Global Stagflation: An Intro

In the west there was the subprime crisis, starting late last year. Then there was the oil price rise to $147 in July this year. Our stock markets peaked at 21,000 in January 2008. Everyone expected a correction but nobody knew when or how severe the fall would be. As our markets fell precipitously, the RBI and Govt. felt the best solution would be to drain liquidity out of the system (when other central banks were pumping in liquidity) and to let the rupee fall dramatically.

We have seen catastrophic change in the western financial world in less than 12 months. The subprime crisis forced the US govt. to orchestrate a merger of Bear Stearns in March. And the ever widening ripples of the subprime crisis brought about a sharp fall in equities, particularly in the equity that homeowners had in their own homes. This in turn triggered further shock waves through the system as banks and institutions were found with toxic assets. The result was the collapse of major financial institutions in the west. In the early September, the US govt. was forced to virtually nationalize Fennie Mae and Freddie Mac. Lehman was allowed to go under. And no financial institution, no matter how big, was safe. Merrill Lynch rushed into a merger with Bank of America. In the UK, Lloyds took over HBOS, the biggest mortgage lender.



The market downturn everybody agrees is not the result of poor fundamentals in these countries but of developments in the US, especially its subprime housing market where defaults and foreclosures have been on the rise. Institutions reeling under the knock-on effects of that crisis are selling out in Asian markets to find the money to rebalance their capital structures or meet their commitments. Such behaviour is easily explained. Institutions overexposed to complex structured products whose valuation is difficult are saddled with relatively illiquid assets. If any development leads to liquidity problems they are forced to sell-off their most liquid assets such as shares bought in booming emerging markets. A quick return to stability in those markets therefore is dependent on developments elsewhere.


Media reports and assessments by public and private financial institutions make clear that India invites and enjoys global attention as one of the high growth, emerging markets n the world economy. This perception of India as an uncaged tiger in the global system derives whatever strength it has from developments during the last four years when India, like other emerging markets, has been the target of a surge in capital flows from the centres of international finance. And India has emerged as a leader among these markets over the last one year or so, when India’s integration with the global economy has intensified considerably.

The global credit crunch, economic slowdown and weak sentiments, with its attendant liquidity constraints, will lead to weak FII Portfolio flows into the Indian markets. This will be a major determinant of the Indian markets in the medium term and they are unlikely to pick up in the foreseeable future.
Today, there is a consensus that the FIIs will not return to emerging markets like India in a hurry. That will probably see the markets remain in tight range band of 12,000-16,000. There are of course, a few naysayers who see a gloomier scenario, predicting that the markets could test even the 10000 levels before January 20009.


Corporates access to overseas funds will be limited and more expensive going forward.
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