Deflationary pressures loom

Last week, the US Treasury "yield curve" inverted for the first time since 2007. While the yield of the US Treasury bill that matures in three months stood at 2.45%, the yield a 10-year Treasury note fell marginally below to 2.439%. For decades, the inverted yields were considered as a reliable predictor of a future recession. Worries on global deflationary pressures further increased after a measure of the US manufacturing activity fell to a 21-month low and an index of manufacturing in the eurozone plunged to its lowest level since 2013. The yield on Germany's benchmark 10-year government bond also fell below zero for the first time since October 2016.

Consequent to these developments, the US stocks tumbled on last Friday and the Asian markets including Indian markets fell up to 2.5% on Monday. Last time when the global deflationary pressures peaked in early 2016, the Sensex fell 25% to 22495 in February 2016 from over 30000 in March 2015. However, this time, the Indian markets are unlikely to be impacted in a big way. Even if it falls due to deflationary worries, the Indian equity market is likely to recover in a big way like last time. Post-February 2016, the Sensex gained over 60% in the following two years.

The announcement by the US Fed last week that it likely won't raise interest rates at all this year is a big positive development for the Indian economy and the markets. Further, the US Fed, having ended Quantitative Easing (monetary stimulus) successfully, can always go back to such stimulus measures if deflationary pressures keep rising. As trade war is not helping the US economy, the US would be ultimately forced to tone down its rigorous trade barriers on other major economies.

Though India's exports get impacted due to rising global deflationary pressures, it also has quite a unique advantage of substantial gains from falling oil prices. In early 2016, when deflationary pressures peak out, Brent oil price crashed 74% to a 23-year low of $28 a barrel from 2014-peak prices.

This month foreign investors have already invested over Rs 38,000 crore in the Indian equities. Forex reserves once again crossed $400 billion. These developments should help improvement in the rupee exchange rate in the short to medium terms. The fact that India is still a fast-growing economy, possibility of oil price falling badly in the event of a significant rise in deflationary pressures, the decision of Fed not to raise the interest rates and quite a robust outlook for the rupee is likely to keep the Indian markets quite stable. Even if it falls initially, it is likely to gain back substantially within a year or so like last time.

Of course, the Lok Sabha elections would have bearing on the markets – however, the repercussions for the markets, in case of any possible political instability, should be the least. No major economic reform measure is pending now. Moreover, the 'cost' (both monetary and physical energy levels required) of facing the General elections has increased manifold over the last three decades. Therefore, there is a possibility of some stability being maintained at the Union Government post elections.

The writer is founder and managing director, Equinomics Research and Advisory