Saturday, February 09, 2008

A Deep Disconnect

A report by English economist Lord Meghnad Desai in November 2005 alerted the world to the possibility that large third world nations were “decoupling” from the key drivers of the world economy, the United States, Japan and Europe. He predicted that the fate of many Asian economies, particularly China and India, were becoming less dependent on the fortunes of developed nations. The report argued that if Gross Domestic Product was measured using purchasing power parity (or PPP) that represents the true value of a country’s output, India is the world’s fourth largest economy after the US, China and Japan. Moreover, China and India together accounted for roughly half of global GDP growth in 2005. According to IMF estimates, emerging markets and developing economies will grow at a rate of 8.1%, compared to the US’s 1.9% in 2008. But last week, to borrow a cliché, as soon as the US sneezed, India and most of Asia caught a cold.

The likely prospect of a recession in the US was enough to send the Bombay Stock Exchange’s 30-stock Sensitive Index (Sensex) tumbling. On January 21 and January 22, the market lost a quarter of its value (it recovered half that in the days that followed) due to a variety of external factors – the sub-prime mortgage crisis in the US, oil at $100 a barrel, the Iraq war and turmoil in credit markets. Despite US President George Bush’s announcement of a $150 billion economic stimulus plan to revive the economy, global markets have remained gloomy. Credit card defaults are rising in the US, a logical corollary of the mortgage defaults. When real estate prices fall spending becomes a casualty. US consumer spending has kept the world economy booming for five years, and reduced US spending could mean a global downturn.

Indian stock markets are increasingly being driven by foreign portfolio investments. The Sensex scaled 21,000 points this January from just 15,000 in July 2007 on the back of investments by Foreign Institutional Investors (FIIs) of $20 billion last year. According to NASSCOM, India’s information technology and IT services industries contributed 7% of GDP in 2005. The IT industry is driven by demand for their services from the West, particularly the US. Thus, India cannot remain immune to what happens in the US, the Euro Zone and the UK and yet maintain high growth rates. India's commerce minister Kamal Nath conceded as much at the World Economic Forum in Davos when he said no economy in the world can be fully insulated from a US recession.

But the fact remains that India and China are less dependant on the US economy than almost all their neighbours. In a recent article, The Economist pointed out that thanks to their large domestic consumption, just 8% of China’s GDP was dependent on exports to the US while in India’s case the corresponding figure was a miniscule 2%. Rating agency Standard and Poor’s latest report on the risk posed by a US recession to Asia’s economies underscores the same point. S&P says that unlike South Korea, Singapore, Malaysia, the Philippines and Thailand, which are “vulnerable” to a US downturn, India and China are “not vulnerable”.

So what explains the apparent disconnect? Why are Indian and Chinese stock markets reacting so readily to bad news from the US when their economies barely register a blink? In India’s case, the latest dip in stock prices could be one of timing a much as that of sentiment: The Rs 11,700 crore Reliance Power IPO has sucked out a plenty of liquidity as investors have sold stock to invest in one of India’s most valuable companies.

But there is a deeper reason, in fact a real “decoupling” between capital markets and economies. Stock markets operate on sentiment. Only over the long term can we discern a relationship between the real worth of companies and the prices at which their shares are traded. Markets are fundamentally propelled by emotion while economies are driven by hard information that every individual and firm base their actions upon. It’s when we confuse the world of stock markets for the real world that we get into serious trouble.


Mithya: Two people in contemporary Hindi cinema never fail to amaze me- Vishal Bhardwaj and Rajat Kapoor. It is a Sisyphean task to encapsulate this movie in a few words but at some level this is "an existentialist gangster film". Monsieur Godard, forgive me if you have taken umhbrage to it.

Red Road: I absolutely loved the way this movie combined Bertoluccian obsession and style of taking of Michael Haneke. The raw sex scene obliterates the scene between Julianne Moore and Mark Wahlberg in "Boogie Nights".

Machuca: For all those find Dreamers a bit too hard to digest, this one is more like an adolescent version of the Bertolucci's much-talked film; albeit, the historical backdrop is much more spread out too.


At 1:17 AM, Anonymous shravya said...

Candidly, i skipped half of ur article while reading it.Maybe u ought to put a pre script saying: only for people interested in economics of societies..
Too much of actuarial details..

At 4:30 AM, Blogger sowmitra said...

baundi ra...brilliantly written..sometimes difficult to follow...but I can see a editorial in here...[:)]

At 8:36 AM, Anonymous Anonymous said...

This is real good one with lots of facts and intricate understanding of economic aspects. I really like reading it. It shows your grasp on several subjects.

At 5:44 AM, Blogger garcia kafka said...

@shravya: I wanted to move away from my comfort zone- ramblings. I wanted to write something really enlightening..

@sowmitra and anonymous: Thanks a lot for liking this article of mine.. I really did loads of research and it feels good that it's being seen as an "editorial:..

At 4:12 AM, Blogger sadu said...

Sorry I can't figure out what u were trying to 'enlighten' .Ur talk about how US hosing collapse sent shock waves to global market , matches what Swaminathan said in one of his article few months ago.

At 7:32 AM, Blogger Insomniac said...

This comment has been removed by the author.

At 7:41 AM, Blogger Insomniac said...

kafkasque comments on indian economy...that's a good one..but a tad too difficult for non economists..and particularly software understand..
well i read ur comments on TZP..probably u forgot that this movie was made for indian audience..and almost more than 90% don't have an idea about dyslexia..and stars like Amir khan cannot address a niche audience..and most of all the economy..since ur gud at it..the profitability of a venture is of primary concern..and considering all these in account aamir made more than decent kudos to him..probably u hav a taste for good foreign cinema..if that's the case ..then i understand it's difficult for u too digest the kitschy and sentimental drama portrayed by TZP..but for people like me and most of indians who have been fed on melodramatic movies...TZP was a welcome change and showed us what good cinema is all about..

At 5:48 AM, Blogger garcia kafka said...

First things very first, if you are an employee of TCS and if you dont know the fact that the third quarter results in North America are not impressive enough, then even before you know u will be given the pink slip.. Economics is an in inextricable part of whatever walk of life you might be.. Talking of TZP, its a specious remark to say that Indians are fed on melodramatic fare.. Isnt it imperative that this trend is diffused rather than lap onto it..? And lets not call it good cinema considering the absolute murder of what could have been an evocative story..

At 8:48 AM, Blogger Arun said...

When you group india and china together you should understand that the way the two exonomies run is totally different,china's economy is manufacturing based and it has the highest market for its good,while india's is more service based,which as of today had stood the test of time to be the best.But to get to the position where these countries are today it would be easier for many developing countries to take the indian route as it doesnt require years of building and gaining a place in the market,So countries like Brazil and many developing countries are basing their effort on english and software.So for india to be grouped with china for long it should along with services,develop a core industries,else it could easily be replaced by a different country which offers service at a lesser rate.

Nice to see a blog from you against your routine..continue the good job.

At 9:58 PM, Blogger garcia kafka said...

@Arun: India has woken up from its deep slumber and it understood that whenever US sneezes we will, inevitably, catch cold.. We can only hand a handkerchief to US when we concentrate on manufacturing.. No wonder then that the mandarins in Delhi are looking at making "Made in India" a brand just like "Made in China".. Thanks for the comment..


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