India: markets stay out of EM firing line

After the Argentine peso depreciated sharply at the end of last week, talk has begun of a wider EM rout. Once engines of growth for the global economy, emerging markets are now seen as vulnerable with signs of weakness emerging in the Chinese economy and the US Federal Reserve reeling in its asset purchase programme, adding to domestic woes.

While the spotlight was on Argentina on Friday, how unstable are markets in India?

In fact, although the rupee has dropped almost 2 per cent to the dollar in the past week, the benchmark Sensex index has been broadly level, following a rally at the end of last year when political and economic events were driving confidence in Asia’s third largest economy.

India’s markets are currently looking more stable than some other emerging markets. It’s a trend that analysts at ICICI bank have picked up on in recent months, estimating that the rupee has appreciated some 6 per cent since September. Compare that to the next best performer, Brazil’s real, which is up just 2 per cent, while the Indonesian and Turkish currencies have dropped between 5 and 10 per cent.

That’s a change in sentiment – India was one of the most fragile economies last year, when initial talk of ‘tapering’ created panic in emerging markets.

“If there is a global risk aversion India also will get hit adversely,” says Anubhuti Sahay, an economist at Standard Chartered. “But the vulnerability has definitely reduced, so even if we do see global risk aversion we may not see the rupee getting hit the way it did in May and June 2013.”

The greatest improvement in the Indian economy has come from the current account deficit, which ICICI analysts see dropping to 2.2 per cent of GDP in the current fiscal year from 4.8 per cent of GDP a year earlier thanks to the squeeze on gold imports.

Similarly finance minister, Palaniappan Chidambaram, now looks set to meet his target for a fiscal deficit of 4.8 per cent of GDP this fiscal year. He’s recently shown his commitment to do whatever it takes to remain below that cap, with disinvestment plans and special dividends payouts from state-owned companies.

It was tapering that really scared investors in India, but inflows of foreign institutional investment have turned positive – at $2.8bn so far this financial year.

Of course, there are new risks in India. The upcoming general elections could easily swing the mood in the markets. And after a report last week suggested changing the way the central bank targets inflation, there is now a chance that governor Raghuram Rajan will hike rates again tomorrow.

The lesson is that, unlike the 1990s, emerging markets today have very distinct characteristics. As analysts at Capital Economics emphasised last week, there is a strong need to differentiate.

Capital put India in the group of ‘EMs with domestic structural problems’ along with China and Brazil. That’s a different issue to, say, Argentina and Ukraine where Capital thinks there has been grave mismanagement. And it’s a different issue to Turkey and South Africa, which have been living beyond their means and the prospect of Fed ‘tapering’ is the biggest threat.

Related reading:
Argentina woes weigh on EM currencies, FT
India’s battle against inflation, FT
The strength of Buenos Aires is the weakness of Argentina, FT