Being in an export oriented sector, with revenues from US of most IT services companies touching 30-5o%, Sub Prime Loan Crisis has entered the popular pshcye of everyone and anyone involved. Nowadays almost every cost cutting measure is blamed on it - starting from the smaller sugar packs in the pantry to the employee travel freeze to the top honchos talking of de-risking the existing business models. ET yesterday carried an article of Satyam looking at Malaysia as an alternate location for offshoring services because the Malay Ringgit does not appreciate as much as the Indian Rupee (INR) in relation to the US Dollar (USD)
So what is the mystery of the INR appreciating compared to the USD? We would probably need to go back 7 years to unfold the entire story.
2001-2005 -> Real Estate Boom in the US results in the loan interest rates going down, because the risk of repayment reduces as a direct co-relation. So the average American finds it that much easier to take loans from financial institutions. Thus higher value-loans were given out to subprime borrowers; people whose credit-worthiness in low to catch on to the wave. The lenders' confidence in the real estate boom made them convert these subprime loans into bonds - this is what is know as securitization. These bonds were sold to banks, insurance companies etc. These bonds were also sold to hedge funds which invest in global markets.
2006-2007-> The real-estate scenario takes a complete U-turn and the risk in returning or rather in the repayment the loan increases significantly. Interest rate triples in the United States and it becomes difficult for the subprime borrowers to return their loans forming a vicious cycle of cause and effect. Borrowers prefer defaulting on their repayments and cuases the real estate prices to nose dive. In the meantime the Bonds turn into bad debt and the real estate prices fall further. The hedge funds to recover their money reduce their holding in other fast developing and rising global markets, namely the Indian Stock Market .
Result -> The market for Rupee increases – this reduces the value of dollar in comparison.
Summary -> Interest Rate Parity and Exchange Rate parity is relative in comparison with two countries.
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