Sensex is no barometer of economic health
By Dr Ashwani Mahajan
For the last few weeks, there have been big upheavals in the share markets of the country. Sensitive index of Bombay Stock Exchange, which was at 19,084 on July 8, 2011, went down to 16,453 on September 30, 2011 before crossing 17000 mark a few days later. Similarly Rupee went down from Rs 44.37 per US$ on July 8, 2011 to Rs 49 per US$ on September 30, 2011 and hovering around that level since then. Investors lost billions of rupees in the process, resulting severe shocks in the markets. However if we leave aside a few exceptions of ups and downs in the demand, there are no signs of any down turn in the economy. GDP growth is expected to remain sufficiently high at reasonable level, around 8 per cent this year too.
There is no doubt even amongst the experts about the fact that the downfall/upheavals in share markets and in the value of rupee are primarily due to international reasons. Rising debt of US and also of European economies and the problems of repayment and even possible default in the countries like Greece in Europe and ever rising problems of other parts of Western Europe are causing upheavals in our domestic share markets and rupee is also going down day by day for the last few weeks.
For about last 3 years, USA and Western European economies are going through deep economic crisis for the first time after great depression of 1930s. When developed capitalist countries went into recession, general belief was that these powerful nations would be able to come out of the crisis on their own. Government of these countries even tried to win over the recession by giving huge bail out packages based on their economic muscle. Thanks to these bail out packages, these economies were seemingly reviving and there was a marginal reduction in rate of unemployment there. Financial institutions in these countries also showed some improvement. However, for the last few months, recession is again raising its ugly head in these countries. Experts are warning that this recession may get deepened in the coming months. Renowned economists Nouriel Roubini and Robert Shiller have forecasted that there could be a big downfall in US in the coming days. Founder of Rogers Holdings, Jim Rogers believes that there could be a big downgrading in US economic rating. Economists believe that this expected recession in the year 2011-12 or 2013 is going to be much worse, as US has already exhausted most of its policy instruments ranging from printing of more currency and enhanced spending to fight out economic recession. In the times to come US will not be left with many options to combat the crisis. Recently an international rating agency Standard and Poor’s has downgraded US economic rating, consecutively for the second time in the recent months. This down grading in economic rating has increased the problems of US administration manifold. While President Barak Obama was trying to paint a rosy picture of US economy, downgrading in economic rating has poured water on his endeavour. US policy makers may have to take suitable measures including increase in the interest rates to fight out recession. But caught in the problem of rising debt and its repayment, Federal Reserves have extended the already extended period of low interest rate. Before US policy makers could do anything, recession would have caused much damage to US economy. An attempt by US government, which had been termed as ‘twist’, to transform short term loans into the long term ones, has increased concerns about decline in liquidity in the international markets, which has resulted in a record (in recent times) decline in the global and Indian share markets. When the government of Greece decided to sell off, one of its airports to repay their debts and then came the news of forcible reduction in the government spending in Greece, coerced by the lending agencies, the international markets were obviously saddened. In such a situation, nervousness in international and Indian markets is obvious. However, we have to think in depth, what could be the impact of this recession in the west on Indian economy in the long run?
Similar situation had occurred in the year 2007-08. Not only had our share markets sunk, even the rupee also slid significantly. However, Indian economy had grown at the rate of 7 per cent that year too. Next year the economic growth had surpassed 8 per cent benchmark. Rupee had gone down to 51 per US$. However, our share markets rebounded again and the rupee also improved to Rs. 44 per US$. During recession of 2007-08 and 2008-09 our exports declined, but at the same time our imports also declined, resulting in an improvement in the balance of trade. Fall in the export demand, was more than compensated by domestic demand. Our economy marched on at 7 to 8 per cent growth, while developed countries were going down by 2 per cent.
We have to understand that sensex is no barometer for the economy. On any day sensex comes down by 3 per cent and some other day it goes up by 3 to 4 per cent. It would not be wise to think that the economy has gone down by 3 per cent on a particular day or has gone up by 3 to 4 per cent some other day. Upheavals in the sensex, are caused by outflow of foreign exchange by Foreign Institutional Investors (FIIs) due to their compulsions of their international operations. Whenever they are in trouble in international markets, they are compelled to take away dollars to save themselves. In the process not only share markets nose dive, even the value of rupee goes down. However, when they bring back these dollars, share markets improve, and also the value of rupee.
It is true that imported goods may become dearer when value of rupee goes down, which may cause inflation in the country. However, this may not last very long. Instead of getting worried due to upheavals in the share markets, the government has to make suitable improvement in its foreign trade and investment policies. We have to reduce our dependence on imports and make appropriate policies for export promotion. FIIs, who fly by night, have to be suitably regulated. We may impose 3 years lock-in period on the investments made by FIIs. We need to impose high tax rates on repatriation of profits by FIIs.
(The writer is Associate Professor, Department of Economics, PGDAV College, University of Delhi, Email: [email protected])