Crash 038; Boom

Enough has been said about the changes in inflation expectations for the US, and the possible increases in interest rates for periods longer than previously expected. The trigger for the correction in markets across the world has been largely attributed to the unwinding of 8216;carry trades8217; that involved borrowing in cheaper regimes and investing them in risky assets like emerging markets and commodities. Behind the surging prices of all assets across the world was the liquidity that was unleashed by the large developed markets, the US and Japan chiefly, to enable their economies to get back to their feet.

Instead of reviving their economies as expected, too much money that lay around too long began to chase risky, speculative assets. Into asset classes at home mostly home mortgages and across the world in commodities and stocks, some of which came into emerging markets as well. In the meanwhile several factors have realigned themselves, creating new uncertainties for the global markets as a whole.

The recovery for the developed markets is on a tougher course than ever before, predominantly due to gains of smaller economies from globalization, and a systematic erosion of competitive advantage for larger economies. The simpler connection of global growth rates to developed country growth rates has snapped, and ease of movement of capital, labour, information and finances across the world has made it so much more difficult for the developed economies to compete.

In this recovery cycle, optimism about employment and consumption in Europe, Japan and US is low, primarily from an inability to export to the world as before and the alarming increase in importing from the rest of the world. The size of this impact for US is large enough to now call its trade deficit a 8220;global imbalance.8221; No one is kidding themselves that US will manage to export in quantities that enable managing the trade deficit. Nor is the dollar depreciating as rapidly as expected, waiting eagerly for possible currency re-alignment from the exporting countries. When productivity and better economic performance cease to address what begin as cyclical economic downturns, they grow up into structural issues that need much more than managing growth, inflation and interest rates.

The loss in competitive edge in larger economies is real, and the responses unknown. The options range from playing the protectionist card through the WTO, to talking down currencies through the IMF. Therefore the secular and structural rebalancing of global economic prowess is bound to be long and winding, rather than abrupt and sudden 8212; with the attendant spill-over effects on the rest of the world. The effort at unwinding of the global liquidity is but one such illustration.

How is the story for the Indian markets different? There is the curious combination of real changes in the economy that are positive at one level, and the huge asset-price chasing behaviour at another. To a stranger who looks at the capital-starved infrastructure on the one hand and the Rs. 50,000 crore daily volume on the stock and derivatives markets on the other, the country does present puzzles.

The two stories are different, but it may not be in our interest to keep them that way in the long run. As growth fosters employment and better income, if domestic consumption of goods and services move up as they have, we build a tremendous level of strength to be able to weather the tailwinds of the 8216;global adjustments8217;. We can strengthen that even further by enabling capital investments from domestic and foreign investors for the long run. If, on the other hand, we have huge informal debt markets that fund leveraged positions to chase momentum gains on stock markets and real estate markets, leaning on global investor interest, we increase our vulnerability to the same global adjustments.

There is so much that policy can do to attract long term capital where it is most needed, and enable long term saving options as viable alternatives to short term speculative trades of ordinary investors. Unfortunately, much of those initiatives are locked in the process of political consensus, so that pension reforms and FDI decisions are postponed from one Parliament session to another, while there is always space to consider what is an office of profit.

The debates in the media are representative of our short-term view of possible policy options. The suspicion about foreign investors and their intent, and whether they represent 8216;hot money8217; and therefore will have to be somehow controlled and contained, has returned even as we allow FDI proposals to decay. The call to protect the 8216;small investor8217;, who may have lost his shirt, resumes without putting in place a long-term pension option that will bring in millions that conservative investors have kept away in saving instruments.

There is widespread anxiety to know why exactly the market fell and how much more it can fall, and whether the government or the regulator can offer a helping hand in talking the market up. Somewhere underlying these responses is the simplistic assumption that the key for a small economy like ours to take on a changing, risky, world lies in understanding the market crash. The bigger job lies elsewhere, in creating sound resilience for our economy, which is the long-term India story.

The writer is chief R038;D officer, OptiMixUma.Shashikantoptimixnet.com