A season of paradoxes

By C. R. L. Narasimhan

This is a season of paradoxes. On the one hand, the economy is out of a long recession and is on its way to a recovery. Equally gratifying to the policymakers ought to be the finding of a survey which places business confidence at a very high level. That would suggest among other things that entrepreneurs are convinced of the recovery. On the other hand, of course, is the stock market behaviour. Inscrutable as it has been for most of this calendar year, the stock market has set off alarm signals in the way its indices have fallen.

Very recently, adding to the market woes created by the crashing share prices, the rupee after a long period of stability has started declining breaching the psychological barrier of 44 to a dollar and falling to an all time low of 44.74 on Thursday last.

Can the paradoxes be reconciled? In all developed countries, the share markets to a large extent relate to the real economy. Of course there are leads and lags. Aberrations occur as well but in general sound macro-economic numbers do get reflected in stock price patterns.

Both the American stock exchanges, for instance, were until recently witnessing sustained and unprecedented rises, which was attributed to an economy growing relentlessly.

Official action such as even those involving purely monetary measures (say a bank rate hike) is tested at the stock market. The after-effects of those measures are also evaluated in terms of market performance.

Investors' expectations and their confidence levels in the economy do get mirrored in stock prices.

Better corporate performance and results during periods of economic boom further corroborate the bullish sentiment. Besides, a whole lot of data on sectors such as housing, consumer spending and car sales are used to gauge the economy.

The big question now is can the current paradox in India - definite signs of recovery in the macro-economy buoyed by robust business confidence existing side by side with declining stock prices - be explained in terms of the western model? Starting from the basics, there is no need to dispute or be sceptical over official statistics that indicate economic recovery. Several agencies have corroborated it.

For instance, the Reserve Bank of India's recent annual monetary statement says that there was a sharp acceleration in industrial output, with the rate of growth being of the order of 7.9 per cent between April 1999 and February 2000, with manufacturing alone registering an 8.8 per cent growth.

Other macro-economic numbers also look good. External reserves, for instance, have been at their highest levels recently.

The only area of concern related to a possible failure of the monsoons, but even that has been allayed with the latest forecasts predicting normal rains for the thirteenth consecutive year.

Business confidence, according to a report of the National Council of Applied Economic Research (NCEAR) has never been better in recent times.

The quarterly survey of the think tank says that the confidence index for April this year which had improved significantly since the last report (January 2000) is at the highest since December 1995. Businessmen base their optimism on the improved investment climate and better capacity utilisation. The fourth quarter results of a large number of companies for last financial year have been uniformly good.

Continued business confidence is an essential adjunct for a further recovery. The optimism revealed should reflect in other spheres as well. The financial markets should mirror the sentiment. A high level of market capitalisation of existing stocks should attract other companies to the capital market, thus helping in capital formation. Sadly none of those is happening.

Stock prices have been erratic for most of the recent past. What is worse, they have been on a decline with the Sensex falling below 4000 last week. The other visible financial market, the forex market has also witnessed hectic activity recently after a long lull. The rupee has been sliding badly against the dollar. On Thursday, the RBI announced tough measures to prevent volatility and ensure orderly market conditions.

Imperfect stock market

The only logical explanation for the paradox of good economic numbers existing side by side with weak stock prices lies in understanding the imperfections of the market mechanism. In India the stock market cannot be used as a barometer to judge economic progress. At least not yet. Unfortunately every one at the highest levels of policy making seemed to think that the high stock prices of January and February were caused by the nascent recovery. They could not backtrack on this perceived connection when the stock market let them down.

Today's stock declines in India follow a more realistic assessment of the technology stocks which were driving the indices up earlier. Policymakers would be better off concentrating on capital market reform than on hastily connecting the real economy with the stock markets.

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