Tuesday, January 22, 2008

The Asian Stock Market Meltdown

The oft-repeated adage that goes “when America sneezes, the rest of the world catches a cold” was proven to be true once again when stock markets across Asia crashed, some to record levels. The Indian markets were not to be spared—the Sensex tumbled 1,408 points on Monday, and share prices continued to dive today on opening of the markets when trading had to be halted.

It is indeed intriguing that such devastation did not occur sooner, though the effects of the subprime crisis were largely known by the middle of 2007. The Economist has some answers for this phenomenon:

“For some, this merely represents a case of stockmarkets catching up with reality. It is now a year since the subprime crisis first emerged. In that time central banks have cut interest rates, investment banks have announced big write-offs and various rescue packages have been suggested. But the end of the crisis is not yet in sight. Indeed, another leg of the debt crisis may be under way, if problems of monoline debt-insurers (an obscure but important bunch who guarantee the timely repayment of bond principal and interest when the issuer defaults) are not contained. If the American economy is not now in recession, it is close enough not to make a practical difference to sentiment.

For much of past year equity investors knew those salient facts but chose instead to take comfort from three more bullish factors. First was that the Federal Reserve would rescue both the markets and the economy, as it has done so often before. Second, even if the American economy faltered, the rest of the world (particularly Asia) could take up the burden of producing global growth. Third, given the global picture, corporate profits could stay high.

All three assumptions are now coming under question. … An indication of the change in sentiment came when America's administration announced plans for a fiscal stimulus on Friday. In good times, that would have kick-started a market rally; in the current mood, the package was seen as a sign of desperation.”
The Government has, unsurprisingly, advised investors to stay calm. The Economic Times reports that the Finance Minister Mr. P. Chidambaram has based this advice on the fact that the fundamentals of the Indian economny are strong. The news report further quotes: "The economy will grow this year at close to 9.0 percent and even according to Dr. Rangarajan's committee report it will grow 8.5 percent next year."

However, even to a person like me who is not an economist, it is becoming clear that the decoupling of markets (such as India and China) from the US economy or other major markets is a myth in this increasingly globalizing world, and this episode is one additional piece of evidence pointing towards that direction. Any policies of the government for regulating the markets will have to necessarily take this crucial factor into account.

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