INDIAN BANKS AND GLOBAL MARKET MELTDOWNS

Consequent to the financial sector reforms initiated in 1991, Indian banking got a facelift with the foreign equity participation. The traditional banking system paved way to the technology-based banking. The products and dealing style changed to match international standards. Banks are now going to the customers than the customers to the banks, as was the practice a few years back. Banking industry became a profitable investment opportunity to retail and wholesale investors. The integration of Indian financial market with global market facilitated Indian banks to play in the overseas market. Consequently, the major banks created exposures abroad and when the recession in the global market could lead to substantial loss to our banks also. These sentiments played heavily resulting into the sudden crash of our stock market. Now the question is should we get panicky?

If we analyse the financial strength of our banks many of them are fundamentally strong. For example the ICICI Bank, India’s second largest bank has a capital adequacy ratio of 13.4 per cent as against the international standard of 9 per cent. Indian banks are still conservative in their lending operations. The collateral-based lending followed by Indian banks enables them to fall back on the collateral security in the event of loss of primary security. The supervisory and regulatory system in India is much stronger than that in US or UK. In India, the Reserve Bank of India is exercising close in-site and off-site supervision of the Indian and foreign banks operating in the country. There were no bank failures after the fall of Palai Central Bank in 1960 thanks to the intervention of RBI and facilitating merger with another strong bank. Bank deposits up to Rs.1 lakh is covered under the deposit insurance scheme. The banks also own assets in the form of land and buildings at prime centres. Therefore, there is no need of getting panicky on the fate of Indian banks.

Now the question is why people reacted so heavily on rumours? The answer is simple. It is the mob psychology. People do not want to test with their hard earned earnings. The so called investment advisors also has role in spreading such rumours. Their interest is that by advising to sell, they can expand their business because the investors are being saved from a further market crash. In this process they also gain because they also earn commission on the large volume transactions put through them. What happened in India recently is an excellent example to understand how sentiments can play in the stock market.

However, the market took a rebound on the assurance from RBI and Finance Minister. The government should seriously think of initiating action against such rumour mongers who are playing with the poor investors’ money.

MARKET SENTIMENT

What is Sentiment?
Human beings by nature cannot withstand loss to themselves or their near and dear. A death in the family, loss of property or wealth always brings sorrow to human beings. Every human being feels happy when any one in the family or among the friends has some fortune. Similarly, we always join with our friends and relatives in their sorrow. We have seen the bystanders also cry when someone mourn on a loss of property, loss of wealth or life or near and dear. This passion or feeling or emotion is generally known as the sentiment. Every human being is sentimentally attached to his/her family and near and dear. This sentiment distinguishes a human being from the animals.

Market Sentiment
The market sentiment is the intuitive feeling of the investing community regarding the expected movement of the stock market. The investors are sentimental about the market because they are either afraid of loss of their investments or expect a boon out of the booming market. Market Sentiment is the feeling or tone of a market, which is contributed by those participating in the operations. The sentiments sustain in the market as long as the market exists. Using sentiment is key to making money in the markets, particularly making money when everyone else is losing it. If market sentiment is bullish, then most investors expect an upward move in the stock market.

If sentiment in the market grows it means there are some wishing to move the prices up. Measuring sentiments is a difficult task, however, the post-effect can be measured. The evaluation of sentiment is the analysis of events, audience, determination of techniques according to which traders usually act. Usually, when something happens in the market the traders and investors respond to it in different ways. A positive move will be happily accepted leading to enhanced investments whereas a negative move may lead to sudden reactions like withdrawals leading to market crash. When an individual reacts to situation, it may not affect the market and therefore need not be considered as the market sentiment. But when the whole participants starts behaving in the same manner leading to the market moving to s specific direction in response to an event or happening in the market, it has to be considered as market sentiment. In short, the key to understanding the market and profiting from it is known as the Market Sentiment. Market Sentiment is based upon the fact that trading and investing is inherently emotional, and when a trader's emotions over rule his logic, that trader loses rational thinking and ending himself up in a loss.

How it Helps:
Market sentiment can help traders determine a trend's staying power, the strength or weakness of the trend, or when the trend's strength is questionable or even ending. There are still many who do not use market sentiment, and for this mistake, they pay the price by watching those profits slip through their fingers faster than they could grab onto them. The sentiments in the market indicate the behaviour of the market and enable the traders and investors to take advantage of the current market situation to the maximum extent. By studying the past trend one can derive conclusion on the type of sentiment the market pursue on different situations. For example, after the September 11 event, US stock markets crashed leading to the simultaneous crash in the world market. However, though people expected a big crash after the Tsunami in 2004 December, fortunately, the market did not respond. Another example is the sudden crash of stock market indices consequent to the spread of rumours about the financial soundness of ICICI Bank and the rebound of the market based on the statements issued by the Finance Minister Shri. P. Chidambaram, Reserve Bank of India, SEBI and the Mr. K.V. Kamath, CEO of ICICI Bank assuring the strength of the bank.

One important aspect of the formulation of sentiments in the market is the impact of the event on the market. The market will be affected if the companies whose scrips are traded in the stock exchanges perform as expected. There are different situations when a company may not be able to perform as promised. Some of these factors are policy of the government, political outlook of the ruling party, changes in economic fundamentals etc. When there are some changes in these parameters, the market will look at how this will add to the cost of the company and eventually a reduced bottomline. Therefore, understanding the sentiments and ability to read the sentimental movements will enable a trader to adopt suitable strategies and enhance his profits.

Sentiment Indicators:
A general approach to understand the market sentiment is by looking at the put-call ratio. Put call ratio is the ratio of put options to call options. When the put-call ratio is less than 1, it indicates that the market is bullish and the investors and traders resort to buy put options or write call options. On the other hand, if the put call ratio is more than 1, the indication is that the market is bearish and the strategy investors follow is by buying call options or write put options. Thus following the put call parity closely one can understand how the market behaves and formulate on strategies in order to reduce the losses.

Call and Put Options
A call option gives the holder the right to buy the underlying asset by a certain price, with no obligation for delivery of the underlying. A put option, on the other hand gives the holder the right to sell the underlying asset by a certain date for a certain price known as exercise price or strike price and the date is known as maturity. Options are excellent risk management tools. Since the contracts are exchange traded, the liquidity is preserved and when ever we want the money back, the position can be unwound and the investments could be taken back.

Contrarians Investments
Sentiment analysis tries to determine whether the market has grown unreasonably bullish or bearish and whether it is time to bet against the market crowd. Analysis of this kind is the basis of contrarian investing. Most times it's unwise to bet against the crowd it is usually profitable to be on the crowd's side. When the crowd grows extreme, it's time to switch sides. Contrarians try to identify the times when the crowd has turned extreme and hence identify market extremes. Taking the right side in such circumstances is a rare opportunity to comprehensively beat the market. For example; Warren Buffett dissolved his investment partnership in 1969, returning cash to investors. He could find no worthwhile investment opportunities and believed that the market was overvalued. 1970 saw a big fall in stock prices from those in 1969. In fact the whole of the early 1970s were terrible for stock investors. At its lowest value in 1974 the Dow Jones Industrial Average had fallen 40 percent from its highest level in 1969. In 1999 and again early in 2000, Sir John Templeton predicted a market crash on the scale of the great crash of 1929.

Conclusion
Knowing the market sentiments enables a trader or investor to take a suitable action and either reduce or eliminate his loss or enhance the profitability. The sentiments are formed looking at the potential loss to the corporate entities whose shares are traded in the exchanges. There are traders who could not survive in the market and suffered huge losses. Studying the market sentiments provide excellent research opportunities.

CAPITAL ACCOUNT CONVERTIBILITY AND CAPITAL MARKET

Capital account convertibility has now become a popular topic of discussion, especially after Reserve Bank of India published the second Tarapore Committee Report. Capital account convertibility refers to the freedom to convert the domestic currency to any internationally accepted currency. I also mean conversion of foreign currency into the domestic currency. The issue became a topic of debate after the first Committee on Capital Account Convertibility headed by Shri. S.S. Tarapore submitted their report in 1997. The second committee on Capital Account Convertibility, headed by Shri. S.S. Tarapore again submitted their report in July 2006. A lay man raise a question “ why the capital account convertibility attracts so much discussions?

Capital account is a part of the Balance of Payment (BoP) of a country, which represents the capital inflow to the domestic economy from other parts of the world. The current account, the other part of the BoP consists of trade account also. The trade account represents the trading balance, which is the net of exports, and imports A deficit trade account indicate imports exceeding the exports. The current account is the sum total of the other receipts and payments like debt service charges, travel and tourism and other payments and the trade account. Capital account on the other hand purely shows the capital inflow and outflow to the country and abroad.

While making their recommendations, the committee studied the international experience as well. The Latin American and East Asian currency crisis gave great lessons to learn before any country opt for full convertibility. Making a currency fully convertible attracts foreign investors extensively. When the domestic capital formation is very weak, countries will depend on overseas market for funding their business operation. Essentially, these countries will be forced to keep the interest above the international rate in order to attract capital. However, such countries will be forced to bring down the interest rate in order to protect their economy, which would eventually result into a sudden capital flight and depreciation in the value of domestic currency. The Committee on CAC was aware of this imminent danger and suggested a road map in their first report.

The major suggestions of the Committee were the spreading of implementation over a period of three years, financial consolidation by reducing the fiscal deficit , separate money and debt management, fiscal transparency, inflation targeting at 3-5 per cent, consolidation in financial sector, reduction of the level of Non-performing Assets in the Banking sector to below 5 percent, reduction of CRR to below 3 percent, refining the exchange rate policy by adopting a rate band of +/-5.0 percent etc. The Committee also suggested a schedule of implementation in a phased manner covering a period from 1997-98 to 1999-2000. The second committee suggested relaxation in invest norms, prohibition of Participatory Notes ((PN), increase in the limit for remittance abroad by individuals, permission to mutual funds to invest abroad etc. and suggested a five period ending 2010-11 for implementation. Many people have expressed their reservations against going for a full convertibility in light of the East Asian currency crisis.

Though capital account convertibility enables the residence to enjoy the benefits available at overseas markets through cross border investments and borrowings, the contagious effect of a currency crisis due to the integration of markets around the world always poses a danger to the economy. The worst affected would be the capital market since the capital market around the world are highly integrated. Empirical evidences show that a movement in the international capital market will have a reflection in the domestic capital markets also. Secondly, the opening up of economy would promote heavy inflow of FII activities in the capital market and resulting into excessive bullish tendency. This tendency will attract the domestic retail investors substantially and a reverse trend on account of a sudden withdrawal of FII activities will bring substantial loss to the domestic retail investors and damage the domestic economy to a great extent. The FIIs are looking for profit and when ever they smell a sign of reversal of returns, they will take back their investments and shift to another centre from where they can earn more. Therefore, in the interest of the economy, it is advisable to permit capital account convertibility under a controlled regime than opening up the economy fully.