Nervous markets

Insofar as foreign institutional investors (FIIs) have been the prime movers behind the stock market surge of recent months, it is only to be expected that events overseas will immediately impact the market in India. Five months ago, international concerns about the health of China's banks led to a sharp drop in India's stock prices; this time the worries are about the debt market in the US and other western economies. The first mini-crisis was sparked off exactly as had been forecast, by a decline in US house prices, which caused the collapse of two funds that had exposure to the troubled sub-prime (high-risk) mortgage market in the US. Then, last week's failure to market debt linked to two large leveraged buy-outs raised fears that the problems in the debt market were deeper and broader than might have been imagined earlier. The inevitable result was a "flight to safety" by capital, impacting among other things the yen carry-trade (people playing the arbitrage game by borrowing in low-interest markets like Japan's) and the emerging markets, which are seen as riskier propositions than (say) investing in US government bonds. The significance of last week's events therefore lies not in the specifics of each episode but the risks flowing from the global inter-connectedness of financial markets. The inevitable question that follows is, how great is the risk of contagion?

The short answer is that no one knows. While the immediate impact has been on stock prices, the more substantial effect could well be on leveraged buyouts""which some Indian firms have used in recent months to acquire companies overseas. With the failure to sell debt linked to two buy-outs, global companies that had been planning to hawk assets are already announcing postponement of plans. The result could be slowing down of activity in the mergers and acquisitions market.

As for stock prices, speculation at this juncture will be focused on how deep and wide the "correction" in prices will be. Indian stock prices are high (with price-earning multiples for index stocks ruling near 21), especially when seen in the context of a slowdown in profit growth. To the extent that India's market takes its cues from global trends, and since stock prices dipped quite sharply in late Friday trading in New York (after Indian trading hours), the expectation will be that today's market will open with a downtick. Whether that will prompt the smart money to pick up stocks at the new lower prices, or whether it will stay away from the market to see whether further dips occur, is hard to tell. If the FIIs (which probably own close to 15 per cent of total Indian stock, and a larger proportion of floating stock) were to get really nervous and start serious disinvesting, it would immediately affect the rupee""which ironically would make India's software companies look like good investment bets again! What can be said with some confidence is that the "real" world economy is in good shape. The latest quarterly data on American GDP and the strong performance of Europe in recent months, coupled with record growth numbers in both India and China, tell of a buoyant global system, and this should give confidence that any drop in stock prices should logically be corrected before long.