Creeping shadow

The thrashing taken by India’s stock markets may not compare with some well-known and wealth-destroying crashes of the past but the unrelenting decline has unnerved investors.

Last weekend’s precipitous fall took the indices to their six-month lows and erased a good part of the gains they had made last year. There is no indication that the bleeding has been stanched and there are warnings of further declines in the days to come. The comments of the prime minister, the finance minister and others about the serious threat posed by inflation to economic growth have been cited as contributing to the despair of the market.

But this is not the only element in a confluence of factors that have damaged the markets. There is fear that the stimulus measures for the economy announced in the wake of the 2008 slowdown may soon be withdrawn or scaled down. It is also possible that there will be further rate hikes by the RBI.

The markets had already taken into consideration the risks posed by high inflation, increasing interest rates and costlier crude to the economy and to the profitability of companies. There are other countries too that face the same set of problems. But there is reasonable optimism that even then the growth target of 8.5 per cent may be achieved. What the market pessimism shows is that the prospect of good growth is not enough to keep the indices stable or rising.

The pervading negative sentiment in the country arising from corruption scandals was a significant dampener for the markets. It has even cast a shadow on political stability. Markets need not only the numbers from the economy to flourish but also an environment in which there is assurance of the enforcement of the rule of law in all fields.

All emerging markets are in a bad shape, but India is among the worst hit. Foreign financial institutions have withdrawn large chunks of their investments from them. The main reason is that developed markets, especially the US, are better bets for them now.

This  underlines the dangers of unregulated inflow of hot and short term international money into emerging markets. It is difficult to check these flows and the temporary gains made from them are very tempting. But they also inflict pain by destabilising markets.