ARE WE OVER-REACTING TO SUB-PRIME?

The sub-prime crisis is well and truly upon us. Institutions once considered infallible are toppling like nine pins. The key question is how badly will India be affected by this problem and are we showing the classical signs of a knee jerk recation?

The sub-prime crisis is of American and European origin and Indian markets are down much more than these markets even though directly we are the least affected. Our banking system is still extremely solid ( thanks to the RBI) and at worst a few private Indian banks with exposure to sub prime assets might suffer from losses which are just a fraction of their total assets. So the impact of the damage to the Indian economy would be basically on three fronts viz. drying up of flows to the capital markets, shortage of funds for corporates to borrow in order to meet their capital expenditures and reduction in orders to export driven industries.

Clearly the first one would not affect the fundamentals other than prevent companies from raising funds at hugely inflated valuations ( which was one of the reasons for the rise, remember Reliance Power). The second factor would be valid, but not to the extent projected, because a large number of companies have already expanded capacity and have their capex requirements tied up. Again the RBI is expected to do its bit by realeasing some of the throttle it had on the liquidity on the system, aided by a falling inflation rate. As far as reduced business to Indian exporters is concerned, they would face pressures to lower their prices in order to keep up sales, but in this they have the US Dollar on their side which has appreciated by almost 20 % from its lows against the INR. So even though India might face some collateral damage from the sub prime crisis, it is not expected to majorly impact the fundamentals of the economy and might indeed have some desirable side effects.

India being a net consumer of commodities would be the biggest beneficiary of the fall in prices. This would give a boost to sagging bottomlines. Not only that, Indian corporates could look at acquiring overseas companies at bargain prices due to the fall in share prices. This could help them to consolidate their position and quietly wait for the cycle to change. I believe that the current fall presents Indian investors with an incredible opportunity to buy stocks which are fundamentally sound but are beaten down without reason to such low valuations. If you look back a couple of years down the line, I think those who have the guts to buy today will not be regretting their decision.