In economics, most decisions are tradeoffs.
The current boom in the initial public offerings (IPOs) of companies seeking to list their shares in the stock market is a great example of this. In the recent past, even small IPOs have attracted bids worth thousands of crores. An IPO boom is currently on.
Why is this happening? In the last two years, the interest rates on fixed deposits have fallen to levels lower than inflation. If you have your savings invested in deposits, you are basically losing money because the savings aren’t growing at a rate good enough to maintain pace with inflation.
Since the beginning of 2020, the Reserve Bank of India (RBI) has printed and pumped close to Rs 5.5 lakh crore into the financial system. The surfeit of money has led to lower interest rates. The RBI has also massively cut the repo rate or the rate at which it lends to banks. Further, the slowdown in lending has led to a situation where banks aren’t interested in collecting as much deposits as they were in the past, leading to falling rates.
There are two reasons why the RBI wants lower interest rates to prevail. At lower interest rates, the hope is that people and corporates will borrow and spend more money. In theory, this was expected to help the economy, though the evidence of this happening is at best shaky.
Also, the tax collections of the government which had been slowing down even before the COVID pandemic struck, crashed post-COVID. This meant that the government had to borrow more. As the banker to the government, the RBI has ensured that the government is able to borrow at lower interest rates.
Further, many small businesses have shut. People have lost jobs or seen their salaries being cut or incomes falling. All this has led to a situation where people need to generate an extra quick income from somewhere. This is where stock markets have come into the picture. The number of demat accounts between December 2019 and May 2021, have gone up by 55 percent to 6.10 crore. This has led to a lot of money pouring into IPOs.
The massive success of Zomato and other few IPOs has indicated to retail investors and high net worth individuals that there is good money to be made by applying for an IPO, hopefully getting an allotment, and then selling for a gain on the day of listing.
Banks and non-banking finance companies (NBFCs) are also happy to lend money to prospective investors to finance an IPO purchase. All this is primarily because of the extremely low interest rates that currently prevail vis a vis the inflation. And this is the tradeoff or the cost of low interest rates. As the old adage in economics goes, there is no free lunch.
What has also helped is what the economist John Kenneth Galbraith called the extreme brevity of financial memory. Investors have forgotten last year’s massive crash or the crashes before that. Hence, their tolerance for risk has gone up.
As Howard Marks writes in Mastering the Market Cycle: “For a bullish phase to hold sway, the environment has to be characterized by greed, optimism, exuberance, confidence, credulity, daring, risk tolerance and aggressiveness.” The trouble is all this doesn’t last forever, as investors tend to assume during any bull run. As Marks puts it: ‘”Eventually they will give way to fear, pessimism, prudence, uncertainty, skepticism, caution, risk aversion and reticence. … Busts are the product of booms.”
Of course, right now no one is bothered about this given that the good run is currently on. Nevertheless, it is worth remembering what Galbraith wrote in A Short History of Financial Euphoria: “ The rule will often be here reiterated: financial genius is before the fall.”
(Vivek Kaul is the author of Bad Money. He tweets @kaul_vivek)
Published on: Friday,August 13, 2021, 01:44 PM IST
