It has been over a decade since the world experienced the worst ever financial crisis leading to a global recession. The crisis led to untold misery, with people losing their jobs and livelihood, besides experiencing significant decline in wealth.
Governments responded in ways best known to them, based on what the experts suggested and what was politically feasible and attractive.
A crisis of comparable magnitude had earlier taken place in the 1930s. Quite obviously, the policy measures adopted differed significantly during the two crises.
Learnings of the past seven decades were effectively used to fight the latest crisis, and new policy measures, as yet unknown and untried, were deployed.
As always, when economists are involved, unanimity of views is a virtual impossibility.
Whether such policy measures were effective, and whether alternative actions could have had greater impact, will always be open to debate.
What is indisputable is that when a crisis strikes, especially of such a magnitude, liquidity is critical. The Reserve Bank of India (RBI) left no stone unturned in injecting liquidity into the system, ensuring that the crisis was averted as quickly as possible. Interest rates were reduced, coming close to zero percent in many countries, at times even flirting in the negative zone.
The injection of liquidity, of course, did not remain a short-term affair and various central banks have established programmes that lead to continuous infusion of funds in the market. Terms such as quantitative easing, tapering, and inflation targeting have now become an integral part of the market’s lexicon.
Why is continued monetary easing essential? Apart from inadequate regulation, high level of debt was the primary cause of the financial crisis and, in fact, of its severity. From 1950 to 2007, private sector debt (household and corporate) as a proportion of gross domestic product (GDP) increased to 170% from 50% in advanced economies.
The subsequent drawdown of debt-stifled demand, which would have resulted in a far more serious recession but for the various measures undertaken to boost demand. These measures included fiscal expansion and monetary easing.
Fiscal expansion has its limits and eventually, had to be halted, with monetary policy taking up its customary expansionary function of boosting the economy.
It was widely believed that monetary easing cannot continue indefinitely and will need to be reversed sooner rather than later. The US Federal Reserve, in fact, started raising interest rates from December 2015 when growth picked up in the country, but had to quickly retrace. A decade after the crisis, monetary policy continues to be expansionary, with no sign of a reversal.
The 10-year real interest rate in the US, currently at 1%, indicates that any increase in rate is practically ruled out for the next decade. That holds true for Japan, Europe and other economies too. Historically, low rates, close to 0%, have never persisted for such a long period. Two decades of virtual uninterrupted monetary expansion is unheard of. Being uncharted territory, its implications are unclear to anyone, including the central banks.
What are the repercussions for the Indian equity markets? In the long run, market movements are determined by economic growth rate, in particular the corporate sector earnings and the overall liquidity in the economy. I am not optimistic about growth rate of the Indian economy in the coming years and believe it will go down further. (Read: Here is why Private Investment is Down
At the same time, global liquidity will find its way into the Indian economy and its markets. India is likely to be one of the largest beneficiaries of any money that flows to emerging markets. The interplay of the liberal liquidity conditions and plummeting growth will be interesting to watch and will determine the course of the Indian equities in the years to come.
The situation is fairly novel since we have never experienced prolonged liberal liquidity, as we expect to do now. We may indulge in crystal gazing to predict its impact but we are in uncharted territory. Economic forces rarely work unidirectionally. While we may project a positive impact on equity prices, it could also have pernicious unintended consequences, as yet unknown to us. Hopefully, the regulators and governments will display sagacity and acumen to counter any negativity emerging from high liquidity, especially in conjunction with low growth.
One thing is quite certain. Given the low growth rate of the economy, any time there is an apprehension of withdrawal of liquidity from the Indian markets, the adverse impact on equity prices is likely to be severe. One needs to be prepared for such brutal fall in stocks and be on alert for any impending squeeze on global funds. The fall could undo years of wealth creation in no time.
(Sunil Mahajan, a financial consultant and teacher, has over three decades experience in the corporate sector, consultancy and academics.)