Mumbai: The sharp rise in crude oil prices over the past weeks has emerged as the biggest risk to the stock market rally in India because it could widen the country’s fiscal and current account deficits, and weaken the rupee, analysts said.
Indian markets posted their first weekly loss this year for the week ended 24 February. Investors booked profits after a seven-week rally and even as Brent crude prices reached a 10-month high of $125 per barrel.
After a slump in 2011, when Sensex, the benchmark equity index of the Bombay Stock Exchange, plunged 25%, and the rupee fell 16%, Indian markets have seen a sharp rise this year due to sustained foreign inflows of $5.6 billion (nearly Rs27,500 crore) in net equity investments so far this year.
The 30-stock Sensex has risen nearly 16% thus far, while the rupee has surged 8.4% against the dollar, placing India among the best-performing markets of the world in dollar terms.
The rally so far has been led largely by monetary easing in the West, with the rising tide of liquidity pushing up prices of stocks and commodities across the globe. While the leading commodity gauge, the Thomson Reuters CRB Jefferies index, has climbed 6% so far this year, crude prices have jumped faster, rising 16% in the same period, matching the rise of Sensex.
Photo: Bloomberg
In the past week, Brent crude prices rose 3.5% and breached the $120 mark as tensions between Iran and the US and its allies escalated, fuelling worries over oil supply.
European buyers of Iranian oil have cut back on purchases ahead of a European Union embargo effective 1 July. Some of Iran’s biggest customers in Asia including China have also reduced buying, the Reuters news agency reported.
While last week’s market fall may be a temporary pause, and continued foreign inflows may yet lend support to Sensex, any further jump in crude oil prices will weaken the Indian economy and make local stocks unattractive, analysts said.
The performance of emerging markets lagged behind that of developed markets and commodities last week.
While the Dow Jones Industrial Average rose to nearly 13,000 points, the highest since the financial crash of 2008, the MSCI Emerging Markets Index declined 0.3%. According to fund tracker EPFR, emerging market funds saw the weakest weekly inflow since mid-December.
Indian markets underperformed peers last week, with Sensex falling 2%.
“If crude continues to inch higher, markets will not rise and they will become range-bound,” said Tirthankar Patnaik, equity strategist and chief economist, Religare Capital Markets Ltd.
India is more vulnerable than other markets because it is heavily dependent on oil imports, 9% of which comes from Iran, according to a 22 February report by Macquaire Capital Securities India (Pvt) Ltd. India has committed to reducing its oil imports from Iran, and its oil imports could spin out of control, as the embargo by Western nations bites, the note added.
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“Every $1 per barrel rise in crude prices raises the current account deficit by $700-900 million,” said Patnaik. “The fiscal deficit will also rise, given the incomplete pass-through to consumer prices, unless the government raises diesel prices.”
Deja vu
Similar fears had spooked stock markets around the same time last year, when oil prices had shot up to $120 a barrel. This was after oil production in Libya, the world’s 12th largest oil exporter, was crippled as protests against the 41-year rule of Moammar Gadhafi spread across the North African country in February 2011. Fears of global demand destruction owing to rising crude oil prices had cooled oil prices subsequently.
This time may be different. Oil demand may rise higher than the market anticipates as global growth picks up while risks to oil supplies mount, a 23 February report by Barclays Capital said. The report advises investors against taking short positions in crude oil futures.
Rising crude oil prices will also add to inflation and pose a risk to the rise of the rupee. The improvement in India’s trade deficit towards the end of last year stalled in January and may reverse owing to high oil prices, Standard Chartered Bank wrote in a 24 February note to clients.
The strength of the rupee has been driven by “global liquidity rather than any convincing signs of Indian recovery”, the Standard Chartered note said.
The recent rise in oil prices only adds to the near-term concerns and may be the trigger for a correction, the note added.
Stock markets may also see a similar correction if the crude oil rally continues uninterrupted and foreign investors weigh in the possibility of a rupee depreciation. India’s economic fundamentals have so far not provided much room for comfort as economic growth and corporate earnings have slowed.
Fears that the economy’s growth slowdown could be structural were strengthened after Reserve Bank of India governor D. Subbarao said in an interview with The Wall Street Journal last week that India’s non-inflationary growth rate had fallen to about 7% from 8.5% earlier.
After months of persistent declines, the consensus earnings estimates of Sensex firms have stabilized at around the Rs1,298 per share mark for fiscal 2013, down 13% since the start of the current fiscal. Still, it will be a while before analysts make upgrades to earnings estimates and many caution that corporate margins may further fall.
“The pricing power of corporates is decreasing but costs are soaring. Hence, the impact on margins will be seen in the coming quarters and it is not good for the broader markets,” said Raamdeo Agrawal, managing director, Motilal Oswal Financial Services Ltd.
Analysts are counting on a tighter national budget in mid-March to strengthen the economy and lend support to markets. Till then, global cues will continue to set market direction. The second tranche of long-term refinancing operations, or monetary easing, by the European Central Bank (ECB) and economic data from the US this week will set the tone for markets globally.
The amount of monetary easing by the ECB and indications of further such measures will shape sentiment for both commodities and stocks. Indian investors will keenly track the movement of crude oil prices that will impact the budgeted deficit numbers. With crude prices breaching $124 a barrel, the government’s annual oil subsidy bill could climb to Rs2 trillion, Agrawal said.
Graphic by Sandeep Bhatnagar/Mint
krishna.m@livemint.com
Ravindra Sonavane contributed to this story.