Business

A stitch in time saves nine

— PHOTO: AFP

STEMMING THE ROT: The dome of the U.S. Capitol in Washington DC. Top Republican and Democrat lawmakers plan to work through the week-end with officials from the administration to hammer out a proposal to stop the U.S. financial crisis.

A stitch in time saves nine goes the saying. But time only will tell whether the Bush administration’s radical bailout plan and the prompt intervention by major central banks the world over, including the Reserve Bank of India (RBI), last week, would actually help find a permanent solution to the unprecedented crisis facing the global markets.

Given that the central banks have infused a staggering $300 billion into the global financial system and the governments in several countries have committed themselves to pitch in their bit to address the situation, there is every reason for investors to heave a sigh of relief. But, their confidence continues to be extremely low not only in India, where the stock markets have been slumping since the beginning of this year, but also in the world markets.

The week began with announcements that: Lehman Brothers filed for Chapter 11 bankruptcy as potential suitors to the firm backed out; Bank of America acquired Merrill Lynch in an all-stock transaction valuing the latter at $50 billion; and the American International Group (AIG), the world’s largest insurance company, asked the U.S. Federal Reserve for an emergency funding.

Bad news hit the markets across the world by hour and day. No wonder the benchmark indices of the global markets touched new lows.

Lehman Brothers Holding — with $60 billion in bad debts — is the fourth-largest investment bank. Merrill Lynch is the third biggest investment bank— which also stuck with toxic sub-prime (real estate) with $40 billion write-downs. Towards the end of last week, AIG was bailed out by the U.S. Federal Reserve which extended AIG a line of credit of $85 billion at punitive interest rates and also took 79.9 per cent of the company’s equity.

As a result of these cataclysmic events, the global stock markets tanked on Monday last week. The Dow Jones Industrial Average lost over 500 points on September 15. Major European markets also fell sharply with the major stock indices in the region showing falls of 3-5 per cent. Asian markets joined the sell-off on Tuesday (with drops as steep as five per cent) in one day as many of them were closed on Monday. Back home, the Sensex crashed by 3.3 per cent on September 15 echoing the ultra bearish global sentiment. Tuesday was a day of relative calm in most of the world markets except for trouble spots like Russia, where the markets tanked a massive 21 per cent. However, the carnage resumed on Wednesday with stock markets falling across the board. Global markets crashed again by 2-5 per cent as panic set into the global financial system.

On Thursday, a massive $300 billion liquidity infusion into the world financial system was announced by the central banks of the U.S., the EU, Japan and Canada with the objective of calming the markets and providing liquidity to financial institutions. This liquidity injection seems to have worked so far as the markets recovered just as quickly as they fell.

A massive rally of 410 points was seen in the Dow Jones Industrial Average. The rest of the world markets followed suit on Friday. Asian markets were all up. Friday’s rally has almost wiped off the massive losses seen early in the week.

While the stock markets were falling, Indian currency too was declining against the U.S. dollar.

Later, a major intervention by the RBI saved it from plunging to new lows. In the light of current developments in the foreign exchange markets, as on some previous occasions, the RBI decided to sell foreign exchange (U.S. dollar) through agent banks to augment supply in the domestic foreign exchange market or intervene directly to meet any demand-supply gaps.

Several central banks and financial regulators have responded with unusual and unconventional measures to facilitate the orderly operation of financial markets and ensure financial stability.

On the home front, a statement made by Finance Minister P. Chidambaram on Thursday that the Indian banking system was ‘reasonably insulated’ from financial market woes unfolding in the US and that there was likelihood of a credit squeeze in the domestic economy as a fallout of the global financial crisis, has helped Indians put things in a perspective.

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