The Global bump and the Indian hump | India in the Globalized Market
While retrospectively it is often easier to find solutions except in markets which are slaves in the hands of speculations and uncertainty. Hence its time not to be perplexed by the blip but probably ponder over it to avoid any major setback – Himadri Chakrabarty & Titir Bhattacharya*
After an eventful 2017 of booming global financial markets, tepid commodity markets and ever-volatile foreign exchange market, 2018 began with enthusiasm coupled with caution. The caution underlying the old adage “What goes up must come down”, has been proven correct with the market inconsistencies in the month of February. As far as India is concerned, though alarms on “markets turning bearish” might be too early a judgement, what cannot be ignored is that there is a “camel-like hump” temporarily affecting Indian markets. It remains debatable if the internal dissatisfaction caused by the Indian General budget expectations or the expectation on the global events may be attributed to this concern. However, what unifies both the forces is the “pessimistic expectations” among the investors and consumers in the Indian and global markets. To address this quagmire, it is important to conduct an event study analysis of the various markets in India and the world.
The month of February was marked by a plunge in US stock markets and typical of our globalised economy, this decline in US stock markets immediately had international ramifications. The Dow Jones industrial average fell 4.6 percent from a drop in 1100 points in February, its biggest one-day percentage decline since 2011, leaving many wondering what triggered the drop and whether worse is to come. In Europe, Stoxx Europe 600 (SXXP) closed at its lowest since November 2015, after a plunge of 1.6 percent, while DAX 30 of Germany, CAC 40 of France and UKX of UK suffered losses of 0.8, 1.5 and 1.5 percent respectively. In Asia, Nikkei fell by 0.43 percent, while in India Sensex and Nifty suffered losses of about 3 percent in early February.
The stock market sell-off earlier this month that marred global financial outlook can be considered a textbook example of how the performance of financial markets is an imperfect and sometimes inappropriate indicator of the health of the economy. It highlights how stock markets often do not represent the fundamentals and can even act perversely in response to strengthening of economic indicators.
The sell-off in the US markets can be traced back to release of wage data by the Labour Bureau that exhibited stronger than expected wage growth and employment growth. Such performance of economic indicators generated expectations that era of easy money would be replaced by rising interest rates motivated by concerns regarding inflation. This expectation of higher interest rate prompted investors to move to bonds from stocks, triggering off the worldwide plunge in stock markets. It is noteworthy that similar to the US, the European economy too was characterised by strong fundamentals as seasonally adjusted industrial production for December 2017 was 0.4 percent higher than November 2017. Compared to December 2016, there was a growth of 5.2 percent. Drawing analogy with the Black Monday of 1987, as has been done by Eichengreen, it can be maintained that a robust banking sector in the US, capable of withstanding volatility, would ensure minimal negative implications for the real economy. Also, as long as systematically important financial institutions(SIFI) are not affected, the possibility of contagion can also be precluded, which in fact implies fairly quick recovery of Indian markets as well.
The plunge in global equity markets had implications for foreign exchange market, which was exhibited by movement of the Indian rupee vis-à-vis other major currencies. While at the beginning of the month of February, with sell-off in equity markets and increased demand for the dollar, the rupee hit a six week low of 64.36 against the dollar, over the course of the week it gained some momentum. The recovery was in part due to a weakening dollar and strong domestic equity markets. The optimism, however, was temporarily dampened by widening of trade deficit on account of higher gold and oil imports. Expanding imports was also accompanied by a rising gold and oil prices, supported by a weak dollar.
As far as the domestic dissatisfaction is concerned, the Long-Term Capital Gains Tax of 10 percent for stocks sold at greater than 1 lakh in addition to the short-term tax of 15 percent has been a general dampener in the investors’ mood who were gradually shifting from the risk-averse mode of fixed deposits to risk friendly mode of equity markets.
The announcement has affected the institutional and retail investors likewise and many detractors of the Government have the announcement as “The Right Thing at the Wrong Time”.
In all the above events, it is quite clear that expectations have “crowded out” reality leading to the volatile nature of markets. Rightly so, John Maynard Keynes in 1926 wrote in his essay “The End of Laissez-Faire”:
“Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance.”
Quite often financial indicators are used as a proxy for expected macroeconomic conditions. Academic researchers (e.g., Chen et al., 1986; Fama and French, 1989; Schwert, 1990) have long argued that business conditions should be positively correlated with future stock returns because an economy’s business cycle should affect corporate cash flows and discount rates. However as often cited as the loophole of regression models, these expectations and forecasts are based on past data. The past performance of an index hence can never be an exact representation of any particular investment, as you cannot invest directly in an index. In such a scenario, it is imperative that the Government or the Central Bank uses some signalling mechanism to drive the expectations towards a better alternative through clarifications on announcements which might have caused the flutter. Quite often, Macroeconomic trends are driven by wage rate, exchange rate and interest rate among which the latter two are closely linked with the financial markets. However, as earlier cited expectations on wage level data have indirectly affected the financial markets as well, hence highlighting the contribution of financial markets to market distortions. The same has been furthered by deregulation of financial markets, internationalization of financial relations and the globalization of the financial system.
In this respect, the role of Central Bank as the monetary policymaker and the Securities and Exchange Board of India (SEBI) as the market regulator assumes significance in keeping the market mood in balance.
As far as the future outlook is concerned, without sounding apocalyptic, several Wall Street veterans echo the sentiment that several “corrections” might be underway in the financial markets. The situation has been complicated by a continuously weakening greenback despite optimism regarding US economic scenario. The dollar has experienced a decline against most major currencies, which spells a brighter outlook for emerging economies. Japanese Yen experienced a strong performance, reaching almost a 19 months high since July 2016, followed by reappointment of Haruhiko Kuroda as BOJ head for a second term. Apprehensions about US equity market and the dollar come at a time when the world is faced with a possible liquidity crunch with China moving away from its stimulus policy. As far as future events at the domestic front in India are concerned, tensions of scams are in the air which might act as fodder for the volatility. Moreover, election results, often considered influential in short-term dispersion are due in the state of Karnataka and also general elections due in 2019 might be preceded by certain popular announcements.
While retrospectively it is often easier to find solutions except in markets which are slaves in the hands of speculations and uncertainty. Hence its time not to be perplexed by the blip but probably ponder over it to avoid any major setback.
*Himadri Chakrabarty & Titir Bhattacharya are doctoral students in Economics at IIM Calcutta
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Kootneeti Team
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The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of The Kootneeti Team