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ShareAs I write this, the Sensex is hovering around 16850 points. And though the market has recovered of late, it's still down around 19% from its all-time high of 20873 that it touched on January 8, 2008.
So the question is, after reaching such heights, why did the market collapse in the first place and now that a recovery of sorts is in the process, going ahead what should investors expect?
To answer the first part of the question, we have to look at events that took place outside India.
The starting point, as it were, was the downturn in the housing market in the West, eventually leading to the collapse of Wall Street giants such as Lehman Brothers, Bear Sterns etc. Consequently, foreign institutional investors (FIIs) started selling stocks in India, not because there was something fundamentally wrong with the country, but because their parent bodies were in deep trouble abroad.
Out of the $60 billion that had been invested since India opened its doors to foreign investors, almost two-thirds was exported out. And as the basic economic law of demand- supply dictates, when supply exceeds demand, prices will fall. The story doesn't end here. The heavy-duty selling eventually translated into an increased demand for dollars (to be repatriated out of India) thereby causing a run on the exchange rate.
So, in a bid to prevent the rupee from going into free fall, the Reserve Bank stepped in to mop up the excess liquidity by buying rupees and selling dollars.
This in turn dried up the rupee liquidity, leading to an acute shortage of credit in the financial system. Industry, starved of cheap and accessible capital, started suffering. The general slowdown that emerged got reflected in lower earnings. And lower earnings translate into still lower stock prices. The circle was complete. A credit crisis in the West brought about a stock market crash in far off India.
That being said, the market has indeed recovered over twice from its lowest level of 8160, touched on March 9. Actually, markets globally have recovered, since the last stage of the sell-off was an overreaction to the global financial crisis. Risk-spooked investors, hitherto reluctant to commit their funds, have started trickling in now that a systemic collapse seems unlikely.
Specifically with relation to India, the root cause of the problem -- the subprime securities -- never did exist in our market. Our banks are well capitalised and well regulated. A sustained policy of controlling foreign borrowings has resulted in limited dependency on foreign sources of capital.
With inflation no longer a threat, the government has pulled out all stops to encourage growth and limit the collateral damage that the recession-ravaged West can wreak on our economy.
The monetary easing initiated by the RBI is releasing a huge amount of liquidity in the system that hopefully will ease the flow of funds through the financial pipeline of our economy.
Key amongst the various measures undertaken were a cut in the rate at which banks borrow from the RBI (repo rate) to the lowest ever of 3.25%. Simultaneously, the rate which RBI pays banks to park their idle funds (reverse repo rate) was also slashed, thereby sending a very strong signal to banks that the RBI is going to systematically disincentivise banks from using it as a safe keeper of their money -- it must flow to the industry.
At the same time, the credit reserve ratio, which is the share of deposits that banks need to park with RBI, has also been brought down in five successive cuts to 5%. The aggregate liquidity that has been released into the system due to monetary actions undertaken so far is expected to be in the region of Rs5.6lakh crore.
On the macro front, GDP growth rate is expected to decelerate to 7.5% this year. But even this rate makes India one of the fastest growing economies in the world. At a time when the West is in the midst of nationalising its banking system, Indian banks are well capitalised, well regulated and most are already nationalised. Rounding up, a savings rate of 35% and a favourable demographic makes India as insulated as it can be against a global recession.
Therefore, if the RBI manages to control inflation -- thereby maintaining the purchasing power of the rupee -- in an economy that has limited dependence on exports, growth can be maintained on the back of domestic consumption itself.
This situation reminds me of a quote from Warren Buffett. He said: "Five years from now, 10 years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now. I have no idea what the stock market is going to do next month or six months from now. I do know that the economy, over a period of time, will do very well, and people who own a piece of it will do well. Just don't borrow money to buy your piece."
While Buffett's statement was to do with the US market, it can literally be copy-pasted and adopted for our market too. And this you can only do if you stop listening to stock market gurus and other storytellers.
Markets will rise and fall based on future national, international, political geo-political, economic and financial events. No one can forecast today (not even Buffett himself) what tomorrow will bring. All that these people do is extrapolate the present and present this extrapolation as the future.
Over the next 5-10 years, India will do well. Do participate in this prosperity. How best to do this would be the subject matter of next week's column.
The writer is director, Wonderland Consultants a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com
