download monthly pdf

Total Pageviews

Search This Blog

Tuesday, December 1, 2015

Know about financial leverage

Excessive leverage( leverage refers to the use of debt to acquire additional assets. Financial leverage is also known as trading on equity. Below are two examples to illustrate the use of financial leverage, or simply leverage.

For example Mary uses $400,000 of her cash to purchase 40 acres of land with a total cost of $400,000. Mary is not using financial leverage.

Sue uses $400,000 of her cash and borrows $800,000 to purchase 120 acres of land having a total cost of $1,200,000. Sue is using financial leverage. Sue is controlling $1,200,000 of land with only $400,000 of her own money) has been the single most important cause of economic and financial instability in the world. And we seem to be right in the midst of the problem once again, after barely having been able to shrug off[shrúg óf(minimize,हटाना)] the 2008 impact.

Be it the developed world or the developing ones, debt binges at various points of time have caused stress and vulnerabilities[vúl-nu-ru'bi-lu-tee(weakness,कमज़ोरी)] . Right from the Third World debt problem of the early 1980s to the Asian economic crisis of the late 1990s.

If it is the imprudence[im'proo-dun(t)s(unwise,अविवेकी)] of the governments that led to failures, the most recent being Greece, reckless[rek-lus(careless,लापरवाह)] borrowing by corporates created the junk bond crisis . Trillions of dollars of national wealth were eroded each time countries were faced with the outcome of the overhang of debt.

This time, the warning bells are for emerging markets where non-financial firms seem to have overstretched themselves. During the period 2004-14, corporate debt in emerging markets grew from $4 trillion to over $14 trillion.
Excesses in corporate leverage could impact the domestic economy. Recent developments in corporate debt of emerging markets firms, discussed by IMF in a recent report, could prove perturbing[pu'tur-bing(worrisome,चिंताजनक)] for policymakers and regulators. Major inducements for raising debt are not increased profitability or productivity, but easy availability of money and lower interest rates. That made emerging market corporates even negotiate for longer maturities.

Corporates also seem to have used easy debt for buyback of shares to consolidate[kun'só-li,deyt(strong,मजबूत)] their control and thwart[thwort(spoil,व्यर्थ)] competition. For instance between pre-crisis (2004-2007) and post-crisis (2010-13) years, key performance indicators for emerging market corporates such as profitability, asset quality, and solvency declined. This normally should have made corporates become more prudent[proo-d(u)nt(wise,बुद्धिमान)] , but in reality more debt was acquired even for projects with lower profit potential.

The Global Financial Stability Report (October 2015) noted, “As advanced economies normalise monetary policy, emerging markets should prepare for an increase in corporate failures.”

And that is only for starters. More problems are piling up[pI(-u)l,úp(collect,इकट्ठा)] for emerging markets. In 2010, stock markets globally lost $10 trillion worth of value. Global investors have taken away $40 billion (19 billion from stocks, 21 billion from bonds) from emerging market stocks and bonds during the September 2015 quarter, a level similar to 2008. Even a 250 billion yuan infusion could not prop up the falling stock market in China.

Emerging markets are facing intense pressures from slower growth, rising debt burden, capital outflows and declining prices for commodity exports. Frequent bouts of debt leading to financial stress and crisis put the global policy framework into question.

Countries undergo periodic financial sector assessment programmes. Financial Stability Boards were created to make periodic studies. A number of reports such as Global Financial Stability Report (IMF) and the Global Financial Development Report (World Bank) bring out empirical[em'pi-ri-ku(experimental,अनुभवजन्य)] research and perspectives on a wide range of current developments with regular frequency.

Serious gaps, however, still exist in appreciation and understanding of aspects of growth and stability. This is despite so much research and dissemination[di,se-mu'ney-shun(spreading,फैलाव)] being available in the public domain, apart from the power of various instruments and interventions that rest with the government and the central banks. The world has not yet finished with the outcome of splurging[splur(spend money,पैसे उड़ाना)] by sovereigns in the euro region and now a fresh crisis could hit the emerging market corporates.

India, fortunately, is relatively positioned on a stronger pitch as of now. Its currency lost only about 5 per cent against the US this year, domestic economic growth remains buoyant[boy-unt(cheerful,प्रफ्फुल)], foreign direct investment is surging and corporate profits growth is expected to be in the range of 12 per cent, against the current Asian average of 3 per cent.

Corporate debt during the last decade grew by about 15 percentage points (as a per cent of GDP) as against the emerging markets average of 26 per cent. India should harness these positives to avert[u'vurt(avoid,टालना)] repercussions[,ree-pu'kú-shun(indirect result,अप्रत्यक्ष परिणाम)] of stress in global and emerging markets.

Download monthly pdf of November

No comments:

Post a Comment

Story: Baby Camel and Mother story 11

A mother and a baby camel were lying around, and fortuitously(suddenly, एकायक) the baby camel asked, “mother, may I ask you some ques...