Why are stock markets up?

Dr Raghuram Rajan on stock markets and state of the global economy

On 8th October 2020, former RBI governor Dr Raghuram Rajan addressed ICRIER’s 12th Annual International G20 Conference. (Video on Youtube)

While he spoke largely on the challenges facing the global economy, he had an interesting view on why stock markets don’t reflect the weak state of the economy.

Most economies have lowered interest rates due to COVID-lockdowns. And this has helped companies and their share prices.

“The valuations, in an environment of relatively low-interest rates, reflect what the economy can become going forward rather than the immediate effects of the pandemic. So if they’re healthy, they’re going to survive,’ Dr Rajan said.

He also pointed out that “the stock markets reflect the largest companies in the economy” but not the small and medium businesses.

These large companies are “going to see an increase in demand because small and medium suppliers are going to go out of business.”

He elaborated with an example: “think of large private banks in India that are healthy. Yes, they will see some loan losses, but not to the extent that perhaps some other banks may face. Plus, they may get additional business as these smaller guys can’t lend in this environment.”

So, if you were wondering why Nifty is going high while all other indicators are going south, here’s your answer.

On relief versus stimulus

Dr Rajan discussed the importance of having clear policies vis-a-vis relief and stimulus.

To briefly distinguish between these two types of government spending:

• Relief is spending to assist businesses stay afloat.
• Stimulus is money that helps consumers buy more goods and services.

Dr Rajan worries that governments may defer relief and instead aim to provide stimulus at the end of the lockdown.

He argued that relief is critical in preventing companies from going bankrupt and assets getting locked up in bankruptcy proceedings.

If a shopping mall shuts down, that real estate gets trapped until bankruptcy proceedings unlock the asset.

If too many businesses have folded up by the time stimulus expenditure starts, this will simply fuel inflation: “too much money chasing too few goods”.

The lack of productive assets will impact the growth of the economy down the road. And it may create a lop-sided economy where small businesses die out and the large ones thrive.

There were other nuggets on:

• the challenges of social distancing in developing countries: “Some of my colleagues have shown that 45% of work in the United States can be done from home, just like I’m doing right now. But in emerging markets in relatively poor countries, Bangladesh, for example, it falls down to 10%.”
• China and the theory of “dual circulation, essentially saying that China has to distance itself from dependence on the rest of the world by increasing its own expertise and reducing the demand dependence. If the world separates into two or three big blocks, this would be a problem both for productivity as well as growth.”
• the importance of focusing on infrastructure development. “The easiest way to recover is infrastructure. And the most far-thinking countries have focused on the infrastructure that is going to be alive and well 30 years from now. For example, one aspect of infrastructure spending by the Chinese has been on charging stations so that they can actually enhance electric car use in the future. Clearly, charging stations are a public good. In some sense, it could be provided privately also. But the more you have, the easier it is to buy an electric car.

Dr Rajan’s other policy prescriptions would be well worth the time of leaders and central bankers, and may be of interest to those trying to understand these uncertain times.

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