T N Ninan: A change of mood

WEEKEND RUMINATIONS

The price-earnings ratios for listed Indian companies are now lower than they were a year ago. So why is no one buying? The answer is of course that expectations about the future have changed. The 7 per cent fall in stock prices this past week has done what the preceding weeks of turmoil on the markets failed to do "" make people ask how much more bad news waits round the corner. With the biggest American mortgage company (Countrywide) on the brink as of Thursday/Friday, people are right to be nervous. Central banks in different countries are still scrambling to control the collateral damage. And as India's stock market feels the pinch of foreign institutional investors (FIIs) pulling out, no one can rule out the prospect, however remote, of the bottom falling out of the market.

The FIIs own about $200 billion worth of listed stock. Of this, about a quarter is accounted for by hedge funds, who can be expected to be the first to cut and run. We saw this past week the consequences of 1 per cent of that $200 billion being pulled out; what if 10 per cent seeks an exit, as is conceivable when one looks at the quantum of hedge fund money that has come in? The answer is, there will not be much of a market left, because there won't be many buyers to be found. In that scenario, who cares about P:E ratios?

Even discounting such disaster scenarios, it still is safe to assume that sentiment has changed. It has changed for investors, who can now see that the market may be into a new phase (even if only for the short term). It has changed for businesses, as sundry opinion polls, here and globally, tell us. It has changed for consumers because interest rates have gone up by about 3 percentage points since a year ago, and no one is talking of that being corrected; so loan repayment installments that have gone up will stay up, and wallets will continue to feel the pinch. And it has changed for exporters and importers, because the rupee has suddenly lost its strength against the dollar and is dipping. Even the exporters who could hope to gain from this new trend have to worry about the possible loss of momentum in export markets.

One of the consequences of inflated asset prices is the birth of under-capitalised companies that think an IPO or a private placement can be a substitute for cash flow. But with the prospects for high-priced IPOs having dimmed, some of these companies are now in the credit market, but not getting the loans they seek. The credit rating agencies, meanwhile, are under fire overseas for not having warned of the gathering storm, and will be doing their sums afresh even in India. Under the scanner will come the highly leveraged firms (among them some real estate big daddies, whose stock in trade "" the famous land banks "" have lost value in the meantime). Throw into this cocktail the heightened level of political uncertainty because the Congress and the Left have fallen out. It is a safe bet, therefore, that people and companies are now going to be more careful about both spending and investment than they were two months ago; that can only mean a slowdown. How much must be a matter of guesswork just now, and will become clearer in six weeks, when the second quarter financial results start getting announced.

A change of tempo need not be a bad thing. Any sustained bout of fair weather on the markets creates business excesses as investors and consumers start discounting risk more and more. So it is healthy once in a while to re-assess risk equations, especially when the direction of the wind changes. If the storm that has built up now does not become a financial cyclone, and if the course corrections being made by everyone leave us with an economy that is in better over-all balance, the state of the post-shock economy may well be what the doctor ordered. It is at that point that the mood will change again, for the better.