Friday’s stock market crash, accompanied by a fresh slide in the rupee and a spike in domestic gold prices, is a signal to policymakers that their efforts at artificially stabilising the exchange rate and ‘talking up’ the economy aren’t working. On the contrary, these are now beginning to seriously unsettle foreign investors. The immediate trigger for the biggest single-day market fall in four years was the Reserve Bank of India’s curbs on outward foreign exchange remittances by domestic companies and residents. The markets interpreted this as a throwback to the era of capital controls and speculated about such clampdowns being extended to repatriation by foreign investors as well.
But while this was probably an extreme overreaction, the fact is a correction has been long overdue in Indian markets. Stock prices of bellwether companies have been out of sync with their fundamentals for quite some time now. Even after Friday’s bloodbath, the price-earning multiple of 16 for companies constituting the benchmark Sensex does not reflect either their current or prospective earnings growth. Their aggregate profits have grown by a measly 9 per cent annually over the last five years. Even this growth may be difficult to sustain, with stalled investments plans, a sudden hardening of interest rates and over-leveraged balance-sheets of established corporate groups. To make matters worse, there is the looming threat of a flight of capital from India, should the US Federal Reserve go ahead with phasing out its current monetary stimulus policy. Moreover, India isn’t particularly attractive to foreign institutional investors (FII) looking to make their emerging market allocations today. Other Asian markets are cheaper at 10-12 times price-earnings, besides harbouring lower political, external balance and currency-related risks. The only thing probably holding back FIIs from selling heavily now is the fact that they stand to lose from making a hurried exit from India. With domestic investors lukewarm about making fresh commitments to equities, FIIs have come to own 40 per cent of the value of all stock available for trading in Indian markets.
The possibility of an FII exodus is a window of opportunity for policymakers to frame concrete growth-promoting measures. Trying to fix the rupee through capital controls or imposing restrictions on gold imports is not the way forward. It is welcome that the Government has clarified there will be no further import curbs. Clearing the way for stalled infrastructure projects, ensuring feedstock supplies to power plants, and resolving issuing relating to iron ore and coal mining will be sufficient to keep FIIs interested and ward of a payments crisis.