Along with the equity markets, crude oil prices also crashed this time. Financial experts immediately chorused that falling oil prices will benefit India immensely. This is silly for two reasons. One, falling oil prices are turned to good account by the government through higher taxes. They are rarely passed on to the consumers. The Modi government did this in 2015, in 2018, and again this time. Two, to say that an oil crash will benefit India is a selective and self-serving argument because it only looked at one part of the equation. Oil prices crashed because of fears of a severe global contraction and demand recession. Surely, you cannot look at the fall in oil prices as a positive, without reckoning on the fact that entire businesses may shut down and many others get severely maimed due to demand contraction. Businesses don’t care about input cost as long as there is demand. If there is a demand slowdown, lower input costs are irrelevant.
The real issue is whether the coronavirus
contagion will be stopped or effectively contained. Cities and countries are shutting themselves off one after another. Schools, colleges, and leisure and entertainment centres are closing, conferences are being cancelled, and international travel has collapsed. Simultaneous global containment is the need, but in a globalised economy it also means a simultaneous global contraction in trade, transport, and tourism — a sure recipe for recession. The US government has tried to ease the pain by cutting interest rates and taxes, and loosening monetary policy. But, of what help are fiscal and monetary policies when there is no incentive to do more business and there are enforced hindrances?
Are the markets overreacting? On Friday, the Indian markets were locked in the lower circuit on opening and leading to a mandatory halt in trading for 45 minutes. Just before they reopened, US index futures shot up on some flimsy government announcement, which reverberated across global markets. So the Indian market reopened to a massive rally. It seemed like a bipolar market, depressed one hour and euphoric the next. This perfectly sums up human reactions to known unknowns, when we overreact. We know that the epidemic will affect us all but don’t know how much. When we think it will affect us severely (fear), we sell out of panic and when we think it will be contained (euphoria), we perceive a buying opportunity. People hate uncertainty and react strongly to it. The greater the uncertainty, the stronger is the reaction.
There are three types of bear markets, according to Goldman Sachs — one driven by a specific episode or event, like war, an oil price shock, or an emerging-market crisis. It could also be events like demonetisation in India or 9/11 in the US. The second is cyclical, caused by a changed economic cycle, due to factors such as rising interest rates, impending recession, and fall in profits. This kind of bear market can lop 30 per cent off the index value (already happened). The third is a structural bear market, created by huge imbalances in the economy and financial bubbles, very often followed by a price shock and deflation. The decline in such bear markets is around 57 per cent. Which kind is the current one? I am guessing that institutional investors think it is event-driven or cyclical. The fact is, we don’t know. If the epidemic is sharply contained in a month or two, we have a huge buying opportunity. If not, we are staring at a serious economic crisis, the contours of which we are totally unaware of.