This lack of liquidity has been the primary driver of the record high outflows from emerging-market equity funds: The last 30 days have seen $36 billion go out, significantly higher than that seen even during the 2008 crisis. For markets like Brazil and Turkey, which have historically been susceptible to fund outflows, these are the worst on record. For India, $4 billion stampeding out over the past month ($2 billion over the past week) is close to the worst seen in 2008, though as a share of market capitalisation the ratio is a bit better.
Illustration: Ajaya Mohanty
There is a natural mean-reverting trend about short-term flows — after one burst, sellers balk at the sharply lower prices, and some new buyers begin to get interested. Some regulatory actions like the short-selling ban imposed by markets like Korea also help in the near term. But these do not last long: Even as the markets rebound from the sharp correction over the past month, one must remember that the key risks remain unchanged.
There is no easy antidote to the income lost due to travel bans and cancellation of public events that are necessary to slow down the initial spread of the virus. It may be several weeks, if not months, before it becomes possible to quantify the loss of income. Unlike delayed purchases of items like cars and televisions, most of the income lost from services not consumed is income lost forever. Just lower interest rates may not suffice to counter this. Very few countries would have the logistical ability to deliver the type of stimulus that Hong Kong gave (10,000 Hong Kong dollars to every adult), even if they were to arrive at political consensus to consider it.
The rising gap between the yields on Italian and German sovereign bonds in the last few weeks also points to markets fearing renewed debates on how higher fiscal deficits in Italy, which may be inevitable, given the scale of the epidemic, would be perceived by other nations in the European Union. The fact that past epidemics have driven political change would not be lost on investors.
The sharp drop in oil prices adds another layer of uncertainty. At a global level, the oil price is just a transfer price from the producer to the consumer, and though producers get hurt by lower prices, consumers gain. A $30 drop in the price of Brent crude, for example, can mean $42 billion of annual savings for India, which is nearly 1.4 per cent of gross domestic product (GDP). More than half could flow directly to consumers if taxes were not raised, becoming the consumption stimulus that is needed to stem the downward spiral triggered by slowing credit growth in India; once sequestered as taxes, it becomes challenging for the government to distribute it as widely.
However, for several oil-exporting economies, the drop in income could be debilitating. The cuts in capital expenditure in further exploration and extraction of oil, and the potential risk to lenders exposed to oil producers or service providers, is perhaps easier to quantify. The bigger risk is that several of the smaller producers (but where oil revenues are a very large part of national income) could see the government losing its ability to provide even basic services like law and order and health, running the risk of a descent into anarchy. The larger producers have built up buffers over the past two decades, and may not have this risk unless low prices sustain for several years.
It may be a few months before the markets are able to “draw a circle around these problems”, meaning that the costs are quantified, and the allocation of these costs is broadly understood. In all this global turmoil, the India-specific problems of a financial system short of capacity, effective interest rates that are still ahead of the nominal GDP growth, and poor consumer and investment sentiment, have slipped from headlines, but still need to be addressed. The coming weeks and months will require cohesive and speedy action by policymakers: The challenges could very well be turned into opportunities.