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Sensex 17k: What should investors do?
November, 17th 2009

AS I write this, the Sensex is hovering around 16850 points. Now, though the market has recovered of late, its still down around 19 per cent from its all time high of 20873 it had touched on the January 8, 2008.

The question is after reaching such heights why did the market collapse in the first place and now that a recovery of sorts is in the process, what should investors expect?

Recap: What brought about stock market crash

We have to look at events that took place outside India to answer the first part of the question. The starting point, as it were, was the downturn in the housing market in the West eventually leading to the collapse of Wall Street giants such as Lehman Brothers, Bear Sterns etc.

Consequently, FIIs started selling stocks in India, not because there was something fundamentally wrong with the country, but because their parent bodies were in deep trouble abroad. Out of the USD 60 billion that had been invested since India opened its doors to foreign investors, almost two thirds was exported out.

And as the basic economic law of demand-supply dictates when supply exceeds demand, prices fall. The story doesnt end here. The heavy-duty selling eventually translated into an increased demand for dollars (to be repatriated out of India) thereby causing a run on the exchange rate.

So in a bid to prevent the rupee from going into a free fall, the RBI stepped in to mop up the excess liquidity by buying rupees and selling dollars. This, in turn, dried up the rupee liquidity leading to an acute shortage of credit in the financial system.

Industry starved of cheap and accessible capital, started suffering. The general slowdown that emerged got reflected in lower earnings. And lower earnings translate into still lower stock prices. The circle was completed. A credit crisis in the West brought about a stock market crash in far off India.

Market recovery

Market has, however, recovered over twice its lowest level of 8160 that it touched on March 9, 2009. Actually, markets globally have recovered since the last stage of the sell-off was an overreaction to the global financial crisis. Risk spooked investors, hitherto reluctant to commit their funds, have started trickling in, now that a systemic collapse seems unlikely.

Specifically with relation to India, the root cause of the problem the subprime securities never did exist in our market. Our banks are well capitalised and well regulated. A sustained policy of controlling foreign borrowings has resulted in limited dependency on foreign sources of capital.

With inflation no longer a threat the Government has pulled out all the stops to encourage growth and limit the collateral damage that the recession ravaged West can wreak on our economy.

The monetary easing initiated by RBI is releasing a huge amount of liquidity in the system that hopefully will ease the flow of funds through the financial pipelines of our economy. Key amongst the various measures undertaken were a cut in the rate at which banks borrow from RBI (repo rate) to the lowest ever of 3.25 per cent.

Simultaneously, the rate which RBI pays banks to park their idle funds (reverse repo rate) was also slashed thereby sending a very strong signal to banks that the RBI is going to systematically prompt them to use repo as a safe keeper of their money it must flow to the industry.

At the same time CRR which is the share of deposits that banks need to park with RBI has also been brought down in five successive cuts to 5 per cent. The aggregate liquidity that has been released into the system due to monetary actions undertaken so far is expected to be in the region of Rs 5.6 trillion!

Indian economy

On the macro front, GDP growth rate is expected to decelerate to 6 per cent this year. But even this rate makes India one of the fastest growing economies in the world.

At a time when the West is in the midst of nationalizing its banking system, Indian banks are well capitalised, well regulated and most of them are already nationalised. Rounding up, a savings rate of 35 per cent and a favourable demographic model makes India as insulated as it can be against a global recession.

Therefore, if the RBI manages to control inflation thereby maintaining the purchasing power of the rupee, in an economy that has limited dependence on exports, growth can be maintained on the back of domestic consumption itself.

This situation reminds me of a quote from Warren Buffet. He said Five years from now, ten years from now, we'll look back on this period and we'll see that you could have made some extraordinary (stock market) buys. That doesn't mean it won't get more extraordinary a week or a month from now.

I have no idea what the stock market is going to do next month or six months from now. I do know that the economy, over a period of time, will do very well, and people who own a piece of it will do well. Just don't borrow money to buy your piece.

While Mr Buffets statement was to do with the US market, it can literally be copy-pasted for our market too. And this you can only do if you stop listening to stock market gurus and other story tellers. Markets will rise and fall based on future national, international, political, geo-political, economic and financial events.

No one can forecast today (not even Mr Buffet himself) what tomorrow will bring. All that these people do is extrapolate the past into present and present this extrapolation as the future.


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