RISKS EMERGING FOR INDIAN ECONOMY, MARKETS
The emergence of new macroeconomic headwind can put cold water on the hopes of a faster recovery in India’s economic and corporate earnings growth. The economic stability of the last three years, albeit amid low growth, was aided by a confluence of favourable factors such as record low crude oil prices, soft bond yields (read interest rates) and ample global liquidity. This translated into a low current account deficit and fiscal deficit, thereby adding to the favourable macroeconomic environment.
All these factors provided wings to Dalal Street bulls and consequently, stock valuations soared even as the underlying corporate earnings growth was poor. A rising tide of confidence and lack of investment opportunity in other asset classes pulled in a torrent of domestic capital in the equity market creating an unprecedented bull run, especially in the second and third tier stocks. The era may be coming to an end as India’s macroeconomic conditions worsen.
The tailwind are now gradually transforming into headwind as crude oil prices have more than doubled to around $70 a barrel levels from their multi-year lows of $26 recorded in January 2016. Similarly, bond yields in the US and India are up nearly 150 basis points from their lows. Higher interest rates make equity investments unattractive as it weighs on earnings growth besides, tightening of earnings yield spread over bond yields.
On the external front, India's exports are not growing fast enough, while its import bill continues to rise, thanks to rising crude oil prices and consumer goods imports. This has been accompanied by a rise in fiscal deficit, which is likely to worsen further. The result has been a downward pressure on the rupee after nearly two years of stable exchange rates.
This has made equity markets edgy and the uncertainty is likely to persist for at least a few more months until clarity emerges about India's macroeconomic condition.