When I was a student in MBA school, I used to dream of an ideal world.
I used to believe in the lessons that my esteemed teacher would impart. Eyes lit with optimism, a burning desire to apply the knowledge in the real world, I set afoot outside school.
I still remember when I went to live in Africa — I carried my corporate-finance textbook with me. Boy, was I naïve!! My guru, who understood my zeal, asked me to set aside the books and took it upon himself to impart real world lessons to me.
Today, I have discovered one such loophole, which is being deeply exploited by a few investors and by the big banks. It is a unique opportunity for Indian citizens and residents overseas as well as big banks to make more and more money due to an unusual circumstance in the market.
For the past many years, I have noticed inverse thinking in the market. In times of fear (2008-2009) and to some extent now, the market always considers buying U.S. dollars and U.S. Treasurys as the “risk reduction” trade.
I can scream until I am blue in the face that it is the exact opposite.
The most indebted nation in the world is the United States. The scale of debt (per person, percent of GDP, etc.) is rising to unsustainable levels. There is no real sign of reduction of spending as we seem to hit higher and higher levels of deficits each passing month.
Compound that with almost no job growth, tepid real business growth and stagnant housing market. All of these aren't signs that make me want to go out and buy U.S. dollars. And yet the global traders seem to believe that buying U.S. dollars is the flight to safety trade.
The current Greece and Europe crises have created a massive U.S. dollar-buying opportunity in the past few months. While the U.S. economic fundamentals haven't improved significantly, we certainly have seen very large buying of U.S. dollars globally.
This has created U.S. dollar liquidity shortage in the global markets. Banks around the world are starved of U.S. dollars. The crisis has reached epic proportions already and currencies that are under the gun are hurting more than others.
India and the Indian rupee is one such victim. Due to the acute shortage of U.S. dollars in the Indian banking and corporate circles, the Reserve Bank of India has become desperate to gain liquidity. As a result, it has forced the local and foreign banks in India to offer incredible interest rates on foreign currency deposits.
In simple terms, if you are a qualified investor (Foreign Institutional Investor) or a Indian resident or citizen staying overseas, you can send in U.S. dollars and invest in a U.S. dollar-denominated CD for one year and earn 3.1 percent interest.
Here in the U.S., you can earn maybe 0.5 percent or a maximum of 1 percent dependent on your bank for a one-year deposit.
So if I have the ability to borrow funds in U.S. dollars and send it over to India to invest in CDs without any conversion risk, I can enjoy interest arbitrage and earn a healthy margin.
Large banks can borrow funds at 0 percent to 0.25 percent and invest in Indian bank CDs at 3.1 percent, earning a spread of more than 2.5 percent for just transferring money and then bringing it back after a year.
So much for working hard to earn money. Paper pushing seems to pay after all.
I am finding out how much I can borrow and if I have any spare U.S. dollars, it is headed to my bank in India to earn money for free …
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