stock market crisis: will the crisis in emerging markets eventually affect Dalal Street?

The crisis is deepening in emerging markets and the rift is widening far beyond obvious names like Pakistan and Nepal. When an economy celebrated in the not-too-distant past is on the doorstep of the IMF, one can understand the magnitude of the crisis in emerging markets. Once touted as a miracle economy, Bangladesh could now be on the verge of an IMF bailout. Such is the searing heat in emerging markets.

In such a scary situation, one cannot help but start digging deeper for any hidden macro risks in India. Could the consensus view of a relatively stable macroeconomic situation for India be clouded by some serious fears? Or has India’s macroeconomics really come of age after those fragile days of 2013? Let us dive in and explore.

The emerging market crisis follows a well-known pattern. In times of high liquidity cycles (as the Fed eases), the money supply is plentiful and reaches distant shores to entice the usual emerging market suspects of fetching consumer-led growth with borrowed capital.

In a playbook style, a falling dollar index, a rising local currency, cheaper imports, lower interest rates, etc., all play together to fuel local consumption. In times of abundant liquidity, currency valuations are skewed to artificially high levels to mask the underlying dual deficit issues (current account and fiscal) that are typically the case for most emerging markets, which import far more than they don’t export.

When the music stops, which usually happens when the Fed starts tightening, the reverse momentum of the dollar index rising, the local currency falling, interest rates surging, etc. . brings hidden vulnerabilities to the surface. In these times, markets begin to look closely at certain metrics such as dollar debt to GDP, current account deficit, level of foreign exchange reserves, upcoming dollar debt payments, etc., with a microscope. If the market smells the rat in any of these indicators, it beats the currency in a vicious cycle to bring the country to the brink of bankruptcy. This usually happens in a self-fulfilling feedback loop, with a falling currency triggering outflows which in turn fuels further currency decline which worsens already hurt twin deficits, inflation, etc.

Thus, the key element is investor confidence in the macro metrics. If broken, it triggers a vicious cycle, as explained above. Confidence comes from a variety of factors, including the level of foreign exchange reserves, central bank credibility in managing inflation, dollar debt to GDP, short-term debt payments, current account manageable, etc.

Where is India?

The level of foreign exchange reserves is reasonably high at over eleven months of imports (even after its recent depletion in the defense of the rupee). Similarly, India’s dollar debt is at a manageable level of around 15% of GDP, well below that of many Asian peers. RBI enjoys high credibility in tackling inflation risks. These are positives for India, but there is also a delicate point.

That is, India’s historical vulnerability to the high current account (CAD) deficit that suddenly rises during such times of crisis, especially when crude breaks above the $100 level amid weakening of the rupee (because 80% of India’s energy needs are imported). This has always been a potential landmine for India, especially during the Fed tightening cycle. Will this time be different?

To answer that, let’s go back and look at the main difference between 2013 and today in terms of CAD vulnerability. Not to mention that India was named as one of the Fragile Five countries in 2013. The main macroeconomic difference between 2013 and today stems from the different growth trajectory between crude and software exports. Dollar software exports more than doubled over this period, while dollar crude imports stagnated or declined slightly (even at this high level).

In terms of data points, software exports have grown from $70 billion (approximately) in FY14 to $178 billion (according to Nasscom) now (FY22), while energy imports (including LNG) decreased from $140 billion in FY14 to $130 billion in FY22. This has provided enormous comfort by mitigating our macro vulnerability to oil risks.

Today, software export revenue covers more than the total oil bill by a factor of 1.3 (even at this high oil price of over $100) compared to a precarious situation during the financial year 2014 when the oil bill represented 2 times software export revenues. This comfort will only multiply with the projection of more than $300 billion in annual exports by 2025 according to Nasscom projections, given the huge cycle of super digitalization globally.

Also keep in mind that oil imports as a share of total imports fell from a level of 30% in FY14 to a level of 21% in FY22. It doesn’t stop there. India’s focus under current policy leadership on renewables, ethanol blending, CNG infrastructure, potential leadership in green hydrogen, discounted oil supply from Russia , etc. further strengthen India’s macro-architecture. Needless to say, India has come a long way in its macro stability, especially in its external financing and CAD management.

In our view, this development alone will alter the contours of India’s macroeconomic risk profile. This change is the least discussed and the least understood in the investment community. Add to that the growing credit profile of Indian companies and banks following a huge cleanup of corporate and bank balance sheets.

With the NPA cycle behind, the risk of potential crashes in the financial sector fading (like ILFS in the 2018 tightening cycle), India’s macro appears to be one of the few bright spots for global investors . This is probably the reason why India recorded nearly $34 billion in investment in the PE-VC space (28% YoY growth) in the first half of the calendar year, when FIIs were busy withdrawing more than $25 billion from the stock markets.

This emerging comfort on macroeconomic stability, progressive political environment, relative strength of the rupiah and positive long-term growth prospects, etc. could possibly be the reasons for the growing confidence of the domestic investment community and the enormous resilience Indian markets have shown during the current crisis. The next few months will tell us if this prognosis is good or bad. Interesting times to watch!

(ArunaGiri N is the Founder, CEO and Fund Manager at TrustLine Holdings Pvt Ltd)

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