Watch out for trouble beyond Sensex bubble

Bubble ahoy! Across the world, stock markets are inflating crazily. Don\’t think that the Sensex boom is driven by Indian policies and economic results. Rather, global markets are highly interconnected today , and typically rise and fall together. The Sensex hit a record 32,000 last week even as the MSCI World Index broke records and the US Dow Jones Index scaled new heights.

So, most explanations of the Sensex boom in our media are misleading. Yes, India is the fastest growing major economy in the world. Yes, GST and Modi\’s other incremental economic reforms are significant achievements.But stock markets are booming everywhere else too. To grasp what is inflating the boom, look at the world economy .

The global economy is no longer growing at the breakneck speed of 2003-08. China, which became the growth star with 12-14% growth in those days is now down to 6.5% according to official data, and even less in reality , say market experts like Ruchir Sharma. The US, Europe and Japan are all recovering, but growing much more slowly than in earlier times.

The long-term outlook for the West is sluggish. In his book, The Rise and Fall of American Growth, productivity guru Robert Gordon showed that US productivity growth fell from 1.7% per year in its boom years after World War II to 0.7% per year after the 1970s, and is now not far from zero. The situation is roughly the same in the EU, Japan, and even China. The internet boom gave a fillip to productivity from the mid-1990s to 2004 but that then petered out. For all the talk of 3D printing, robotisation and artificial intelligence, no breakthrough in productivity is in sight.

Meanwhile, population growth in the US is slowing, and Trump\’s immigration curbs may slow it further.Population growth is zero or negative in most of Europe and Japan. China\’s workforce is about to peak, and is projected to start declining after 2020.

Now, GDP growth is nothing but the growth of population plus the growth of that population\’s productivity . If both are growing at zero or slow rates, then GDP growth will necessarily be slow. That is the big macro-picture, and it is not encouraging.

Developing countries like India have brighter prospects.They are far below the productivity levels of the West or even China, and so have much scope to catch up. In India, the gap between the backward heartland states and the progressive coastal ones is huge, and here too catch-up possibilities are large. But the Western economies, once the locomotives of global growth, are going to drag down emerging markets like India.

Why , in these weak long-term conditions, are stock markets booming everywhere? Because central banks in Western countries have in the last seven years printed trillions of dollars in an attempt to revive their economies. The central banks have also bought trillions worth of bonds and other financial assets. This has sent market prices soaring.

It cannot last. At some point, central banks will have to reverse gear. The US Fed is gradually raising interest rates, and is preparing to sell the massive stock of securities it bought during “quantitative easing“. The dollar flood will be followed by an ebb. That will end the money glut pumping up markets. Investors will realise that the main bubble-creator has shut down. They will start to panic and send markets crashing.

The central banks think, optimistically, that they can manage the money reversal smoothly. Alas, markets are creatures of euphoria and despair, and rarely adjust smoothly.

So, to judge coming trends, do not focus on just trends or signals from the government, RBI or Indian economic indicators. The big shocks will be global in origin, with unpredictable timing.

The bubble can continue inflating for years before bursting. Remember, Robert Schiller got rave reviews for writing Irrational Exuberance in 2005, yet the US bubble inflated for three years more. The end is always nasty , but can get postponed for remarkably long periods.

What can India do to prepare for that event? First, it must adjust margin requirements and discourage borrowing to invest in financial assets. If debt-free, an investor can ride out the worst storms. Investors should shift out of cyclical stocks. Corporations are still over-borrowed, and the RBI should tell banks to aim for lower debt-equity ratios for their borrowers. The RBI should also build up forex reserves to withstand big withdrawals by foreign portfolio investors.

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