World Market crash

Why Indian markets cannot be an isolated beneficiary 

The 24th of August may have had traces of “Black Monday”, but it was far more benign compared to 1987. However, the impact was much bigger in terms of its seamless spread and the carnage across emerging markets. Over the last few days there have been consistent arguments on how India can outperform in these difficult global conditions. That argument may be flawed! Here is why…

Carry trade unwind is agnostic…

A lot of the selling that we saw in the last few days was a classic case of unwinding of carry trades. Low interest rates in Europe and Japan created an opportunity wherein traders could borrow in Euro and Yen and allocate to emerging markets. That trade worked perfectly as long as the Euro and the Yen remained weak. With the weakening Yuan and the US delaying rate hikes, the Euro has started strengthening. This has upset calculations of the carry trade borrowers and has resulted in rapid unwinding. Carry trade unwinds are normally macro decisions and global investors are unlikely to differentiate between emerging markets.

A cheaper China impacts all…

We would like to insert a caveat here. Unlike Brazil, Australia, Indonesia or Malaysia, India is not a commodity driven economy. Hence the impact on its currency will be limited. But India has a problem of a different kind. In industries like steel, machinery and tyres, Indian producers are not globally competitive. Low-cost producers like China have already captured a chunk of the market in India and depreciation of the Yuan will only worsen matters. On the downside, India does not have the export basket that can benefit from a cheap rupee. A large trade deficit is the major bottleneck in a situation like this. Obviously, India stands to lose.

Indian macros are vulnerable…

This is the biggest risk that India runs. While India has reason to be pleased about improving macros, they continue to be vulnerable. Things can change for the worse in a short span of time. Firstly, inflation is still largely a function of monsoons. A weak monsoon can put tremendous pressure on food inflation. Secondly, India’s current account deficit appears to be improving due to cheap oil and commodities. Even a small 30-40% bounce in prices can change India’s economics. Lastly, India continues to depend overtly on portfolio flows to bridge its current account deficit. As we saw in 2008 and 2013, these flows can be extremely volatile and unpredictable. That is the worry!

To summarize, India does have some natural hedges. But, she really cannot escape a global contagion. Hoping to grow in a tight global situation would be a tad optimistic and also ambitious! ©

You can ask us your stock related questions with#AskReligareOnMarkets via our Twitter channel @religareonline

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