Free Fall

LAST week's rollercoaster ride on the bourses of the world proved but one thing: that India is no longer an island in the global economy. And when the bottoms fell out of stock indices both sides of the equator, the markets in India cried as well. Says S. Venkitaramanan, former Reserve Bank of India (RBI) governor: "India is no longer insulated from what happens in the world." Flash back just 10 years ago to 1987 when the Wall Street plunged sharply, earning the epithet of the Second Great Depression; the Indian stock exchanges remained Sphinx-like and buoyant.

Within 10 years, India's integration with the global economy is virtually complete, thanks to the inflows from foreign fund managers. Instant communication and global financial flows have interlinked not only all the free markets of the world, but even the different financial instruments. It was the currency contagion sweeping across Asia that triggered off the slide on Indian bourses. "The rest," says Alok Vajpeyi, country head, BZW India, "is purely out of empathy and apprehension."

It was the same sentiment that perked the global bourses on Wednesday (October 29), thanks to the morale-boosting reiteration in sound fundamentals of the economy by US Federal Reserve chairman Alan Greenspan and Hong Kong chief executive Tung Chee-Hwa. On Wall Street, IBM's decision to buy $3.5 billion of its own stock helped too. The Dow Jones Industrial Average—the main New York Stock Exchange index, akin to India's Sensex—rose 337 points, half way through the over 7 per cent loss since Monday last. The Hang Seng index at Hong Kong gained 180 points in the first five minutes of Wednesday's trading. Back home, the National Stock Exchange also brightened the impending Black Diwali by recouping most of the losses of the day before: the NSE-50 gained over 74 points to close at 1,107. On October 21, it had fallen by 142.35 points.

However, at the traditional moorat trading to welcome Vikram Samvat 2054 on October 30, the Bombay Stock Exchange reflected the global turmoil none too subtly. The BSE Sensitive Index (Sensex) shed 131 points in little more than an hour of trading. The NSE-50 lost 22 points on the first day of the Indian business new year.

There are many lessons for India here. Speculators have in the last few months ruthlessly exposed the fundamental weaknesses of the so-called Asian Tiger economies, and hammered down Thailand's baht, Malaysia's ringgit, Indonesia's rupiah and the Philippines' peso (see box). By October 20, rumours were rife that the speculators were turning their attention to the Hong Kong dollar. Investors, already jittery, hurriedly started selling their holdings on the Hong Kong stock exchange, and converting the cash into US dollars, for, if the Hong Kong dollar fell, the value of their investments in US dollar terms would drop.

The Hong Kong government has till now stood firm. It has put the might of its $88 billion forex reserves to keep the currency steady. And backing up this staggering figure is another one, the $120-billion forex reserves that China has. China is committed to maintaining the Hong Kong dollar exactly where it is: pegged to the US dollar at the rate of 7.8 HK dollars to one greenback. Said Hong Kong finance secretary Donald Tsang: "The only people who will be burned by speculation against the Hong Kong dollar are the speculators." While the authorities started buying Hong Kong dollars with its forex reserves to bolster it against the sell orders of speculators, they also jacked up interest rates as high as 300 per cent, so that speculators would not have access to cheap money to fuel their feeding frenzy. Some banks refused to grant loans for forex trading. This pushed stockmarket investors to sell their holdings to generate the cash that the high interest rates had made extremely expensive.

Within hours, the panic had spread across the planet-girdling electronic networks that are the world's financial markets today. For, with the global integration of markets, money is now only electronic impulses, and massive transactions just a modem and a keystroke. The scare in Hong Kong, one of Asia's strongest economies, set off a domino effect. It took only a series of blips on computer screens to lower the wealth of the world's five richest men by almost Rs 20,000 crore—close to the entire net worth of India's wealthiest company, the Oil and Natural Gas Corporation (ONGC). Bill Gates—the world's richest man—alone lost a staggering $1.76 billion (Rs 6,336 crore). The mayhem had spread from Hong Kong to London, New York, Sydney; Europe, the Americas, Africa; stockmarkets, currency markets, money markets. In Brazil, the share index fell 14 per cent, the largest in five years. In Canada and South Africa, share prices made their steepest plunges in a decade.

But why were the Indian bourses affected by the global meltdown? After all, our currency is not fully convertible, so Indian rupees cannot be freely converted into, say, US dollars any time and taken out. It is thus insulated against the speculator assaults that brought the baht or the ringg it to their knees. And islands don't cry.

Warns Sameer Arora, chief investment officer, Alliance Capital Asset Management: "Despite the fact that our economy is inherently strong, dramatic currency devaluation could well have happened here." Indeed, there are already enough expert voices clamouring that the government should devalue the rupee. With currencies dropping against the dollar in many Asian countries that directly compete with India in global trade, Indian exports will now be more expensive than, say, Indonesia's. Right now, to fund managers across the world, the Indian rupee could be looking seriously overvalued. Says Venkitaramanan: "India cannot argue convincingly that it has a stronger defence for the rupee than Hong Kong had for the dollar. Nor does it have a more robust economy." Although India has healthy reserves, exports are down, credit off-take has been slow to start, and the GDP growth estimate has been lowered from 7 per cent to 6.5. Says Arora: "A 6 per cent devaluation of the rupee in six months won't kill the market out here. It will make India a much cleaner country. The RBI may decide to do it gradually, but delay can only postpone the uncertainty."

 And when international fund managers begin to believe that a devaluation of the rupee is inevitable, they sell their shareholdings and take the dollars out, before devaluation whittles away the worth of their investments. Just what they did in Hong Kong. Says a BSE broker: "Over the past two trading sessions, FIIs have sold stocks worth Rs 350 crore while domestic financial institutions have bought shares worth Rs 150 crore only. "

 The worst may not be over just yet. As if on cue, the day after the NSE index lost 142 points, corporates and banks began buying dollars heavily. The rupee opened at the previous evening's closing levels of Rs 36.26/27 and weakened to Rs 36.32/33 before authorities pitched in to close the day at Rs 36.31/32 to a dollar. Any sudden demand for the dollar now could well trigger a serious run on the stockmarkets. The trouble is, everyone's currently paranoid. For, in an unrelated development, even the global prices of gold and other commodities have been falling. "That and the fear of devaluation may inhibit fund managers to put their money in Indian shares for the time being," says Arora. According to financial and currency experts in Mumbai, if the rupee is devalued by a certain extent by March 1998, the dollar inflow may start once again.

Currently, India assumes a very small portion of the global investment portfolio. In fact, of the $9 billion that has come into the country through FIIs, almost 60 per cent of the amount has been brought in by only three US players: Morgan Stanley, Capital, and Schroeder. On a monthly level, the average inflow is between $250 million and $300 million. And over the next six months, even these amounts are unlikely to appear in Mumbai's Dalal Street. Argues Arora: "The four GDRs scheduled over the next few months will take care of major inflows over the next months."

 He is referring to the government's disinvestment plans, where it will sell its stake worth $1.5 billion (Rs 5,400 crore) in four companies—Gas Authority of India, Indian Oil, Mahanagar Telephone Nigam, and Container Corporation of India—in the GDR market. "But," warns K.N. Dey, vice president, Mecklai Financial & Commercial Services, "so long as the secondary market remains depressed, chances are that the government may not get the desired price and may well think of postponing the GDRs." Shaky FIIs are already looking at anything from Asia with suspicion.

The last week has thrown up two great lessons for the planet, both obvious but both overlooked so easily. One, that market forces always make sure that the truth will out. That the veils of hype—about Bangkok's supposedly booming property market, about Malaysia's multibillion-dollar infotech projects, or Indonesian president Suharto's son's "national car" venture—will finally fall away under the most neutral glare on earth, that of the market.

And two, that the butterfly effect—a moth flapping its wings in Brazil and setting off a cascade of events that end up as a typhoon in South China Sea—doesn't exist only in metereology.

The third lesson is for those who are suddenly talking about the evils of globalisation and free markets, and those who are about to be swayed by these arguments. Last week's financial bloodbath, in fact, conclusively proves that the market system works, and is truly fair. Malaysia is in trouble because it deserves to be, and prime minister Mahathir Mohammad's dark mutterings about all this being a Jewish conspiracy to ruin his predominantly Muslim country are rubbish. And if the Hong Kong government breaks the speculators' backs and keeps the dollar steady, that is what the speculators deserve. The markets don't have favourites.

Though that's a chilling thought for India. For it is committed to make the rupee fully convertible by the year 2001, and leave it to the global market currents. It will then sink or swim on the basis of India's economic fundamentals. Chilling thought.