Businessworld
K Yatish Rajawat
Has the Minsky Moment passed? Now that the US Federal Reserve has announced a half-percentage point cut in two key interest rates — the Fed funds target rate, which is analogous to call money rates in India, and the discount rate at which banks can borrow from the Fed against securities — many seem to believe that the worst is behind us. But economist Hyman Minsky, who proposed the ‘Financial Instability Hypothesis’, would probably disagree. His views on credit cycles have been borne out in recent years: about the savings and loan credit crisis of the late 1980s, the Asian financial crisis at the end of the last century, and the technology stocks bubble in the early part of this century.
Lately, the term ‘Minsky Moment’ has become a fashionable way of describing what happened. Many economists have been credited with originating the term, among them Paul McCulley of PIMCO and UBS economist George Magnus. In a recent interview, Magnus says that “a Minsky Moment is the point at which normal lending and borrowing behaviour is interrupted such that it threatens systemic risk and leads to the intervention of the central bank”. Which they did, from the European Central Bank through the Bank of England and the US Fed to the Bank of Japan.
In Minsky’s words, from 1974, “The first theorem of the financial instability hypothesis is that the economy has financing regimes under which it is stable, and financing regimes in which it is unstable. The second theorem of the financial instability hypothesis is that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.”
But in India, most analysts and commentators dismiss it as not being applicable. Falling house prices and insolvency in the US and their connection to Indian equity markets is not very clear to most. Indian markets have risen on the back of global liquidity flows. Foreign funds have pumped in more than $39.9 billion (Rs 1,77,829.60 crore) between August 2003 and August 2007. But as the credit squeeze continues, global liquidity is affected, and risk is reassessed. It is, therefore, important for us to understand how the current credit cycle will play out.
Nouriel Roubini, professor of economics at New York University’s Stern School of Business, writes on his blog “the last few years suggest that a Minsky credit cycle has probably now reached a new peak. US households have leveraged excessively. Rising consumption, falling and negative savings, increase in debt burdens and overborrowing, especially in housing, an increase in leverage that was supported by rising asset prices of housing or equity”. All indications of a Minsky credit cycle, and this cycle takes time to unwind. Over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand. Which is where we are today, with respect to global credit markets.
UBS’ Magnus says the current Minsky credit cycle is not confined to the US housing market. “The deterioration in credit quality, delinquencies and defaults has already spilled over into leveraged loans, private equity and merger deals, and the US auto and credit card sectors,” he says. “It has also affected financial institutions in the UK, France, Germany, Australia and Taiwan and, probably, elsewhere too. What we are seeing is a revulsion against asset-backed credit and securities, especially mortgage-backed, and growing concerns about creditworthiness.” Magnus does not see the situation recovering anytime soon.
So, how does all this affect India? Vinod Sethi manages a $1-billion foreign fund investing in India. “The Indian markets have been driven by FII money till now, and some of their favourite stocks have very high valuations even by global standards,” he says. “The short-term impact can be that foreign fund flows slow down or stop; but this is debatable, and its impact is based on how long the contagion will last, and which banks and investors get pulled into it.” But market participants are now expecting a resumption of fund flows on the back of the Fed’s interest rate hike on Tuesday.
What happens to global liquidity, upon which Indian stockmarkets depend to some degree? Some economists are pessimistic about the likelihood of a quick-fix solution, despite the cuts in US interest rates. A repeat of a long-term capital management type bailout also looks remote. While the credit cycle does not affect corporate earnings in the short run, it may have a recessionary impact on the US economy, curtailing employment, consumption and spending.
“As investors in US markets consider recessionary expectations and returns on both equity and debt, they will look towards growing emerging markets, including India,” says B.P. Singh, advisor to the UK-based Atlantis Fund. “In the past five years, FIIs have gotten used to an absolute rate of return; they want 8-20 per cent returns on their investment.” In other words, almost all institutional investors, be they pension funds or university endowments, want hedge fund type returns. The only place they will be able to get this kind of an absolute return would be in emerging markets such as India, Singh points out.
Some folks favour the opposite view. If the credit cycle worsens in the US, most foreign funds will probably book profits in emerging markets, either to inject liquidity into their home markets or because of redemption pressures. “Some of the hot money that came through carry trade, which was primarily arbitrage money borrowed from low-interest Japanese market, has already gone out of the Indian markets because of the credit squeeze,” says a fund manager who advises a billion-dollar India-focused fund. “Hedge funds that suffer collateral damage due to the credit squeeze in the US will exit India.”
Waiting for debt-deflation dynamics to become evident in broader measures of the economy’s health, notably job creation, may take a while. The term ‘Minsky Moment’ is misleading; it is a dynamic, not a moment in time. So, don’t hold your breath about a recovery any time soon.
