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Is a US slowdown good for Indian markets?
Abheek Barua | February 06, 2008
January has turned out to be the cruellest month for the Indian stock markets. A news report I came across claimed that it was the markets' worst start to a year in the last 28 years.
This sudden bearishness is underpinned by a number of changes in the market dynamic. The most critical, in my opinion, is the de-linking of the local market from US interest rates.
This reflects two things. First, there has been a rapid escalation in risk aversion, which has reduced the appetite for all risky asset classes, including emerging market stocks.
Let me just elaborate on this a bit. The Japanese money market, with its exceptionally low interest rates, has been the principal funding currency ("carry currency") for higher-yielding assets across the world. With rising risk, investors sold risky assets and bought back the yen to pay off their yen loans. This led to a rapid appreciation of the Japanese currency. Only a significant depreciation of the yen would signal a change in risk appetite and the possible return of FIIs to our shores.
Second, investors are slowly pricing in dimmer growth and profit prospects for India as the US heads towards recession. Elevated valuations (at its peak the Sensex was trading at a price earning multiple of 22, using projected earnings for a year ahead) have not helped India's case.
I suspect that the negative sentiment towards Indian and other emerging equity markets will continue for a while. While the jury is still out on whether the US is already in a recession or not, the US Fed's somewhat panicky policy gestures seem to suggest that it is preparing for the worst.
That might, ironically, bring global funds back to America. Past recessions have shown that investors don't flee American shores in times of crisis. Instead, they start buying the safest of the safe assets, US treasury bonds, with a passion. The fact that the dollar has tended to appreciate against major currencies over most recessions reflects this flight to safety.
Indian stocks are likely to remain in the dumps for a while but I don't think it is the beginning of a prolonged bear market. While I have argued against the notion of decoupling -- the theory that business could go on as usual in Asia even if the US economy were to slide -- it is unlikely that economies like India or China will see a severe slowdown.
The US Fed's response to the apprehension of recession is to cut interest rates relentlessly. Other central banks might not match the Fed, cut for cut, but it's likely that they will pare rates to a degree.
When could this happen? The US Fed has taken a bit of flak for pandering to the whims of the financial markets. However, its strategy of cutting rates relentlessly is likely to buoy not just the financial markets but the real economy as well somewhat soon.
I am not suggesting that America's problems will disappear overnight in the third quarter. Problems could linger both in the financial markets and the real sector but one could just see the mix of data and news emerging from the US turning favourable. This could be the turning point for Indian equity markets.
The author is chief economist, HDFC Bank [Get Quote]. The views here are personal.