The Indian stock market is beginning to reflect the true scale of the global financial crisis. The wave of selling on the two big exchanges reflects the larger bearish mood across Asian markets, which in turn have taken their cue from western markets. As the financial crisis has spread from the US to Europe, it has sucked in yet more banks and financial intermediaries. Institutional investors therefore seek to unlock cash so that they can deal with the liquidity problem that has caused a seizure in the world of finance. With FIIs owning about $105 billion in Indian stocks (roughly a sixth of the total market), selling pressure can be expected to continue for weeks and months. So far, net FII sales are still barely $9 billion. The downward pressure on the market will therefore be sustained; most analysts are now of the view that this bear phase will last well into 2009. Domestic investors will therefore wait to time the market bottom, before they get in with their money.
The Sensex has lost close to half its value since January, and is at the level it first reached 30 months ago. But India could count itself lucky, because the S&P 500 index in the US is at its lowest level in five years! Still, wealth destruction on such a scale (about Rs 35 lakh crore in the past year, or more than two-thirds of GDP) cannot but hit other markets, since the wealth effect has evaporated. Other asset prices (notably real estate) will have to fall more than they already have, as demand is going to be scarce. Corporate spending will be curtailed as companies get cautious. Capital spending will be even more constrained as credit has become more expensive and also harder to find; and no one will want to float new paper when stock valuations are so low (74 of the 200 most traded stocks now have single-digit price-earning ratios). Indeed, the low P:E ratios signal the fear that news on the earnings front will not be very good. Meanwhile, no one should under-estimate the impact of events on retail consumer behaviour, especially in sectors where demand is fuelled by credit. There will be many job losses in the financial sector; in other sectors too, fresh hiring will be impacted as companies focus on downsizing. Credit card delinquencies are reported to have increased, in the meantime — a development that signals pressure on household budgets.
The government has responded by trying to get international money to come in rather than go out. The moves to make external commercial borrowing more liberal, and to reverse the position on participatory notes, are however like pushing on a string. More effective is the Reserve Bank position on currency swings; by allowing the rupee to drop to near its all-time lows, the RBI is making sure that the FIIs who exit the Indian market take a double blow, adding the effect of rupee depreciation to the loss caused by lower stock prices. The RBI’s dollar reserves get protected as a result, but what this means is that dollars have become scarce in the foreign exchange market, with even the oil marketing companies scurrying around to get greenbacks. A cheaper rupee also means more imported inflation, even as it provides more incentive to export. The one step which the authorities have not taken, but should consider, is banning short sales — as the US and many other countries have done. That could help bring some stability to what is now well and truly a bear market.
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