitalisation, before the launch of the iPhone 4S brought it down to $350 bln. After several years of dominance, Microsoft at $219 bln briefly gave way to IBM as the second most valuable software giant. At $ 72 bln now, Citigroup lost more than 50 pct from its 52-week peak market capitalisation and has allowed JPMorgan to surpass it and become the largest bank by market capitalisation in the U.S. at $76 bln. For a brief period, Coal India overtook long time leader Reliance Industries in the domestic space, amidst colossal erosion in investor portfolios over the last three years.

All this market behaviour gives rise to several unanswered questions.

When a financial robust government-owned bank like SBI is downgraded while several weaker European banks are rated far higher, are the credit rating agencies above board? Do they have a ‘consistent’ rating rationale? How long will the current global recession last?

What will be the shape of the euro zone over the next few years? Will it stay intact or will it split up?

A lot of focus has been on European banks’ exposure to Greek bonds, what about their exposure to debt issuances by Italy, Portugal, Spain and Ireland? Italy was downgraded 3 notches by Moody’s on Oct 5. What impact will this and other downgrades have on banks’ NPAs and their ratings? Obviously it will lead to another bout of crisis and uncertainty.

In the market capitalisation sweepstakes, which will be most valuable company over the next few years? Will the Chinese conglomerates overtake the Apple and Exxon Mobils of this world? My take is that over the next five years, Google (presently at $162 bln) will overtake both Microsoft and IBM in terms of market valuation. Closer home, Reliance could give way to other PSUs, even as PSU banks like SBI (at around $23 bln) will inch closer to the Citibanks of the world.

Various global markets are presently in a state where there are too many questions without any convincing answers. The fact remains that the contagion effect of the developments in the EU will ensure that at least for a few more months, the global economy grows at a slower pace. Undoubtedly, its impact will be felt on the Indian markets too.

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