The Wall Street crisis right now is about sentiments. Such sentiments characterise both bullish and bearish phases and events snowball. The housing crisis in the US may have provided the trigger, but it is doubtful that lending, sub-prime or otherwise, would have assumed dimensions of crisis had investment banks continued to have access to capital. In that sense, bail-outs in the US and Europe perform a signalling role, more important than quantitative estimates of loss. Indeed, once sub-prime assets find markets and prices (and every asset has a market if the price is right), initial figures of damage may turn out to be over-estimates. There will certainly be debates about disclosure, oversight and regulation and dilemmas over using public money to bail out private misdemeanours. The broader cause of market-based reforms will sadly take a beating, in India and elsewhere. Indian reactions also primarily hinge on sentiments. For instance, Indian commercial banks have limited exposure to US or dollar-denominated securities, ICICI included. Why should there be a run on Indian banks and fear of default? While withdrawal of foreign funds from the capital market is understandable, compounded by rupee depreciation, why should retail investors sell? The Indian growth story remains sound, albeit weakened. There is some real sector decoupling and a growth rate of 7% is not to be sneered at.
This is not to deny sector and company-specific impacts, IT being the most obvious. Companies with forex exposure, or those seeking to raise capital abroad, will be adversely affected, thus potentially postponing infrastructure projects. Hence, one should ease liquidity problems by easing restrictions on capital inflows and reforming the corporate bond market. By the same token, with inflation under control, oil and other commodity prices easing and rupee depreciation, monetary policy needs loosening. Reportedly, the independent debt office was torpedoed by RBI. With an altered dispensation in RBI, monetary policy should now become autonomous of managing the government?s borrowing programme and perform a counter-cyclical role. Stated differently, the Wall Street crisis doesn?t signify the end of market-based reforms (markets too need regulation). Instead, they pinpoint directions for reform, and regulation shouldn?t be confused with control. In the midst of the crisis, the Chinese have gone ahead and announced several financial sector reforms. Arguably, the lessons of the East Asian financial crisis were misread in India. Had that not happened, the country might have moved to a higher growth trajectory earlier. Plagued with political and policy uncertainty, India doesn?t need more dithering. The downward cycle needs to be reversed without waiting for three years. That?s the way to make sense of the sentiment-prone Sensex.