Sudip Bandyopadhyay’s Blog

“I can calculate the motions of heavenly bodies, but not the madness of people.” – Sir Issac Newton, 1721, after the South Sea bubble burst.  Sir Issac Newton is said to have lost his life’s savings during the South Sea bubble.  We think to ourselves, “A smart guy like that should have known better”.  It can’t possibly be that in the sophisticated, computerized 21stcentury, we find ourselves experiencing the same kind of financial panic – the same kind of financial insanity, really – that has dogged mankind at least since the Dutch tulip mania of the 1630s.  We look at those other eras – Dutch tulips and the South Sea bubbles, the panics of 1825 and 1907, the crash of 1929 – and they seem so predictable in retrospect.  They were marked by years of speculative excess, by financial innovation that got out of control and by mammoth asset bubbles that seem incredibly oblivious in hindsight.  There had to be a crash.  It was all so unsustainable!

People keep on stepping on the same rakes because money, like romance, is only partly an intellectual experience. In finance, the process is cyclical.  Some people learn from their ancestors, but mostly they repeat the same mistakes.  Thus it has always been and thus it will always be.  It is not just the analytical part of our brain that deals with money; it is also the instinctive, emotional part – what we like to think of as our gut.  A lot of the time, our gut gets it wrong.  And that is as true of high powered investment bankers as it is of mom-and-pop investors.  Mr. Robert Shiller, the Yale economist, said, “One thing we know about human behaviour is that our memory is influenced by recent events.”   Thus, when we are living through a housing bubble, it is hard not to get caught up, emotionally, in the idea that prices can only go up – even though our analytical brain knows that acting on such impulses defies logic.  But in the moment, a kind of unshakeable euphoria takes over, and we just can’t imagine its ever ending.  Similarly, when times are bad, fear and loathing capture our imagination, and we find it equally impossible to see a glimmer of hope.  We take actions to protect ourselves – like banks refusing to lend to other banks — even though these individual actions result in a cumulative panic.  That is where we are now.

The UK bailout plan has been seized upon, not just in UK but around the world.  Paul Krugman, the Noble Laureate Economist praised the British Government for showing clear thinking and commented that “the British plan isn’t perfect, but it offers by far the best available template for a broader rescue effort”.  The UK Government measure - to recapitalize banks, to guarantee inter-bank lending and to extend liquidity provision are systematic and comprehensive.  The scale of the response is indicative of the depth of this financial crisis – arguably the worst of the past century.  By insisting on high capital ratio, the UK scheme creates fortress banks, able to withstand the after shocks and win wider confidence.  Nervous of each other soundness, banks are not currently lending to one another.  Spurred by guarantee on inter-bank lending, the first sign that the plan is working should be visible in the money market as banks start lending to one another again.  The next indicative to watch will be the availability of credit to the wider economy.

Domestic markets continued to bleed based on weak global cues through out the week, which translated into relentless selling from FIIs. The market sentiment has hit rock bottom and the near term market scenario looks alarming, with the Sensex for the first time in last two years having cracked very significant support level of 10000 and closed below these levels for the week. Cumulatively both Indices, Sensex and the NIFTY have witnessed a deep cut of about 22% till date this month, which is the steepest monthly ‘fall’ ever recorded in last two years.

Crude prices have continued to soften further and have come down to $69 per barrel on weak global demand and on fears of a recession looming large in the global arena. Lower crude prices are definitely positive in the long term for the Indian economy and would go a long way in improving the overall balance of payment scenario going ahead. Inflation was also seen moderating to 11.44% from 11.80% last week. Inflation now seems to have peaked out and is expected to be around 8% by March 2009.

In a bid to bolster market confidence and to infuse liquidity, RBI in a swift action announced another unexpected CRR cut of 100 bps to 6.5% retrospectively (i.e. from 11 October 2008). With this recent CRR cut the cumulative CRR has now been reduced by 250 bps in the just one week.  The latest cut is expected to infuse around Rs. 40,000 crs into the system and the total liquidity injected by RBI with this measures now stands around Rs 1,00,000 crs.  As another measure to provide liquidity to Mutual Funds, RBI has extended a Special Repo window to the tune of Rs 20,000 crs to meet redemption requirements.

Globally, the US markets continued to witness extreme volatility through the week. Market mood remained extremely cautious with negative news-flows from financial majors like CITIBANK, MERRILL LYNCH and JP MORGAN all reporting heavy losses in  there Q3 numbers. Retail sales numbers were also highly disappointing and added to the financial woes.

This week, the market scenario still looks weak as relentless portfolio unwinding from FIIs continues in the cash segment and Buyers are staying away. Sentiments are clearly nervous and ‘fear’ has now gripped equity markets.  Any new global financial market problem may trigger a fresh sell off which could further worsen the sentiments.  Proactive measures taken by the Finance Minister, RBI and SEBI are reassuring and there is a strong reason to believe that all possible steps would be taken to protect and insulate Indian economy, as far as possible from the ongoing global financial crisis.