Why Sensex dropped more than Dow?

The Sensex was hit much harder than Dow although the epicenter of the financial crisis was the US. Since January 2008, for instance, Sensex fell 58 per cent in rupee and 68 per cent in dollar terms; Dow Jones declined 33 per cent.

The Indian market experienced more than a ripple effect. There were hard financial realities that weighed the Sensex down.

First the Indian stocks were, to start with, over-valued. The P/E had climbed up in 2007 from 25 to 35 (2007 companies) which was not justified by the performance of the corporate sector.

In the quarter ending September 08 earnings declined 34 per cent although sales increased 38 per cent. The margins were under pressure because of the increase in raw material prices and the rate of interest.

Even before the US financial crisis came into the open with the take over of Bear Stearns by J. P. Morgan, 15 per cent was already sliced off from the Sensex.

Second, although most Indian banks did not invest in toxic securities (the root cause of the crisis) there was indirect impact through the FIIs. From net buyers they turned net sellers. FIIs were major investors and held about 25 per cent of the floating stock. In a shallow market FII disinvestment made a significant difference.

The sale of $13 billion of securities would amount to about 4 per cent of floating stock. The NYSE was spared similar disinvestment by foreign investors.

Third, the domestic institutional investors (DIIs) suffered liquidity crunch. The repatriation of the money from sale of shares by FIIs had to be covered by drawing down foreign exchange reserves with the RBI. The return of corresponding rupees soaked out liquidity.

This made it difficult for DIIs, including Mutual Funds and Non Banking Financial Companies, to make fresh investments.

There were consequently hardly any buyers in the market in the month of October when liquidity had absolutely dried up. Had the RBI replenished liquidity in time the drop in stock prices would have slowed down.

Fourth, funds were diverted from shares and even small savings schemes to bank deposits following the increase in the rate of interest. The growth of bank deposits which was 15 per cent at the beginning of the year rose to 20 per cent by the middle of September. Debt became far more attractive than equity

The ripple effect of the international financial crisis was thus exaggerated because of FII disinvestment and adverse domestic financial pressures.

The RBI did take the much needed measures, though late, to replenish liquidity and cut interest rate. It is therefore possible that the Sensex that fell fast may rise early even before the Dow.
Source: - Economic Times.

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