The reappearance of global risks

The recent turmoil in global markets, which has taken the rupee back to 63 against the dollar and sent the Sensex hurtling down by 6 per cent over the last two weeks, is a sharp reminder that India, despite improving economic fundamentals, isn’t immune to global risks. The latest bout of volatility was sparked by the escalating crisis in Russia, where concerns about shrinking oil revenues have triggered a run on the rouble. Russia’s central bank responded with desperate, but ineffectual efforts to shore up the currency with a 650 basis point interest rate increase. But global investors have still withdrawn, fearing a 1998-style crisis. The impending US rate hike and China’s wobbly economic data have also added to market jitters.

It is true that the pullout by foreign investors from India and other emerging markets due to oil-related worries is a panic reaction. After all, India is hardly in the same boat as Russia or West Asia in terms of the impact of declining oil prices on economic health. The country in fact stands to make significant savings on its import bill, reduce its current account deficit and improve its fiscal deficit. But while the recent rout in oil is a big positive for India from a macroeconomic perspective, faltering global recovery can create new challenges for certain sections of India Inc. For one, with many Indian companies acquiring a global leg to operations over the last decade, profits for nearly a fourth of the Nifty companies (in sectors such as pharma, software and automobiles) now originate from overseas. Emerging risks to recovery in Europe and China can therefore adversely impact their prospects. Two, commodity processors, who make up sizeable weights in the index, also face a threat to their profit margins from the recent price meltdown. But most important, sovereign wealth funds from oil-rich nations in West Asia have been a significant source of global liquidity and foreign investments into India in recent years. Shrinking petroleum profits directly threaten this source of global capital. According to SEBI data, sovereign wealth funds held equity investments valued at about $22 billion in the Indian market as of May 2014.

These factors have two major implications for Indian policymakers. If the recent crisis is not quickly resolved, attracting foreign capital into India in the coming year will prove far more difficult than they have so far assumed. With the impending US rate hike, even sustaining this year’s record flows may be a challenge. The recent run on emerging markets may also prompt the Reserve Bank of India to take a more cautious stance with respect to the timing of rate cuts. If moderating domestic inflation and sluggish industrial growth until recently made strong arguments for a rate cut, the need to retain foreign investors and shield the volatile rupee may now be the wild cards in the equation.

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