Rising crude prices pose a risk for India’s current account deficit, as it imports most of its oil
Global trouble tends to spiral a long unwinding from risky assets to a flight to safety
As if the Indian market did not have enough domestic issues to contend with, now it has been saddled with the after-effects of increasing global geopolitical risks.
After the US attack on an Iranian general’s convoy, the Nifty 50 index lost about 3.12% since 2 January in dollar terms. This is its biggest drop among major global equity markets.
While indices such as the S&P 500 of the US have lost about 0.7% since 2 January, the decline in some developed markets such as the UK is even less.
An escalation in the Middle East particularly hurts the domestic economy. Global crude oil prices have already increased by over 5% since the attack. Markets are worried that Iran could try to shut the Strait of Hormuz, which could see oil prices skyrocket even further.
This poses a big risk for the subcontinent, which imports most of its oil requirements. This will strain the domestic current account deficit. In the past, rising oil prices have contributed to high current account deficits in India.
In India, higher oil prices exacerbate balance of payments woes and tend to escalate inflation, and could also lead to a hike in interest rates. The rupee has already breached the ₹71.94/dollar mark, losing 0.78% since 2 January.
All this comes at a time when growth in India has been slipping.
“It’s not the global market, but the domestic economy is a bigger concern. This is the reason why the Indian markets have taken a big hit over the last few days. It’s a tight-rope walk between maintaining fiscal deficit and increasing spending, and that’s why earnings which have been elusive for long are not picking up," said Dharmesh Kant, head of retail research at IndiaNivesh Securities Ltd.
Besides, whenever there is global trouble, it tends to spiral a long way from risky assets to a flight to safety. Large investors tend to withdraw from emerging markets and swing back into stronger currencies. Gold has also surged to a near six-year high, even as safe havens such US bonds and dollars, have strengthened.
For the Indian market, the situation gets even more worrisome because the liquidity gush has sent equity valuations soaring. The Nifty 50’s historical price-earnings multiple had surged to more than 28 times earnings, near its all-time high. Hence, this market correction is more pronounced.
“Mega-caps are overvalued, while large-caps are richly valued. The situation in the market is such that valuations are not compelling, so returns from equity may be moderate," said a fund manager of a large domestic fund house, requesting anonymity.
With another risk getting added to the equation, the risk-reward ratio in India’s equity market has gone from bad to worse.