Withstanding capital market shocks

The last few months have seen India’s capital markets tumble in response to various macroeconomic external factors. The Rupee depreciated to one of its lowest values at about 67 rupees to a dollar. Some analysts predict it is still overvalued and is likely to settle near 70. The Reserve Bank of India (RBI) had to run down its forex reserves by $11 billion last month to stem the rupee volatility. Foreign Portfolio Investors (FPI) withdrew about Rs 48,000 crore in the first six months of 2018 – the highest in a decade. The Sensex, Nifty and other stock markets have seen their bullish runs coming to an end.

Even after registering a growth rate of over 6.7 per cent last year and being pegged as the fastest-growing economy by the International Monetary Fund (IMF), why is it that Indian capital markets are still facing turbulence? The answer lies not just in the growth rates, but more so in the risk-adjusted growth rates. Once the various risks are taken into account, the Indian economy does not present a rosy picture to the foreign investors. First, rising crude oil prices is putting pressure on our Current Account Deficit (CAD), forcing the economy to borrow more to bridge the rising CAD. Second, we used to get oil from Iran at relatively cheaper rates, while a large part of our defence imports come from Russia. But the US sanctions on these two countries are likely to make it difficult for India to continue with the same volume of trade with them. Third, the relatively stable and safe US economy is showing robust growth while the Fed is likely to raise interest rates further. These two factors incentivise investors to park their funds in the US. Thus, India is facing some external headwinds beyond its control that are making the capital markets jittery. Rising inflation and government bond yields are two domestic factors that are also making an impact.

In the case of the stock markets, the various indices have not crashed, though their upward acceleration has stopped. This is partly due to the Indian investors who have prevented the stock markets from going downwards at a time when FPIs have withdrawn nearly Rs 48,000 crore.

While most of the downside shocks currently faced by the Indian economy are external and beyond its control, yet there are some important steps that policymakers must undertake to make the economy resilient to such shocks and make it less risky for investors. First, the government needs to continue on its path of fiscal consolidation, both in terms of quantity and quality. By quality, I mean that the government expenditure should be focussed on areas where the returns are the highest – like health, education, increasing export competitiveness, logistics efficiency and infrastructure creation. Second, India needs to diversify its oil import basket. Many countries like Saudi Arabia and UAE are willing to step in if Iranian imports stop. India needs to negotiate this further and also deal with the US on the issue of sanctions waiver. Third, rising inflationary expectations need to be kept under control. The good monsoon should provide a breather this season. But long-term systemic reform of agriculture needs to continue.

The author is a research scholar at Delhi School of Economics