Why are the stock markets suddenly losing their sheen? Are they in one of the defining moments in which they will fall quite sharply before rallying back, if at all? Sharp swings in share prices are by no means uncommon but the precipitous drops of the type seen last in January 2008 when the market valuations plunged by an amazing two-thirds are, of course, rare and more relevantly difficult to predict.
To answer the questions, one has to look at the peaks and troughs of stock prices over a fairly recent period. The week ended February 4 was especially noteworthy. After recording some marginal gains from the middle of the week, the indices recorded heavy losses on the close of the week. Sensex lost 441 points (about 2.5 per cent) to close just above 18000. Nifty fell below the psychologically significant 5400-mark. To view over a slightly longer period, the markets started rising strongly in August, 2010, to peak at 21005 on November 5. The fall by 3,000 points (14.28 per cent) since then until February 4 is significant. What is worse is that seemed to presage the worse things to come.
The gloomy forecasts seemed to come true sooner than anticipated. Stock prices dropped sharply on Tuesday last. Sensex traded below 18000 and Nifty around 5350 in the forenoon session. The fall in stock prices continued into the following week (February 7 to 11).
A sense of deep pessimism has permeated the markets. All of a sudden, uncertainty seems to have engulfed the markets. Barely two weeks before the presentation of the Union budget, the downward movement of stock prices has acquired a distinct, negative connotation of its own. Will the two major worries of the government — inflation and the burgeoning current account deficit — invite strong fiscal measures in addition to what the Reserve Bank of India has been doing?
There is no doubt at all that inflation and the current account deficit (expected to be around 3.7 per cent of the GDP) are the major concerns. But they have been so for quite some time. The reasons why stock markets latched on to the bad news all of a sudden ignoring the good ones need to be looked at from the totality of circumstances.
India's growth story has by no means derailed. According to the Central Statistical Organisation's advance estimates for 2010-11, the GDP growth will be at a respectable 8.6 per cent. This is below the upper-end of the government's expectations of between 8.5 and 8.75 per cent but slightly above the RBI's 8.5 per cent.
In each of the first two quarters of this year, the economy has grown by 8.9 per cent. Hence, the estimate of 8.6 per cent for the whole year suggests a slowdown in the third and fourth quarters. Besides, when final figures come, a deceleration in manufacturing during the second half of the year will be seen. During the first two quarters, manufacturing grew by 13 per cent and 9.8 per cent, respectively. Such a performance is unlikely to continue during the rest of this year. However, the CSO' estimate of manufacturing growth during the whole year at 8.8 per cent is the same as what was achieved last year.
Inflation and the widening current account deficit are the major macro economic concerns. But India faces even greater problems of perceptions — corruption and in governance especially.
The India story may be substantially on track but the reasons why the stock markets apparently do not think so is to be seen in the actions of global investors, especially the foreign institutional investors (FIIs), who have come to occupy such an important place in the Indian markets. Their large investments are for short-term and often volatile but they are considered necessary to bridge the current account deficit. There is an obvious preference for the more stable FDI (foreign direct investment) but it has been going down this year as reported by the RBI at the time of the last review.
The fall in equities in the past few weeks is mainly attributed to large scale selling of stocks by FIIs. According to official figures, they sold Rs.9,339-crore worth of stocks this year up to February 4. It is likely that they share the concerns of domestic investors, with inflation and the widening current account deficit topping the lists. As pointed out, such concerns have weighed with investors in the past too but in the aggregate they were positive on India. (This was seen by the steady rise in stock prices.)
However, at the present juncture, FIIs are pulling out but do not seem to be coming back soon. Ominously, emerging markets as a class seem to have suddenly fallen out of favour with global investors. There could be many reasons: turmoil in Egypt, rising inflation and specific to India fiscal deficit, co-existing with current account deficit. In just one week (ended February 4), investors took out $7 billion, with the biggest outflows coming from China, India and Indonesia. There have been only two occasions in the past — March 2007 and January 2008 — when the volume of outflows was more than the $7-billion. In March, 2007, the investors returned fairly soon. But the exit in January, 2008, was hardly a retreat. Many emerging markets, including India, took a long time to find the bottom after losing over 60 per cent of their valuations. What is worse is the Indian markets are underperforming when compared with other emerging markets. The developed markets are now attracting investors on the basis of a better than expected performance in the latter part of 2010, especially the U.S.
