Mumbai: India has overtaken China as the world’s fastest-growing major economy, but its northeastern neighbour remains the biggest risk for investors in rupee assets, says Morgan Stanley Investment Management. A case in point: the local market’s reaction to Brexit.

The rupee dropped more than 1% to 67.9688 per dollar on 24 June when it was announced the UK had voted to quit the European Union. It has since rebounded to trade at about where it was before the referendum, though it remains down more than 5% since China devalued the yuan on 11 August.

“The risks to India are from the East and not from the West,’’ according to Ruchir Sharma, head of emerging markets and chief global strategist at the firm. “Look at what’s happening post the Brexit. The panic has subsided very quickly and markets are back to where they were before the Brexit. In contrast, see what happened to sentiment and the economy when China had problems in August last year and again in January and February this year.’’

China’s slowdown could impact India as Asia’s biggest economy has been the largest contributor to global growth this decade and is also India’s biggest trading partner, said Sharma, who made the Bloomberg Markets 50 Most Influential list last year. Any further yuan depreciation risks exporting China’s deflation to developing-nation currencies, he said.

The rupee is Asia’s worst performer after the yuan since 11 August, when China’s shock devaluation of its currency roiled global markets and spurred a flight from Indian stocks and bonds. It fell to the brink of a record low in February as emerging markets sold off amid renewed concern about the health of the Chinese economy. However, foreign holdings of Indian assets have climbed since the UK’s 23 June vote to exit the European Union, with expectations for rupee swings since dropping at the fastest pace in Asia.

Problems in China “had a much wider sense of panic and fear in the economy and in the market place," said Sharma, who helped manage over $20 billion in assets as of 31 March. “The EU has been a marginal contributor to global growth. So, what happens in the EU really doesn’t matter as much as it used to matter once."

China’s “debt bomb" has become one of the biggest threats to the global economy, Sharma wrote in his book “The Rise and Fall of Nations," elaborating that much of China’s rise in the 2010s has been facilitated by massive fiscal and monetary stimulus, which entailed a sizable increase in its debt burden. Every one-percentage-point slowdown in China’s economic expansion reduces global GDP growth by nearly half a percentage point, “with emerging markets bearing the brunt," he wrote.

India saw its exports rise marginally in June from a year earlier, halting a record 18-month declining streak. Asia’s third-largest economy grew 7.9% in the January-March quarter from a year earlier, the fastest among major economies and compared with China’s expansion of 6.7% in the period. The two biggest emerging markets are probably growing much slower than official data suggests, Sharma said earlier this month.

The rupee sank 3.5% last August amid the yuan devaluation, as global funds dumped $3.5 billion of Indian shares and cut holdings of bonds by 780 crore. A gauge of emerging-market currencies slid 3.1%. The Indian currency has weakened 4.6% since the devaluation to 67.2750 a dollar in Mumbai on Tuesday.

It is little changed since the Brexit vote on 23 June and has gained 0.4% this month, with foreign investors buying a net $1.2 billion of local shares and ownership of rupee-denominated government and corporate notes rising by 6,780 crore, the most in nine months. India’s currency is reasonably valued and a devaluation will spur inflation and not necessarily help exports, Reserve Bank of India governor Raghuram Rajan said earlier this month.

“Growth is really the big" channel through which India will be impacted by China’s slowdown, Sharma said. “The other channel, obviously is the financial channel, which is, we have seen when the Chinese currency falls, other emerging-market currencies do also feel a bit of an impact." Bloomberg

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