PHEW! The US Fed has cut its benchmark rate by 75 basis points in response to worldwide market pandemonium. This could mean more money to go around. The relief in India, where investors have lost over Rs 10 lakh crore in the stock market over a span of just two days, will be mostly symbolic, though the rate differential could mean more capital inflows. In the very short-term?with the rupee having touched 39.73 to the US dollar, suggestive of big outflows?these would be welcome for a change. Liquidity counts for a lot. Since the indices started sliding last week, conditions in India have been tight. Tellingly, the call money rate even spiked to 52% at one point towards the end of the week. Signs of a liquidity dry-out have been all too evident this week as well. Might we have witnessed a short-term case of asset price deflation caused by too little money chasing too many stocks?
As part of a larger story of market panic, yes. And here, the Indian investor is at a disadvantage vis-a-vis his foreign counterpart. RBI has long frowned upon bank lending for stocks. The Indian banking system is not allowed to lend more than 5% of its incremental deposits for the purpose of investment in the equity market. None of the state-owned banks come anywhere near the limit, and are loath to lend once volatility rises. It doesn?t help that several scams, involving, for example, Madhepura Mercantile Cooperative Bank and Global Trust Bank, have been traced to stock market plays. Anyhow, bank tightfistedness means that domestic investors have to resort to circuitous routes to access credit needed to finance their market exposure. Once leveraged positions start getting dissolved, the problem becomes acute. Players that could have hung in there are forced to exit. Even brokers clamp down on their liquidity assurance to small clients once cash conditions tighten, sending out signals that give lay investors a scare. Without such cash constraints, FIIs are able to ratchet up their exposure to the market?as they did in the wake of the May 17, 2004 meltdown?while local buyers miss the opportunity. If the Indian money market offers adequate lubrication to the equity market, such imbalances need not occur. Astute liquidity management can prevent the deflationary effects of inadequate money, if not reassure investors about the big picture.
