3. Financial Crisis
The term financial crisis is applied broadly to a variety of
situations in which some financial institutions or assets
suddenly lose a large part of their value.
In the 19th and early 20th centuries, many financial crises
were associated with banking panics, and many recessions
coincided with these panics. Other situations that are often
called financial crises include stock market crashes and the
bursting of other financial bubbles, currency crises, and
sovereign defaults.
Financial crises directly result in a loss of paper wealth; they
do not directly result in changes in the real economy unless a
recession or depression follows
4. Speculation
In the capital markets, speculation refers to the buying,
holding, and selling of securities to profit from fluctuations
in price, as opposed to buying these instruments for use or
for income via methods such as dividends or interest.
Speculation is typically a short-term or intermediate-term
active strategy.
The role of speculators in a market economy are to absorb
risk and to provide liquidity in the marketplace, for the
chance of monetary reward. Speculators provide trading
volume and liquidity in what would otherwise be an illiquid
market without the presence of speculators.
5. Economic Bubble
An economic bubble (sometimes referred to as a
speculative bubble, a market bubble, a price
bubble, a financial bubble, a speculative mania or a
balloon) is "trade in high volumes at prices that are
considerably at variance with intrinsic values". It could also
be described as a trade in products or assets with inflated
values.
6. Financial contagion
Financial contagion refers to a scenario in which small shocks, which
initially affect only a few financial institutions or a particular region of an
economy, spread to the rest of financial sectors and other countries
whose economies were previously healthy, in a manner similar to the
transmission of a medical disease. Financial contagion happens at both
the international level and the domestic level.
At the domestic level, usually the failure of a domestic bank or financial
intermediary triggers transmission when it defaults on interbank
liabilities and sells assets in a fire sale, thereby undermining confidence
in similar banks.
International financial contagion, which happens in both advanced
economies and developing economies, is the transmission of financial
crisis across financial markets for direct or indirect economies.
7. Currency crisis
A currency crisis, which is also called a balance-of-
payments crisis, is a sudden devaluation of a currency
caused by chronic balance-of-payments deficits which
usually ends in a speculative attack in the foreign
exchange market. It occurs when the value of a currency
changes quickly, undermining its ability to serve as a
medium of exchange or a store of value. Currency crises
usually affect fixed exchange rate regimes, rather than
floating regimes.
8. Liquidity trap
A liquidity trap is a situation in which
injections of cash into the private banking system
by a central bank fail to lower interest rates and
hence fail to stimulate economic growth. A
liquidity trap is caused when people hoard cash
because they expect an adverse event such as
deflation, insufficient aggregate demand, or war.
Signature characteristics of a liquidity trap are
short-term interest rates that are near zero.
10. Japanese asset price bubble
The Japanese asset price bubble was an economic
bubble in Japan from 1986 to 1991, in which real estate and
stock prices were greatly inflated. The bubble's subsequent
collapse lasted for more than a decade with stock prices
initially bottoming in 2003, although they would descend
even further amidst the global crisis in 2008.
The Japanese asset price bubble contributed to what some
refer to as the Lost Decade. Some economists, have argued
that Japan fell into a liquidity trap during these years.
11. What actually happened?
In the decades following the Second World War, Japan implemented
stringent tariffs and policies to encourage people to save their income.
With more money in banks, loans and credit became easier to obtain,
and with Japan running large trade surpluses, the yen appreciated against
foreign currencies. This allowed local companies to invest in capital
resources much more easily than their competitors overseas, which
reduced the price of Japanese-made goods and widened the trade surplus
further. And, with the yen appreciating, financial assets became very
lucrative.
So much money readily available for investment, combined with
financial deregulation, overconfidence and euphoria about the economic
prospects, and monetary easing implemented by the Bank of Japan in
late 1980s resulted in aggressive speculation, particularly in the Tokyo
Stock Exchange and the real estate market.
12. Time after the bubble's collapse
(Lost Decade)
The strong economic growth of the 1980s ended abruptly at the start of the 1990s. In
the late 1980s, abnormalities within the Japanese economic system had fueled a massive
wave of speculation by Japanese companies, banks and securities companies.
A combination of exceptionally high land values and exceptionally low interest rates
briefly led to a position in which credit was both easily available and extremely cheap.
This led to massive borrowing, the proceeds of which were invested mostly in domestic
and foreign stocks and securities.
Recognizing that this bubble was unsustainable, the Finance Ministry sharply raised
interest rates in late 1989. This abruptly terminated the bubble, leading to a massive
crash in the stock market. It also led to a debt crisis; a large proportion of the debts that
had been run up turned bad, which in turn led to a crisis in the banking sector, with
many banks being bailed out by the government.
This led to the phenomenon known as the "lost decade", when economic expansion
came to a total halt in Japan during the 1990s. The impact on everyday life was muted,
however. Unemployment ran rather high, but not at crisis levels. This has combined
with the traditional Japanese emphasis on frugality and saving to produce a quite limited
impact on the average Japanese family, which continues much as it did in the period of
the miracle.
13. Aftermath of “Lost Decade”
In response to the recession, Japanese policymakers tried a series of
government economic stimulus programs and bank bailouts.
A 2.4% budget surplus in 1991 turned to a deficit of 4.3% by 1996
and 10% by 1998, with the national debt to GDP ratio reaching
100%.
In 1998, a $500 billion bank rescue plan was implemented to
encourage bank lending and borrowing.
The central bank also attempted to increase inflation (which devalues
savings over time), to encourage consumer spending.
By 2003, the Japanese economy began to recover, helped by imports
from the U.S. and China that helped Japan achieve a real growth rate
of 2%.
15. Indian Stock Markets
The stock market has experienced a strong
comeback from the dark days of the financial
crisis of 2008. The Bombay Stock Exchange
Sensitive Index, better known as the BSE Sensex,
has grown phenomenally beginning 2002.
The question that needs to be answered,
however, is whether this is a bubble, and is it
close to bursting?
16. Table 1- Average December P/E Ratios and the BSE Sensex
AveragePE Ratio in
Year Sensex % Change December
2000 3972 20.84
2001 3262 -17.87 15.59
2002 3377 3.52 14.37
2003 5839 72.89 17.3
2004 6603 13.08 18.15
2005 9398 42.33 18.07
2006 13787 46.70 22.51
2007 20287 47.15 26.94
2008 9647 -52.45 12.16
2009 17465 81.03 21.82
17. Is the Sensex Worth It?
Table 1 compares the average December P/E ratios for
the Sensex from 2000 through 2009 with the percentage
increase or decline in the index.
The Sensex fell only twice during this period; both times
the fall was in the year subsequent to a year in which the
December P/E was over 20. The large fall of 52% in
2008 followed two consecutive years in which the P/E
ratios were high, i.e. above 20. The years 2009 and until
now 2010 have also been two successive years of P/E
ratios over 20.
18. Year Ending DJIA % Change Sensex % Change
1997 7908 3659
1998 9181 16.10 3055 -16.49
1999 11497 25.22 5006 63.83
it is clear that 9 out of 12
2000 10788 -6.17 3972 -20.65
times since 1997, the Sensex
2001 10022 -7.10 3262 -17.87
has moved with the DJIA.
2002 8342 -16.76 3377 3.52 Does this mean that the
2003 10454 25.32 5839 72.89 Sensex most of the time
mirrors the movement of the
2004 10783 3.15 6603 13.08
DJIA?
2005 10718 -0.61 9398 42.33
2006 12463 16.29 13787 46.70
2007 13265 6.43 20287 47.15
2008 8776 -33.84 9647 -52.45
20. Output
Another threat to India’s economic growth is the slump
in the country’s industrial output, which dropped five
percent compared to last year. It was the first fall in over
two years.
In fact, the Indian government had expected a growth
rate of 9 percent by March next year, but now analysts
say India will struggle to grow even 7 percent. While
this figure is still much higher than in Europe or the US,
it is the lowest growth figure for India in a number of
years.
21. Parliament
To add to India’s growing monetary worries, both the
RBI and parliament seem hesitant (or unable) to act
swiftly. Parliament has not yet decided on measures to
lift some economic pain, as politicians simply cannot
reach agreement on which measures should be taken.
Meanwhile, the RBI is unable to ease monetary policy,
something that national banks in other countries such as
Brazil and China have already done.
22. European austerity measures
Another threat to India’s economy are Europe’s
austerity measures to ease the euro-debt crisis.
Harvard University professor Amartya Sen told the
Financial Times that this would lead to a “spiraling
catastrophe”, as these measures will result in lower
demand for Indian products and services.“Given that
these austerity measures will continue for the next
decade or so, the outlook for India’s economy is not
bright,” Mr Sen added.
23. Rupee
The falling value of the rupee to the dollar is another
headache for the RBI.
The rupee has lost over 22 per cent since the beginning of
the year.
Global risk aversion is putting pressure on the domestic
currency as foreign funds are pulling out money. Besides, a
widening current account deficit and concerns of investment
in India is also putting pressure on the rupee.
Economists think the rupee will fall further in coming
months.
24. Next victim?
Economists now fear that India and other Bric countries may
be the next victims of the worldwide economic crisis. For
India, smaller growth would have a disastrous effect on
employment and income, as many Indians would lose their
jobs if the economy falters.
The Indian stock markets have come very close to the danger
zone in terms of P/E values. The daily uncertainty facing the
global markets with respect to sovereign debt, bank
exposure, and slow economic growth make this a
particularly dangerous time for investors. The Indian stock
market is vulnerable to any sudden degradation in investor
sentiment that could be brought on by events foreseen or
unforeseen.
