Stock Market Crisis: Will the Emerging Market Crisis Eventually Touch Dalal Street?

The crisis is deepening in emerging markets and the crack is spreading far beyond the obvious names like Pakistan and Nepal. When a famous economy from the not-too-distant past is on the doorstep of the IMF, one can understand the magnitude of the crisis in emerging markets. Once lauded as a miraculous economy, Bangladesh may now be on the verge of an IMF bailout. Such is the scorching heat in emerging markets.

In such a frightening situation, one can’t help but start digging deeper for any hidden macro risks in India. Could the shared view of a relatively stable macro for India be clouded by some serious doubts? Or has the Indian macro really come of age since those fragile days in 2013? Let’s dive in and explore.
The emerging market crisis follows a very familiar pattern. In times of a high liquidity cycle (while the Fed is easing), the money supply is plentiful and reaches far shores to seduce the usual suspects of emerging markets to focus on consumer-led growth with borrowed capital.

In a playbook style, a falling dollar index, rising local currency, cheaper imports, lower interest rates, etc. all come together to fuel local consumption. In times of abundant liquidity, currency valuations are distorted at artificially high levels to hide the underlying double deficit problems (current account and fiscal) that are usually the case in most emerging markets, which import far more than they export. .

When the music stops, which usually happens when the Fed starts tightening, the reverse dynamics of rising dollar index, falling local currency, rising interest rates etc. brings out hidden vulnerabilities. In these times, markets are starting to look closely at certain parameters such as dollar debt versus GDP, current account deficit, level of forex reserves, upcoming dollar debt payments etc., under the microscope. If the market smells like a rat in any of these metrics, it knocks the currency down in a vicious circle 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 fuel a further decline in the currency which exacerbates already damaged twin deficits, inflation etc.

So, the key thing is investor confidence in macro metrics. If it is broken, it sets off a vicious circle, as explained above. Confidence comes from various factors, including the level of foreign exchange reserves, the credibility of the central bank in managing inflation, dollar debt to GDP, short-term debt payments, manageable checking account, etc.

Where is India on these?

The level of forex reserves is reasonably high at over eleven months of imports (even after its recent depletion in defense of the rupee). Likewise, India’s dollar debt is at a manageable level of around 15% of GDP, much lower than that of many Asian counterparts. RBI enjoys high credibility in addressing inflation risks. These are positive aspects for India, but there is also a weakness.
That is, India’s historic vulnerability due to the high current account (CAD) deficit which increases suddenly during such times of crisis, especially when crude oil breaks above the $ 100 level due to the weakening of the rupee (as the 80% of India’s energy needs are imported). This has always been a potential mine for India, especially during the Fed tightening cycle. Will it be different this time?

To answer this, let’s go back and look at the fundamental difference between 2013 and today in terms of CAD vulnerabilities. Not to forget that India was beaten as one of the fragile Five countries in 2013. The key macro difference between 2013 and today stems from the different growth trajectory between crude oil and software exports. Dollar-denominated software exports more than doubled over this period, while dollar-denominated crude oil imports remained stagnant or slightly decreased (even at this high level).

Looking at the data points, software exports have increased from $ 70 billion (approximately) in FY14 to $ 178 billion (according to Nasscom) now (FY22), while energy imports (including LNG) have fallen from $ 140 billion in FY14 to $ 130 billion in FY22. This has brought tremendous comfort in easing our macro vulnerability from oil risks.

Today, software export income covers more than the total oil bill by a factor of 1.3 times (even at this high oil price of $ 100 +) from a precarious situation in fiscal year 14, when the oil bill was the double the revenue from software exports. This comfort will only increase many times with projection of more than $ 300 billion in annual exports by 2025 according to Nasscom projections given the huge cycle of super digitization globally.

Also, keep in mind how oil imports as a share of total imports have fallen from a level of 30% in FY14 to a level of 21% in FY22. It doesn’t stop there. India’s focus under current political leadership on renewable energy, ethanol blending, CNG infrastructure, potential green hydrogen leadership, oil supply at a discount from Russia, etc. it will further strengthen Indian macro-architecture. It goes without saying that India has come a long way in its macro stability, especially in external financing and CAD management.

In our view, this development will alone change the contours of India’s macro risk profile. This change is the most underrated and least understood in the investment community. Add to this the growing credit profile of Indian companies and banks in the wake of an enormous cleansing of corporate and bank balance sheets.

With the NPA cycle behind it, the risk of potential accidents in the financial sector diminishing (such as ILFS in the 2018 tightening cycle), India’s macro appears to be among the few bright spots for global investors. This is probably why India saw nearly $ 34 billion in investments in PE-VC space (28% year-on-year growth) in the first half of the calendar year, when FIIs were busy withdrawing beyond $ 25 billion from the equity markets.

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

(ArunaGiri N is the founder, CEO and fund manager of TrustLine Holdings Pvt Ltd)


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