Sentiment versus fundamentals
-------------------------------------------------------------------------------- We need to accept the reality that periods of decline, like growth, are a part and parcel of economics. -------------------------------------------------------------------------------- M. A.Venkat Warren Buffett's recommendation to "look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it", is a profound insight into how we ought to look at India's economic position today. Market sentiments draw heavily from collective psychological behaviour, which may be too complex to allow objective analysis. But one thing that is clear is that, when more and more people perceive a certain thing negatively, the outcome may actually turn out to be negative. Effect of sentiment >From an economic perspective, there have been several examples where weak >market sentiments alone have wrecked otherwise sound economies. According to >Jeffrey Sachs, a Columbia University professor, the Asian financial meltdown >of 1998 could have easily been averted, had it not been for investors exiting >en masse. The massive exodus of investors inflicted far more harm on the Asian >economies than the macroeconomic anomalies at the time. That sentiment can sour a good situation, can be gauged from other examples as well. If, for instance, the market expects the rupee-dollar exchange rate to increase in future, then the rupee price of the dollar will close high today. Similarly, if the market expects the rupee price of dollar to fall in future, the rupee price of dollar will close low today. Hence, variations in rupee rates become dependent, not on what India's economic fundamentals will be in the future, but on what the market expects India's economic fundamentals to be! Take a real life example of a bank. Public trust in a bank's creditworthiness is far more important to its sound functioning, than its actual creditworthiness today. "Every banker knows that if he has to prove that he is worthy of credit, however good may be his argument, in fact his credit is gone," Walter Bagehot, a British expert on bank runs, noted in Lombard Street, a 19th Century book on financial systems. Putting the above instances in today's context, both CEOs and analysts tracking the Indian economy would tell you that the economic scene here is very unlike that in the US. Though a few of our problems relating to the slowdown require addressing, this doesn't justify the sense of gloom that pervades in the stock markets. Yet, this negative sentiment needs to be dealt with, as it can lead to a worsening fundamental picture. No slump-free economy John Kenneth Galbraith explained what his encounter with India had taught him about "functional anarchy" and "affluent society", famous economic terms that he had coined. Galbraith explained that anarchy is in existence because there can never be any other way to make anything orderly. Order and disorder go hand in hand, as do growth and decline. Throughout history, regardless of the economic policy deployed, there hasn't been a slump-free economy. All kinds of economies have experienced slumps at one time or the other - whether it was inflation-bucking Germany, labour-friendly France, laissez-faire Hong Kong, or interventionist US, the monetarist New Zealand, the welfare-oriented Sweden, or indeed the investment-led China. Galbraith used the story of the peacock to illustrate how economic outcomes are influenced by how you perceive situations. You can choose to admire the beauty of a peacock or disdain its ugly voice. If the beauty of peacock occupied you, you would no longer be mindful of its ugly voice. If the ugly voice of the peacock occupied you, then you would not have seen its beauty! Hence the way we look at things is far more important than what we are looking at. Very often panic is the chief protagonist of a financial meltdown. How then do we get markets to become less vulnerable to panic? Maybe through the understanding that growth and recession are two sides of the same coin. Accepting this reality may actually reduce panic and lead to greater objectivity in dealing with a slump. It is here that India's case deserves attention. Growing at 8.5 per cent is great for a large economy like India, but managing a 6.9 per cent growth is not terrible either, especially when several other economies may even contract over the year. Slower growth, for India, may even be a means to escape inflation, which in recent months had begun to overheat. Accept reality The slowdown has already prompted fiscal and regulatory measures that may aid growth, a cut in interest rates, investments in infrastructure, and so on. But along with concrete measures, it is also necessary to ensure that we let events take their course. Although no one is suggesting that we must parry possibilities for growth and invite a slump, we need to accept the reality that periods of decline, like growth, are a part and parcel of economics. As noted economist John Maynard Keynes said, "The inevitable never happens. It is always the unexpected." Confidence and crisis are issued out of the same mint. By recognising that reality, we could profit from growth in a boom period while guarding ourselves from giving in to too much adverse sentiment when the inevitable fall comes. We will then have acted upon Buffett's insight that one should take advantage of, not fall prey to, economic fluctuations. (The author is a senior member of an MNC.) http://www.thehindubusinessline.com/iw/2008/12/14/stories/2008121450601200.htm Government cannot make man richer, but it can make him poorer --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups "Kences1" group. To post to this group, send email to [email protected] To unsubscribe from this group, send email to [email protected] For more options, visit this group at http://groups.google.com/group/kences1?hl=en -~----------~----~----~----~------~----~------~--~---
