BOOM OR BUBBLE

Nearing the gates of an impending global credit crunch?

KANWAL SALEEM, LAHORE
Aug 13 - 19, 2007

The fear of an impending global economic slowdown resounds throughout the world. Gone are years of low interest rates and high consumption led growth. Rising incomes world over especially in emerging economies like China and India, has led to a steep rise in international commodity prices and soaring inflation. The credit take off has led to the buildup of a real estate bubble and a steep rise in house prices in major cities of the world. Cheap borrowing venues and a sharp rise in mergers and acquisition has resulted in equity markets through out the world to grow in leaps and bounds.

As central banks attempt to tackle inflation through monetary tightening and interest rate increase, it risks jeopardizing the global growth momentum achieved to date. The most visibly negative impact of a global liquidity squeeze will be on financial markets especially equity markets. Share prices will fall with a decline in investor confidence to take expensive loans for takeovers bids. Uncertain financial environment will hence hamper activity in private equity leading to high volatility in share prices.

Interest rates in US have been on a consistent rise since FY04 and 3 month US T bills rate reached 4.82% in Jul-08 as compared to lows of 0.88% in Jan-04. Higher interest rates have caused a housing slump in the United States. Increased mortgage payments have raised default rate thus placing mortgage lenders at a precarious position. The severity of the impact on mortgage investment market can be gauged by the recent bankruptcy of American Home Mortgage the 10th largest lender in US. The housing market doldrums in the US can spill to other economies if banks hit by mortgage losses, reduce loans for takeovers and acquisitions which till have been the main driving force behind equity market excellent performance. Already there has been a global share sell off with major markets like S&P 100, NASDAQ, FTSE 100 and most Asian markets including KSE showing increased volatility and a steep slump in their indices.

US INTEREST RATES ON A CONTINUOUS INCREASE

Source: www.federalreserve.gov

In order to shield their financial markets from a potential meltdown, the central banks of EU, Asia and US, have all pumped a record amount of money into their financial system. On Thursday and Friday European Central Bank injected EUR156bn into its financial system and New York Federal reserve injected USD 24bn on Thursday. However in spite of such steps, European, Asian and US markets have fallen considerably in this week. FTSE 100 lost 3.7%, Nikke 225 index closing at a 5 month low and is down 3% and S&P500 is down more than 1%. Funds of major banks like BNP paribus, Deutsche Bank, UK Man group, etc. have been hit hard because of their exposure to US subprime mortgage market which is in doldrums at the moment.

However in Pakistan, instead of support being provided to financial market in such dire times, the conditions have been made even worse. The State Bank of Pakistan has further tightened its monetary stance with the policy discount rate increased to 10%. This move has depressed market sentiments and can hinder its growth. Moreover further tightening doesn't seem justified when the financial markets in Pakistan are already under huge strains from falling portfolio investment and increased uncertainty caused by a turbulent political climate and worsening law and order situation. In the past two weeks KSE has remained extremely volatile and in this week alone it lost about 700 index points i.e. 5.6% of the total index. The continuation of political uncertainty, tight monetary conditions at home and chances of a global credit crunch means that Pakistan equity markets will remain in flux for quite some time.

LENDING RATES IN PAKISTAN STILL RISING

Source: State Bank of Pakistan