Bears at the Door

T

Some Indian analysts with an axe to grind and unmindful of what had happened elsewhere – a price fall even on Wall Street – put the blame on the left and on Sonia Gandhi, the perennial spoilers of the party. The Indian stock market reacted in panic in May 2004 as well when the present Congress-led United Progressive Alliance government took office with the support of the left. And now, after the recent gains made by the latter in the state assembly elections in Kerala and West Bengal, creditor-rentier apprehensions are that the reform agenda will be abandoned. But attributing the fall in stock prices to this factor is clearly way off the mark. India already offers significant concessions to investors in the capital market. There is no taxation of dividend income; longterm capital gains on listed equity capital are also exempt from taxation. Together with the easing of equity capital caps for foreign institutional investors, permitting hedge funds a free rein, and allowing “sub-accounts” and the derivative instrument of the “participatory note”, these measures have led to an unprecedented inflow of foreign portfolio finance with a consequent stock market boom. As of May 11 this year, the Sensex had tripled since two years ago when the UPA government took office with the support of the left. The frenzied bull run over the past year has, however, defied all logic and run counter to saner predictions. Only the perennial believers in “irrational exuberance” hoped that the surge in stock prices over the past year – especially in the past six months – could be maintained forever. But the inevitable correction, when it does take place, is called a “blood bath”.

While the relatively large inflow of what is essentially shortterm global finance in the liberalised open capital account regime is surely not an unmixed blessing for the Indian economy, it can at least artificially sustain for a while the huge and expanding merchandise import surplus and a widening current account deficit as well – the increase in India’s net liability to the rest of the world. But now, at least the Japanese portfolio investors – and they have been amongst the most significant contributors to the present boom in India’s stock market – seem to be concerned about India’s current account deficit and its financing through foreign portfolio investment. The Japanese investors obviously do not seem to be sure, despite the rapid growth of exports of IT-enabled services, that India will ultimately be able to match its increasing external liability by an enhanced capacity to earn foreign exchange from its international transactions.

All eyes, however, now seem to be focused on the US markets. Interest rates in the US are expected to be raised further, what with the European Central Bank also doing the same, and the Bank of Japan expected to fall in line. Rising prices in the US property market now seem to be levelling off; US consumers will then not be able to borrow more, which in turn, would affect their spending. And with asset prices not rising any further, there will be no higher priced collateral available for US business firms and players in the markets to use to obtain more credit from the financial system. If asset prices then fall and consumer spending plunges, what would it foretell, first, for the US economy, and then for the rest of the world? m

Economic and Political Weekly June 3, 2006