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After topping the league tables for two successive months, India has slid three rungs to occupy the fourth spot among major emerging markets globally. In May, India fell behind Brazil, China, and Russia, the latest update to Mint’s emerging markets tracker shows.

While most emerging markets were hit hard by the second wave, India suffered more, with far greater loss of lives and livelihoods. Unlike in the first wave, lockdowns in the second wave were clamped late, and the economic impact of the lockdowns was felt largely in May. Mobility fell, and so did several key economic indicators, lowering India’s rank in the league tables.

As the second wave ebbs, and vaccinations pick up pace, there is reason to hope that things will get back on track in the coming months. However, there are some dark clouds on the horizon as well. The US Federal Reserve has signaled it might taper its quantitative easing programme to rein in high inflation.

The situation, similar to one faced in 2013, could be damaging for emerging economies including India, but it may not be the same slog as earlier. Some macroeconomic indicators are in better shape than in 2013. The current account deficit position is much more comfortable. India in fact reported a trade surplus in 2020. The forex cushion is much higher now, and retail inflation, although rising, is still below 2013 levels.

Yet, there is one big reason for Indian investors to worry: the fiscal deficit and public debt levels today are much higher than most other emerging markets. As demands for a fiscal response to the second wave grow, and the government resorts to higher borrowing to fund such measures, public finances could once again become India’s Achilles heel.

There is some anxiety on the growth front as well. India’s March quarter real gross domestic product (GDP) showed an improvement of 1.6% compared to 0.5% growth in the previous quarter. However, the disruptions caused due to the current wave could weigh on the economic output in the first quarter of this fiscal, and demand could remain sluggish beyond the current quarter. Several multilateral agencies have pared growth forecasts for fiscal 2022, and so has the Reserve Bank of India.

Slowing Momentum

Although India’s financial indicators - stock market capitalization and the exchange rate - have remained resilient throughout the second wave, the real economy has borne the lockdown scars. The purchasing managers index fell to 50.8, a 10-month low. This was lower than what most other emerging markets recorded in May although being above the 50 mark, it still signaled an expansion. Similarly, although exports grew fast, the rate of growth was lower than several emerging market peers. The underperformance in these indicators pulled India’s overall rank down.

Chart 2:

Mint’s Emerging Markets Tracker, launched in September 2019, takes into account seven high-frequency indicators across 10 large emerging markets to help us make sense of India’s relative position in the emerging markets league table. The seven indicators considered in the tracker encompass both real activity indicators, such as the manufacturing purchasing managers’ index (PMI) and real GDP growth, and financial metrics. The final rankings are based on a composite score that gives equal weightage to each indicator.

India’s March quarter GDP figures were higher than most other emerging markets but this is likely to change for the June-ended quarter, given the much harder hit India took in the current quarter as compared to other markets.

Buoyant Markets

So far, India’s financial markets have done well. In May, stock market capitalization rose 6.1%. Only Brazil had a better showing. The rupee has also been relatively stable although the currency could come under pressure now as the dollar strengthens.

RBI’s easy money policy has kept markets happy, as it has helped inflate asset prices. But now even retail inflation is picking up pace, and it may not be easy for the central bank to maintain its accommodative stance for long. Rising global commodity prices and easy monetary and fiscal policies have been pushing up price barometers globally, and India appears to be among the worst affected now.

Only Turkey and Brazil have higher inflation than India among major emerging markets. Brazil has responded with steep rate hikes. Turkey’s inability to do so, because of political pressures, has made the lira the worst performing emerging market currency. India too faces some tough choices now as the recovery in global demand continues to put pressure on commodity prices. The weakening of the rupee will further add to inflationary pressures by raising prices of imported commodities.

Apart from RBI’s dovish stance, it is the flow of foreign capital that has propped up stock markets since the pandemic began. The earlier-than-anticipated tightening of Fed policy could slow down or even reverse such flows. Emerging markets with fragile economic or health indicators are likely to be hit hardest in such a scenario.

The upshot: India needs to ramp up vaccinations fast, and it needs to be cautious about its debt and inflation metrics.

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