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Market turmoil will sway macro policies financial scene

It was a fall apparently without any cushion. On January 21, Indian stock markets fell by 7.5 per cent. The Sensex lost 1408 points, its biggest single day fall ever. A fall of this magnitude might have caught everyone off-guard but there were already enough indications of an imminent correction.

Correction may be too mild a term to describe what happened last week but then those who saw a calamity are guilty of exaggeration. The markets were weak the previous week. Large FII selling was seen. In four sessions before Monday, they were net sellers to the tune of $2 billion. By Tuesday, the Sensex had cumulatively lost 4450 points, more than 21 per cent from the intra-day peak of 21206 reached on January 10, just eleven sessions earlier.

But a decline in the benchmark indices, though sharp, was not the only defining factor. It was the feeling that the market was on a free fall that truly differentiated the latest crash from the several previous ‘corrections’. Thus, those who expected the stock markets to stabilise after “the manic” Monday were in for a big disappointment.

The markets crashed at the opening on Tuesday forcing the authorities to suspend trading for an hour. Even after staging a partial recovery, stock prices fluctuated violently for the rest of the day. The benchmark index Sensex closed at 16729, some 873 points lower, and the Nifty at 4899, some 309 points below the previous day’s closing levels. However the markets recovered further with the Sensex ending at 18361.66 and the Nifty at 5383.35 on Friday.

All categories of stocks recorded losses as the panic that seemed to have gripped the markets could not be countered by official efforts to calm them. Stocks such as those in real estate, power and financial services which were riding a bubble lost the most. The fact that nothing has fundamentally changed in India mattered little.

In fact, two of the biggest assumptions that seemed to explain recent stock market behaviour were severely tested. The expected support from large domestic financial institutions and mutual funds did not materialise, at least to the extent required. Even as recently as in the last quarter of 2007, these domestic institutions had bought shares even as the dominant foreign institutions investors sold, thus providing substantial support to the markets.

The other assumption, that rational stock market investors would automatically go for value stocks which suddenly seem available at bargain basement prices, has not come true either.

Many blue chips were in fact available at 12 month lows. But primarily because the mood in the markets has comprehensively changed from one of unbridled optimism to deep pessimism there were a few buyers other than those who were covering short-positions taken earlier.

An additional reason has been the inability of the brokerages to meet the additional margin calls even as the existing margins simply evaporated in the face of such a monumental downturn. Some of the newly introduced single share forward contracts were overleveraged and their unwinding brought plenty of pain to the markets.

As far as India is concerned there is little that can be done to counter the rapidly escalating bad news from the U.S. Just three weeks into the New Year, the markets are taking the threats from global markets more seriously than before and reacting in tandem with them.

Ahead of the credit policy review (January 29) and the Union budget, Indian policy makers have very few options to insulate Indian investors from the global stock market crisis.

Global influences have been weighing heavily on Indian markets which are benchmarked against other emerging Asian markets. Developments in the U.S., especially the threat of a looming recession there, have depressed market sentiment everywhere. A weakening U.S. economy will reduce foreign outflows and imports from developing countries. In India it has long been argued that the U.S. crisis will have less of an impact as compared to say China.

The other view ,which is more optimistic, has been that Asia and to a large extent Europe have ‘decoupled’ themselves from the U.S. and hence will remain insulated to a large extent.

As stock market developments during the first two days of last week showed, such beliefs are more than in the nature of wishful thinking. Perceptions of the U.S. problems have begun to matter and so also — on the positive side — the rescue attempts.

On Tuesday, the U.S. Federal Reserve cut its benchmark rates by 0.75 percentage points ahead of a scheduled meeting on January 31. It is for the first time since 1984 that the Fed had effected a cut bigger than 0.50 percentage points. There has been an urgency to effect the monetary cuts because the U.S. economic problems were seen roiling markets everywhere, including India.

Evidently crisis control measures in the U.S. will be keenly watched. The U.S. Government has unveiled a $145 billion package, involving tax cuts, to stimulate the economy. These and other measures will matter not only for the U.S. economy but also for India and its stock markets.

C. R. L. NARASIMHAN

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