RISK OF GLOBAL MARKETS CRASH: THE RBI GOVERNOR’S WARNING – BY Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN

August 8, 2014 | Posted by bobbysrinivasan << back to blog

In a recent speech, the governor of RBI expressed a serious concern about a possible crash of the global stock markets due to lingering competitive lose monetary policies followed by the developed economies.He said, I quote, “sudden price reversals and sharp spikes in volatility is a real possibility in the near term which may result in the global markets going out of control because of uncontrolled sell-off.

The stock markets of the world emphasize the importance of providing adequate liquidity to sustain it. Any distortions such as credit squeeze in any developed economy could ignite a contagion effect pushing all the markets down. For example, Chinese economy is facing a bubble in the real estate. Millions of square feet of office space and public housing remain vacant there. The banks had advanced trillions of dollars to the development of these assets. Sooner or later, these assets should sell-off providing the liquidity to the bank. On the other hand, similar to the one in public sector banks in India some of which have high non-performing assets, we may find a similar situation in china. Unlike India, where most of the borrowings are internal, a large part of Chinese borrowings come from banks across the world. This could lead to a contagion effect, like the one we saw in 2008 during the sub-prime crisis in the US which created havoc in global stock markets.

Dr. Rajan was accurate in predicting the 2008 crisis, so his warnings should not be taken lightly. It would be far better for the financial world, if all the chairmen of central banks sat together and formulated a clear cut policy which will ensure adequate liquidity to the financial markets. If such coordinated efforts are not taken there is always risk of high-volatility in the financial markets, which will then lead to panic followed by a crash.

For India, we are targeting to achieve an economic growth rate in excess of 5.5%. To do this, we need the global capital market to provide the liquidity. This may come as debt or equity to the country or some combination of both. In the event of global stock market, scouting for funds will not be an easy task. Some estimates say that India needs nearly 1 trillion dollars to push the economic growth to higher levels.

In the meanwhile, let us wait and see as to how things will pen out globally.

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