US bailout package 700 Billion Dollar impact

The US Senate passed a $ 700 billion financial market rescue package on a 74-25 vote, authorizing the government to buy troubled assets from financial institutions rocked by record home foreclosures.

However, financial analysts across the globe are not too pleased with this bailout package, as, they feel that the losses could be to the extent of US $ 1.5 trillion. The market is also perturbed over the rising unemployment datas, coupled with falling factory orders which would ultimately lead to a fall in corporate profits.

There has been numerous negative arguments put forth saying that this bailout package may not be enough to rescue US financial companies out of its abyss, which may be right. But we need to look at it from another angle that, if this package were not to come about, an irreparable damage would have been caused, spreading it across the globe and damaging the economies of the emerging markets most, including India.

This package would enable the financial companies to inject the desired liquidity into the system and avoid distressed sale of assets, which otherwise would have happened, in the event of Investment Bankers and companies going bankrupt. Also, even if we assume that the funding gap is to the extent of US $1.5 trillion, atleast this package is to the extent of 50%. No one can really expect the entire relief to come in one go and even US $700 billion getting infused in the system, may control the damage to a great extent and at some point, it may come on its own and be self-sustaining. This fund infusion would greatly help to restore the confidence amongst the banks, as they are presently not willing to lend inter-se, suspecting the creditworthiness of each other.

In Indian stock market, FIIs have investment to the extent of U S $50 billion in equities, of which over; 50% is via participatory notes, which we have been seeing moving from one distressed FII to another healthy one. In the year 2008, FIIs have already sold Indian paper of close to US $ 9 billion, which now leaves small portion remaining invested. Obviously, one cannot really expect the entire FII portfolio getting liquidated, as all of them are not feeling the heat and are hard pressed to exit from emerging markets, including India.

This bailout package can be compared with the BIFR Rehabilitation package having been given to the Indian Corporates in the period between 1996 to 2003. Who would have imagined that a company like Jindal Vijaynagar Steel saddled with debt of close to Rs.5,000 crores with accrued interest thereon of an equal amount would be able to come out of the mess. Once a complete waiver of accrued interest and part waiver of principal were given to these companies, they regained their lost vitality.

In this situation, the brunt of the economy debacle were widely shared by financial institutions and banks, which were largely owned by the government. So, indirectly the relief in the form of rescue package came from the government, and that was the reason, which had kept the stock prices of PSU Banks ruling below its face value. Classic case was that of Bank of India, when it was ruling below Rs.10 and of Indian Bank, which had incurred a loss of over Rs.2,000 crores in one year alone. Most of these PSU Banks, had NPA of 10% and above and investors were not prepared to invest in the stocks of these PSU Banks, and have totally written them off.

A point, which we are trying to push here, is to show the benefits of fund infusion and waiver or grants, which are ultimately borne by the exchequer. It may take about 6 to 12 months of bailout funds to properly move into the system, which will re-lubricate the whole system and would bring back the economy on its track.

Even in US very few banks like Bank of America, J P Morgan, Citibank, or Goldman Sachs have remained in the fray who will ultimately be sharing the larger piece of the cake of the same size.

One argument cited against this US bailout package is that of comparing it at 5% of US GDP, which is at US $ 14 trillion. It is foolish to do so as one cannot expect the entire GDP of a country getting eroded or expecting an infusion of an equivalent amount in the system. Alternatively, one can compare it with the annual fiscal deficit of US economy, which is at around US $ 500 billion and this package exceeds the one-year deficit.

In Indian context, fiscal deficit of US $ 25 billion is expected in our budget for year 08 -09, which is at 2.5% of GDP. In realty, it would exceed over 8%, as fertilizer subsidy and oil companies under recovery itself could be over US $ 60 billion, which is equivalent to about 6% of the GDP.

Every coin has its two sides and one may argue for the sake of argument as one looks at it but the bail-out package is likely to have positive implications, which are likely to reflect in the next 6 to 12 months, especially for the emerging markets, including India.