US sub-prime crisis & Indian economy

Both global and domestic markets got a churn, by the US sub-prime mortgage defaults. Though the markets are recovering, helped by the interventions of central banks of major economies in the system, to ease the liquidity and credit crunch, experts are still taking a cue of the long term effects of the financial crisis.

The crisis having its origin in the US posed higher risk for itself. The problem started to take off in the early years of this decade, when housing prices began spiraling upwards in the US, residing on lower borrowing and lending rates. The latter, thus, boosted the demand for, and supply of new and existing houses. Tempting to capitalized the opportunity, many institutions offered home loans to borrowers with very poor or no credit histories, by charging higher than normal repayment levels. For the purpose, `sub-prime mortgages` were created - to attract investment banks and hedge fund owners, to bet big on this emerging aspect of the US economy. Seven times hikes in interest rates by the US Federal Reserves, since June 2004, however started to spoil the party and housing prices plummeted on rising borrowing cost. Consequently, sub-prime mortgage holders defaulted and headed to bankruptcy in March 2007.

Though the stock markets all over the globe, are now digesting the losses, the very first impact will be observed on the US economy. The resultant housing slowdown may hurt consumer spending, leading to an economic contraction. The economy, consequently, will grow at even slower pace than estimated before the mounting of losses. (Experts are mulling over the possibility of a recession)

The subsequent question can be raised, whether the global economy will really continue to grow at nearly 5%, amid the US slowdown. The managing director of the International Monetary Fund, Rodrigo Rato has said that, financial markets turbulence probably will curb global economic growth slightly this year. According to him, a downward correction is possible but will not be in a dramatic manner. He also accentuated in his recent interview that, the measures taken by the central banks of various countries to resolve the credit problems in the markets are `adequate and efficient`. Even so, it is noteworthy that the managing director altered that, in spite of the calmer mood in markets in recent days, it is still too early to draw definitive conclusions on the dimensions and effects of the crisis.

Indian economy, amidst the global slowdown however, is likely to remain intact from the spread of crisis, as the growth of the economy is rooted in its own ground. The attractive 8% plus growth is mainly driven by Indians, unlike other export-driven economies, which depend on US consumption.

Interest rates, more sensitive to any financial shocks are likely to come down in US with a faster pace than budgeted earlier. The emerging markets like India would be amongst the beneficiaries, as lower rates in major economies would make Indian assets more attractive. On the same ground, US dollar would be a big looser (Read: US dollar would depreciate against other currencies). A slowdown in US economy, weak liquidity and credibility might force investors worldwide to reduce their exposures in the world`s biggest economy.

The Indian economy, thus looks more safe as of now.