In May 2006, when the Sensex declined by 17% in eight sessions, we wrote about the bubble in the West Asian markets: “Better economic and GDP growth is not an assurance to a perpetually booming market.”

Today, as Indian markets get lashed by subprime mortgage, we are asked to calm down as there is no link between the US and Indian markets.

Not entirely true. Stock markets are influenced by two factors — what companies earn, and what people are willing to pay for those earnings. The former is a function of the company’s management, business, and the overall economic growth. Little has changed here. We can assume India's GDP will continue to grow 6-6.5%.

What people are willing to pay for those earnings is a function of what is called liquidity. Though there is no clear definition of liquidity, one can assume it is how much money is sloshing in the system. Imagine you are at a bar and everyone is having a grand time. Then the bartender says, “Hey, what if I cut the price of drinks by 50% — anyone interested?"

You bet! With drinks available cheap, you lose your sense of judgment. By the fifth glass, the waiter in a corner restaurant in some obscure US town looks like a promising young man who could one day build his own chain of restaurants. So you lend him money to buy a house. He is actually what the credit rating agencies would call a “subprime credit risk”. But, because of all those free drinks, in your eyes he becomes a “good risk”.

To do one better, you re-sell the loan to this subprime fellow for a profit. How? Because the guy you sell it to, no matter his nationality, is further down Drunks Alley than you are. So he cannot assess the risk profile any better.

And you use that profit to make another loan to another poor subprime fellow and so on and so forth… The drunks have been having a good time since 2003, lending, buying and selling sub-prime loans to each other. The central banks were the bartenders. From dour men, they became the fairytale spinning stars on TV.

That fairy tale found its way to India and other emerging markets, which got a new name: BRIC. They became the darlings of the drunks. While there have been significant improvements in these countries—including India—the depth or sustainability of improvements were exaggerated.

India has seen nearly $50 billion of foreign inflows—of which $40 billion came in since 2003. Yes, Indian companies and stock market did deserve a lot of that but the assessment of risk has been absent. The subprime blow has so far seen some $2 billion of losses. Losses worth $50-100 billion may yet be exposed, claim experts. Though the market cap of stocks is 300 times the potential losses, the bartenders are now serving less booze and drunks are getting sobre.

Yes, the fundamentals for India are fantastic, and money will flow in over the next decade. But sensible, riskassessed money. We enjoyed the ride for the past four years, now we will feel a bit of pain. Keep your money ready to invest. Stay disciplined, ignore the free drinks, and you will profit: steadily but surely.

Ajit Dayal is Director, Quantum Asset Management Company