The sharp declines in the stock markets around the world last week are significant as much for investors as for the governments framing macroeconomic policies. The almost synchronised fall in equity prices is attributed to major concerns over a possible debt crisis in some European countries. A handful of countries in the Euro zone, notably Greece and Portugal, have come under intense pressure to repay mountains of debt they have run into during years of profligate spending. The fear that even some of the larger European economies such as Spain might be drawn into a financial crisis has affected investor sentiment considerably. The belief that Europe will be the next flashpoint, when most economies of the developed world seem to be stabilising after a prolonged recession, has transformed regional worries into truly global ones. Multilateral institutions including the IMF and the World Bank expect the global economy to grow faster this year than it did during the past two years. However, the recovery is expected to be uneven, with the developed economies witnessing only a muted recovery. The U.S. economy has grown strongly during the past quarter but continues to be beset with high unemployment rates. The news of a possible default by some European countries has drawn attention both to the fragility of global recovery and to the fickle nature of global capital flows.
On Thursday, the Dow Jones industrial average fell below 10,000 for the first time since November. Stock markets across Europe lost as much as 6 per cent of the value. By Friday, the contagion had spread to the Asian markets. The Nikkei in Japan shed 2.9 per cent. Along with the rest of Asia, the Indian stock indices dropped precipitously on Friday. The Sensex went down by 434 points and the Nifty by 126 points. While in India the stock prices recovered somewhat during the subsequent trading sessions, it seems unlikely that the markets will soon regain to touch the high levels they reached in recent times. Last week’s stock price movements around the world once again debunk the decoupling theory, which held that the Asian markets are relatively immune to developments in the U.S. and Europe. In India and other Asian countries, the developments in Europe might trigger a long overdue correction that will bring down the stock prices to realistic levels. For investors and governments a more ominous message is that the problems emanating from the financial markets would once again spill over into the real economies, prolonging the slump and making a full-fledged recovery even more difficult.