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European crisis escalates - Views on News from Equitymaster
 
 
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  • Oct 7, 2008

    European crisis escalates

    Markets see red again
    The deepening of the financial crisis in Europe triggered intense selling activity across global stock markets. While the Asian indices closed deep into the red ratcheting losses of 3% to 5%, European indices too were at the receiving end, closing lower by 6% to 9%. The BSE-Sensex mirrored the trends of the global stock markets and closed 6% lower. Government bonds rallied as increasing risk averse investors flocked to them for safety. The Euro weakened by more than 1% and dropped to a 13 month low against the dollar. Oil dropped to a 8-month low of US$ 88 a barrel mark on the worsening of the credit crunch and signs of a consequent slowdown of the global economy.

    European banks in the doldrums...
    The going is not easy for European banks. The subprime crisis, which emanated from the US and spread its poison to the European financial industry is now beginning to claim victims. And in the past week, European regulatory authorities have been on an overdrive trying to keep banks from going down under. For instance, BNP Paribas will take control of Fortis' units in Belgium and Luxembourg after government efforts to ensure the company's stability failed, while Germany's government and financial institutions agreed on a US$ 68 bn bailout package for Hypo Real Estate Holding AG. The authorities of France, Belgium and Luxembourg pumped in US$ 9.3 bn to bolster the capital base of Dexia, a public-sector lender having a presence in bond insurance. Meanwhile, the UK Chancellor of the Exchequer, Alistair Darling said Britain is 'ready to do whatever it takes''to help its banks. While a massive bailout plan akin to the US bailout package of US$ 700 bn has not been announced as such, European countries are working together "to limit the economic fallout, ease accounting rules, and seek tougher financial regulations".

    The Economist states, "There are two sources of pressure on the banks. To date government intervention has tended to focus on one or the other, but not both. The first source of pressure is concern about solvency, and the ability of banks to withstand further losses. The second source of pressure is liquidity". In the case of the former, even if the rescue package of US$ 700 bn by the US does eventually get passed, losses are still expected to accumulate as the bleakness of the economic environment deepens. As far as liquidity is concerned, many banks including the solid ones are finding it difficult raising long-term debt.

    ...and impacting the shipping industry too
    Akin to the airline industry, the global credit crunch is set to have an adverse impact on the shipping industry as well. And the Indian shipping companies have also been entangled in this web. As per reports in a leading business daily, Indian ship owners have outlined an investment to the tune of US$ 20 bn to replace part of their ageing fleet and expand cargo capacity. Given that many of them depend upon European banks for financing, the latter being embroiled in the credit crisis means that financing is most likely to get hard to come by. The Indian ship owners have so far considerably relied on European banks for their financing needs, as the funding from these banks is cheaper than local funds.

    While owners finance 20% of the cost of a ship, the balance 80% will have to be financed by debt and therein lies the problem. Debt is expected to become more expensive as banks charge more to wriggle themselves out of risks. In the long term, things might get smoothened out given that investment in shipping is a long-term commitment. However, the scenario in the medium term seems tough. Infact, the situation is not likely to improve until banks clean up their books and when this is likely to happen is anybody's guess. What does seem imminent is that the situation is not likely to change for the better next year atleast.

     

     

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