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5 Questions About The Market Turmoil
Some believe the stock markets have overreacted, others believe the worst is yet to come. Here's what you need to know about the markets.
1. What was the Asian Financial crisis that a parallel is being drawn to it?
The Asian Financial Crisis of 1997 affected many Asian countries, including South Korea, Thailand, Malaysia, Indonesia, Singapore and The Philippines – the so-called "tiger economies". Growth in the region's export economies led to soaring real estate values, aggressive corporate spending, and huge public infrastructure projects - all funded largely by heavy borrowing. High domestic interest rates encouraged companies to borrow heavily offshore (at lower interest rates) in order to fund aggressive investment.
Most of these countries had fixed or semi-fixed exchange rates. Large current account deficits created downward pressure on those countries' currencies, encouraging speculative attacks.
The tipping point was the default of Somprasong Land and the bankruptcy of Finance One, bringing to realisation that Thailand's property market was unsustainable. Currency traders began attacking the Thai baht's peg to the U.S. dollar.
As it became difficult to fend off speculators, currencies were forced to float and devalue. As a result, companies that had received large unhedged foreign currency loans now faced impossibly high debt repayments in domestic currency terms. The panicked capital flight that ensued aggravated the currency depreciation, leaving indebted companies in even direr straits.
Between November 1997 and January 1998, Sanyo Securities, one of Japan's top 10 brokerage firms, went bankrupt with liabilities of more than $3 billion; Hokkaido Takushoku Bank, one of Japan's top 10 banks, collapses under a pile of bad loans; and Asia's largest private investment bank, the Hong Kong-based Peregrine Investments, filed for liquidation.
The Asian Financial crisis coupled with a fall in commodity prices hit Russia. By May 1998, Russia's financial system stretched to breaking point and the central bank raised rates to 150% to avert collapse of the ruble and stem the flight of capital. By August, Russia's stock market collapses, Russia defaults and devalues the ruble. Latin American stock and bond markets plunged on fears of default and devaluation in South America. Amid speculation that China will be forced to devalue its currency, Hong Kong's dollar and stock market came under attack. On August 31, 1998, the DJIA plunged 512 points, the second-worst point loss in the Dow's history. On September 17, 1998, Tokyo's Nikkei index hit a 12-year low.
Eventually the IMF and World Bank came to the rescue with bailouts and the U.S. Federal Reserve cut rates to prevent the financial markets from tripping the U.S. into a recession.
2. Why are commodity prices sliding?
Bloomberg reported that the Bloomberg Commodity Index of 22 raw materials from oil to metals dropped to 85.4282 points on Monday, the lowest level since August 1999, while Brent crude fell below $45 a barrel for the first time since 2009.
The 19-member Stoxx Europe 600 Basic Resources Index experienced its biggest single-day drop since December 2008. The Stoxx Europe 600 Oil & Gas Index had its worst day since October 2008.
Commodity prices have been low for a while; the common explanation being the global economic slowdown which has lowered demand for energy, minerals and agricultural products. With growth weak in Europe and unexceptional in the U.S., there is a lack of demand for commodities. Of the BRICs, Brazil and Russia will see their output decline this year, while China is slowing. According to reports, China accounts for about half the global demand for industrial metals, and between 2011-13, produced 50% more cement than the U.S. managed in the entire 20th century. Naturally a slowdown in demand from China will have serious repercussions.
Plummeting oil prices are great news for importing countries like India, but bad news for Russia, Venezuela and Nigeria. Oil prices have been under pressure due to concerns over oversupply, but now fears of a sharp slowdown in the Chinese economy (exacerbated by the devaluation of the yuan) and its impact on global markets has added to the pessimism. Pierre Andurand, a London-based energy hedge fund manager, was quoted in Financial Times saying, "For commodities, the move downwards was led by excessive supplies, but now demand growth is a legitimate concern."
3. What was the reference to 'Black Monday'?
Black Monday refers to October 19, 1987, a Monday, when stock markets around the world tumbled. The crash began in Hong Kong, spread to Europe and the U.S. The DJIA fell 508 points to 1,738.74 (22.61%). Yesterday, China's state news agency Xinhua tweeted that it was "Black Monday!"
The fall in China's stock market could have been viewed as a correction in the world's frothiest stockmarket. But things spiralled out of control. Earlier this month, China, the world second-largest economy, surprised investors by devaluing its currency. On Friday, the country reported its worst manufacturing results since the global financial crisis. China's benchmark Shanghai Composite index fell by nearly 40% since June, after soaring more than 140% last year. Since China has been a major contributor to economic growth, the markets reacted badly.
The Guardian summed it up neatly.
- The DJIA ended the day down 588 points, having shed more than 1,000 points in early trading. The S&P 500 and Nasdaq were both in correction territory, down 10% on their recent peaks.
- In London, almost £74bn was wiped off the value of the FTSE 100 index, in a rout led by mining giants.
- European stock markets suffered their worst days trading since 2011.
- The selloff began in Asia, where Australia's market suffered its biggest fall since 2009 and Japan's Nikkei slumped over 4%.
- China was the worst hit, with the Shanghai composite index dropping 8.5% in the biggest selloff since 2007.
4. How did this affect India?
India's stock market did not escape the carnage. The rupee, which ranged between Rs 63-65 for a while tumbled to almost Rs 67 per dollar, its lowest since September 2013. Reserve Bank of India governor Raghuram Rajan said the central bank will not have any "hesitation" in using foreign exchange reserves to reduce currency volatility. The RBI does not target a specific level for the rupee, but intervenes in forex markets through state-run banks to curb volatility and exercise some control.
While he was careful not to comment on the direction of markets, he did say that "relative to other countries India is in a good position with strengthening growth, a low current account deficit and narrowing fiscal deficit, moderating inflation, low short term foreign currency liabilities and very size-able exchange reserves relative to imports and liabilities".
Finance Minister Arun Jaitley was quoted in Reuters as saying that the devaluation of the Chinese yuan currency may have a transient impact on India.
5. Will the U.S. Federal Reserve raise rates?
All this drama puts the Fed in a precarious position with regards to tightening monetary policy in the very near future. Economists and analysts had widely expected the central bank to act in September, but it is no longer a done deal. The sell-off has made them increasingly dubious of those predictions. A growing number believe the Fed will wait until the end of the year to hike rates.
The Fed's next scheduled meeting is September 16 and 17, which will be followed by a news conference by Fed Chair Janet Yellen. The next one would be December 15 and 16.
In just one week, the odds of an interest rate hike went from likely to unlikely. No one knows for sure. The volatility could abate. And the Fed would consider hard-core data (inflation, employment) before it arrives at any decision.