Cautious March Of Decoupled Indian Markets Continues

It was December 2007. We were at a year-end party to meet a visiting foreign fund CEO. My old friend had come back from a US trip. He had a grim warning about how the US subprime market was seizing up and how winter was coming.

Most of the fund managers had a different take on the US crisis. They felt that India would get more outsourcing business as corporates looked at cut costs. India was seeing a massive capital spending, capacity expansion and bank credit boom.

We would be beneficiaries and our markets would stand out as outperformers in the winter of global correction. Notes were put out on the “India is Decoupled” theme. We were a domestic consumption economy, the contribution of exports was low and our IT services companies would be beneficiaries of greater outsourcing following the global financial crisis (GFC).

The Nifty was at 6,138 as of December 2007. By November 2008, it was at 2,755. That is a fall of 55%.

It took six years till September 2013 for the Nifty to go back to its pre GFC level and carry on. Six lost years in the Indian markets on the back of the GFC, European debt fears and the taper tantrum of Ben Bernanke’s fed in May 2013.

And we had the ignominy of being classified as one of the “fragile five” with hugely over-leveraged corporates, under-capitalised banks with massive bad loans and twin deficits on the fiscal and trade front that threatened our stability as an economy.

Resolute policy and regulatory action got India out of this precarious position over the last eight years. Today, India is well positioned with a strong economy, very low leverage on corporate balance sheets and well capitalised banks with low non-performing assets.

Over the last one year and especially year-to-date in 2022, the Indian stock markets have outperformed their global peers in both the developed and the emerging markets. Similarly, the Indian rupee has depreciated less than the Japanese yen, UK pound and the euro in a very challenging year.

This has brought to the fore “India is decoupled” theories of India’s invincibility in the face of a global slowdown or recession. As global brokerages raise the probability of a European, UK and US recession in 2023, and as China experiences a slowdown in its GDP growth rate, India’s growth trajectory is being commended as an oasis for investors.

It is said that in the markets, history does not repeat itself, but it does rhyme. The 2007–08 thesis of “decoupling of Indian markets” is being played out in 2022, with some analysts propounding that India is well positioned to weather the incipient economic recession and further market corrections.

That may prove to be a mirage yet again. The global issues of persistent inflation, multi-decade high interest rates that will be raised further by ultra-hawkish central banks, geopolitical uncertainties unleashed by the first-in-75-years war in Europe and a surging US dollar that is eroding both developed and emerging market currencies exchange rates, all have led to a synchronised fall across asset classes from bonds to equities to precious metals.

The Indian equity markets have historically been at a premium valuation compared to its global peers. Indian equities are not cheap, even if continued growth justifies their premium.

The Indian outperformance has been on the back of strong regular retail investor flows through the route of systematic investment plan (SIP) into mutual funds and Indian markets. The Rs 12,000 crore odd of monthly SIP flows into equity mutual funds has supported the markets even as foreign portfolio investors turned sellers from October 1, 2021.

Indian macros are relatively better positioned for the next 12 months in the wake of forecasted slowdowns in the rest of the world from China to the US to Europe. But, the fact remains that a strong US dollar has in the past been negative for emerging market flows and stock market performance. India would not be able to sustain its relative outperformance in a scenario of accelerating foreign portfolio investment outflows from emerging markets, as that happened in 2008, 2011 and 2013.

Recently a brokerage firm forecasted a 30% fall in the Nifty in case of a global sell off. The probability is low of that kind of a sharp correction, given the strong fundamentals of the Indian economy and the health of corporate balance sheets with historically low leverage. But, in a synchronised rate hike and recession environment, a panic-induced flight to safety will sink all boats. We are coming off an “everything in a bubble” environment marked by huge fiscal and monetary stimulus along with negative to near zero interest rates.

Normalisation of policy and hikes in rates will bring pain to both the bond and the equity markets as we have seen in 2022 so far. India’s resilience so far has been commendable, but a sustained sell off, as it happens in the latter half of a bear market, could mean a deeper outflow of foreign funds from all emerging markets. India would get caught up in this trend.

The bright spot is that the recovery also will take place early and be sharper in India, given that a negative sentiment, rather than fundamentals, will cause any Indian market correction. On a two-year basis, post the probable US and European recession of 2023, Indian markets look attractive. The next few months are the cause for concern. The cash holdings of fund managers have reached the April 2001 levels in a sign of the prevalent pessimistic sentiment. One leg lower for the US markets is due, which should come anytime between now and March 2023. That will be the time to buy the dip in India and allocate fresh funds. Till then, it is best to wait it out.

India remains an attractive investment destination, and its attractiveness will increase over the next few years. But, right now, the time is to conserve capital and be cautious.

Ajay Bagga is a private investor