Turbulent times for financial markets

By C. R. L. Narasimhan

Last Tuesday's terrorist attacks on the U.S. have naturally caused havoc in the international financial markets. Although it is America that has been specifically targeted, the catastrophic consequences are global. No country, no financial market is immune. For certain well recognised reasons the U.S., its economy and its financial markets have come to occupy pivotal positions in the global economy. The term unipolar world, perhaps best describes the American economic dominance rather than the country's political or strategic dominance. The term globalisation has come to represent interdependence of individual economies with one another with an ever increasing connection to the U.S. economy.

It is not simply a matter of trade dependence, even though that is how most observers quantify a country's relationship with America. The American currency is the currency of the world, overwhelmingly used in international trade and commerce. It is also used extensively by travellers, hoarders and everyone else. Even for terrorists and ``rogue States'' the dollar has a special significance. The American dollar is a reserve currency, with practically all other currencies being directly or indirectly linked to it. The dollar is also the reference currency in all forex dealing rooms. And the dollar's supremacy has conferred a special status on New York as a financial centre. All dollar transactions, wherever they take place, are settled through a bank in New York, which has also the most influential address in the financial world, the Wall Street. The New York Stock Exchange and the Nasdaq have been leading the world's stock exchanges for more than two decades.

Indian markets part of the global system

A quick recap as above - of certain well-known details - was necessary only to show that the terrorist attack has both strong symbolic and substantial messages. By inflicting damage on New York and by bringing down the two towers of the World Trade Center, the terrorists probably wanted to challenge the U.S.'s hegemony and expose its vulnerability. For India and most other countries the terrorist attacks, unprecedented as they have been, have had several unforeseen consequences. As the news of the attacks sank in, both the forex market and the stock market reacted adversely. On Wednesday, the Sensex fell below 3000 for the first time since December 1998. Although it recovered subsequently, by the close of Thursday it had sunk below 3000, a 33 month low. The rupee too came under pressure breaching the Rs. 47.50 floor on Thursday. By the week-end the devastation was complete. The Sensex closed at slightly above 2800. The rupee continued its downward spiral losing another 27 paise closing at Rs. 47.83 to the dollar.

Interestingly, the rupee has continued to decline even though the Reserve Bank of India has intervened. While a medium term depreciation was always on the cards, a precipitous decline can upset everybody's calculations and has therefore been resisted in the past. This time however one is not so sure whether the rupee's fall can be checked so easily. Certainly the terrorist attacks are in the nature of external shocks, whose risks the RBI says it is factoring in while managing the risks in the external economy. Even before last Tuesday the rupee had come under pressure, because of sustained foreign institutional investor selling in the stock market. Their sale proceeds are repatriated in dollars and in such times there is a substantial step up in dollar demand. Soon after the U.S. attack, oil prices went up and although even its near term outlook is not clear, the chances are that the petroleum import bill will go up. Again, in what is seen as a negative point for the rupee, it has declined against even while the dollar came under pressure. For once the dollar has ceased to be a currency of refuge. Other currencies, the euro notably and gold gained in the aftermath of the terrorist attack.

Continuing the trend

The stock exchange sentiment in the country was already weak before Tuesday. The terrorists' strike has only aggravated it. For the Government which has considered the stock market to be a barometer of economic health the latest developments will be most disconcerting. The fact that the building housing the Nasdaq exchange has crumbled is more than symbolic. The tech stock melt down in the U.S. had already affected the highly fancied ICE stocks in India. Moreover, the Indian economy is not in the best of shape. The GDP growth rates have been revised downwards in everybody's calculations.

There is likely to be an adverse impact on financial sector reform too. At a global level one of the sectors most adversely affected is the insurance sector. There will be all round claims, which according to reliable estimates, will exceed $19 billion. That is a lot of money, especially for a business that has not been doing spectacularly well. The relevance of all this to India where the insurance business was thrown open just a year ago is this: will the foreign majors who have teamed up with Indian partners have the stamina to aggressively expand in India?

In the days to come, the financial markets will continue to be gripped by extreme anxiety. The U.S. financial markets are expected to open on Monday but it is unlikely they will be able to provide direction to the rest of the world at least in the near future. The two towers of the World Trade Center housed some leading investment banks, financial services companies and information technology purveyors, who provide substantial logistics support to the financial sector. These firms have suffered physically, might have lost some of their brightest personnel (although no list is available so far) and had their records and data damaged (although there would be a back-up system in most cases). Hence the damage to the financial sector is unprecedented and will by no means be localised.

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Section  : Business
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