This may sound slightly odd?Monday?s Sensex fall of 901 points could not have left everyone in the Indian capital market unscathed?but there is cause for discreet satisfaction in the reading that market slides today are qualitatively different from earlier times. For one, they are not accompanied by horror-stricken scenes reminiscent of sepia-tinted pictures from another era of Indian capitalism. Our national propensity to overreact is on the decline, as the percentage figures moderate the responses of participants?Monday?s was only a 5% loss. Dalal Street is getting used to volatility. Second, market swings are no longer indicative of kneejerk panics, as exemplified by the turmoil of 2004 surrounding the news of an incoming government supported by the Left, nor of market scandals, as in the ?KP stocks? case of 2000. Instead, these slides represent the collective mind of investors analysing?rightly or wrongly is not the point here?the fallout of economic conditions, policies and other factors in a globalising world. The story of the Indian market ?decoupling? from the US was in overbrought territory, and the impact of the American subprime crisis has acted as a corrective. That Indian P/E ratios could live beyond their teens now seems like another overbought story. Equity valuations often lie in the eyes of beholders, and there is no evidence of a broad rejection of the underlying rationale for higher ratios in India than in peer markets. Yet, new equity-affecting risks have surfaced, even as the capital market touches a new maturity.
For policymakers, the worry is whether other segments of the financial sector have kept up with the capital market?s expansion and sophistication since mid-2004. The banking sector is much too short on competition, autonomy and base capital to expand the way it ought to. With official restrictions imposed by RBI on banking assets directly exposed to the stockmarket, there is the risk of indirect exposure having risen beyond prudent levels. Market booms tend to have such effects. In other words, Indian banks may be more vulnerable to market volatility than is supposed. The adoption of Basel II capital adequacy norms next fiscal, with its new risk weights and tools, is only a partial solution to this problem. The government needs to pay as much attention to risks as the banks themselves, if there is to be a sense of mutual assurance.
