The
mainstream press was almost unanimous in its hysteria.
''Bloodbath'' and ''carnage'' screamed the front page
headlines in the English language press, while editorials
sermonised disapprovingly of the apparent irresponsibility
of politicians. Was this all fury about mob frenzy
or state-sponsored riots on the scale of the Gujarat
pogrom of two years ago? No, it was simply that the
stock market indices had fallen sharply for the third
day, after it became clear that a Congress-led formation,
supported by the Left parties, would constitute the
government at the Centre.
So
much of the presentation of economic news, especially
in the financial press, is oriented around the behaviour
of stock markets, that the uninitiated can be forgiven
for thinking that their movements actually reflect
real economic performance. Such an interpretation
is not exclusive to India. Across the world, ordinary
citizens have been conned by the media into believing
that the relatively small set of players in international
stock markets really do comprehend and correctly assess
the patterns of growth in an economy, and that their
interests are broadly in conformity with the economic
interests of the masses of people in those countries.
This is not simply a deeply undemocratic position
(as shown by C.P. Chandrasekhar in his article in
the current issue of Frontline). It is also a completely
false argument, since it has been abundantly clear
for some time now that stock markets are very poor
pointers to real economic performance. Stock market
indices are indicators of the expectations of finance
capital, and they can move up and down for a variety
of reasons, most of which are not related even to
the current profitability of productive enterprises.
They are prone to irrational bubbles and sudden collapses
which reflect all sorts of factors, ranging from international
forces to domestic political changes, and may have
very little relation to economic processes within
the economy.
Consider the latest fall in the Indian stock market.
While it is true that some of it is clearly a reaction
to the uncertainty created by the unexpected and remarkable
defeat of the NDA government at the polls, it also
should be noted that across the world, financial markets
have been in downswing in recent weeks. The New York
Stock Exchange composite index fell by 4 per cent
between 5 May and 14 May, and other markets across
Europe and Asia have shown similar or even larger
falls. Much of this is because of rising oil prices,
the failure of the economically and politically expensive
US military occupation in Iraq, and fears of interest
rate hikes in the US.
It is true that the Bombay Sensex index fell by more
than 10 per cent and the Nifty index by 12 per cent
over the same period, but this is still part of a
more general worldwide trend of decrease in stock
values, and some market analysts have even described
these as necessary ''corrections'' of the earlier
inflated values.
For the past year, Indian stock prices had been pushed
up by large inflows from foreign portfolio investors,
who had recently ''discovered'' India as an attractive
emerging market that has not yet had a financial crisis.
This meant that, despite the fact that very little
had changed in the so-called ''fundamentals'' of the
economy, there were substantial inflows from financial
investors that also caused the rupee to appreciate.
Foreign investors use emerging markets like India
to hedge against changes in other markets; they also
like to focus on particular countries in any one period,
where herd behaviour creates a boom and the countries
concerned become the temporary darlings of international
capital. In India in the recent past, the numerous
concessions provided by the NDA government to such
mobile capital also allowed for large super-profits
to be made through such transactions.
Because the Indian stock market still has relatively
thin trading, these foreign institutional investors
made a big difference at the margin, and were responsible
for pushing up stock values well beyond what would
be ''sensible'' values according to standard international
norms of price-equity ratios. This is typical of the
bubbles that have been created by internationally
mobile finance in various developing countries, especially
since the early 1990s.
It is inevitable that such bubbles must eventually
come to an end, whether through a sharp burst in the
shape of a financial crisis or through a slower and
more managed shrinking of values. When this happens,
it is true that a lot of players who have put their
bets on continuously rising share values will be affected,
but this need not mean that there has been any other
bad news in the economy.
Of course, it is always difficult to attribute causes
to stock market movements, since financial markets
are notoriously prone to ''noise'' and irrational
behaviour. However, more than the actual causes, the
implications of such falls are what matter to most
of us, and this is where the mainstream media have
been the most misleading.
It is usually argued that stock market behaviour is
a reflection of ''investor confidence'' and this in
turn affects important real variables such as productive
investment in the economy, which is critical for growth
and development. This is not really the case, and
has become even less true in the recent period. Especially
since the early 1990s, the stock market has experienced
huge increases and wild swings, while investment has
not shown any such volatility and indeed has barely
increased in real terms.
This is evident from the chart below, which shows
the index of stock market capitalisation in India
since the early 1980s. Stock market capitalisation
increased by around 4 times in the decade 1991-92
to 2001-02, with very large fluctuations in between.
By contrast, total gross fixed capital formation in
the economy increased much less even in current prices,
and in constant prices it barely doubled.
Chart
>> Click
to Enlarge
More to the point, the large
swings in market capitalisation were not associated
with any commensurate changes in investment, suggesting
that the financial markets dance to a bizarre tune
that is all their own, and do not have much impact
on real investment in the economy. This is very important
to underline, because the reason that we are all supposed
to be concerned about stock market behaviour is because
of its supposed effect on investment. In fact, it
is really only those agents who are dependent upon
the return from finance capital who are affected,
while real investment depends upon many other factors.
The other impact that movements in the stock market
have nowadays is on the exchange rate, especially
since so much of the change is caused by the behaviour
of foreign institutional investors. Their movements
over the past year have helped to build up the RBI’s
foreign exchange reserves to an almost embarrassing
amount, partly because their inflows are not being
used to increase productive investment, and partly
because the RBI kept buying dollars in an effort to
keep the rupee from appreciating even further.
While the large forex reserves may have provided a
macho feeling of false confidence to some, in reality
they were a reflection of huge macroeconomic waste,
since they implied that the capital inflows were not
being productively used. They were also expensive
for the economy to hold, since the interest received
on such reserves by the RBI is typically very low,
whereas the external commercial borrowing by Indian
firms in the current liberalised environment was at
significantly higher interest rates.
In this background, some dilution of the forex reserves
may even be welcome. Of course, if the current outflow
turns into a capital flight which is also joined by
Indian residents, then clearly the situation can become
more serious. Such a possibility is now more open
because of all the recent measures liberalising capital
outflow that the NDA government brought in during
the closing months of its rule. The new government
may have to address some of these measures quite quickly,
to prevent excessive capital outflows which can then
become another means of pressurising the government
on its economic policies.
But otherwise, the current downslide in the stock
markets is really not a matter of serious concern
for most Indians, and it should certainly not be much
of an issue for the new government either. The mainstream
English language media, whose business interests increasingly
coincide with those of finance capital, may continue
to shout itself hoarse about it. But then, as the
recent electoral cataclysm has shown, these media
also do not reflect the interests of the Indian people,
nor do they even understand them.
