A break below 16,300 could see the Nifty fall till 15,000 level

Indian equities may remain under pressure even if the geopolitical and energy crisis ends

The Ukraine crisis has led to fears of global growth being stymied by conflict. Crude and gas prices have spiked. The Fed which was braced to raise interest rates may now have to review its stance; instead of inflation driven by demand triggered by faster growth, it may have to contend with inflation driven by supply disruptions, as growth slows.

Open conflict is the worst-case scenario since multiple nuclear powers are involved. Sanctions against Russia, which is the most likely scenario, would mean cutting off one of the world's largest energy exporters. Western Europe, which imports over 70 per cent of its gas needs from Russia, would be hard-pressed to find cost-effective alternatives.

Global markets have seen flight to safety. India imports over 80 per cent of crude and over 50 per cent of gas. Not only do high prices add to inflation and pressurise the Trade Account and the rupee; high energy prices limit the government's ability to raise revenues from fuel taxes and cess.

The Indian crude basket cost an average of $78.68 per barrel in Q3 of 2021-22, rising from $72.16 in Q2 and $67.44 in Q1. In January 2022, the crude basket cost $84.67. February would be higher as prices have jumped to almost $100. Gas prices have also escalated sharply. The controlled price of domestic gas is currently set at $6.13 per mmbtu (Oct 21-Mar 22) after being set at $3.20 (April 21-Sep 21). In April 2022, it’s likely to rise above $10 given the pricing formula. This would be another inflation shock.  

While producers such as ONGC and Oil India would gain, oil refiners-retailers and gas distribution companies will see margins squeezed. The government may find it politically hard to pass on the cost, which means it may ask oil marketing companies (OMCs) to absorb losses, or it may cut fuel taxes.

A lot of the panic is news-based. If the crisis eases, there will be a relief rally in equities. Energy prices may also fall. However, some turmoil is expected to continue in energy markets, and energy prices may stay elevated even if they correct from current highs.

Indian equities could see a continued correction even if the crisis ends. Inflation is running high, and the RBI could be forced to normalise by hiking rates and cutting liquidity. The Q3 results already show a trend of higher costs of power, fuel, and raw materials, which have squeezed margins, and led to weak consumption demand. Banks and NBFCs, which are seeing very low credit growth, will also experience net interest margin (NIM) compression if the RBI has to raise rates, which seems inevitable now.  

The foreign portfolio investors (FPIs) have been net rupee-equity sellers through the current fiscal. They have sold Rs 82,469 crore of equities since April 2021. They have recently started issuing advisories downgrading expected returns from a highly valued market, where the Nifty is at current PE of 22x. Domestic institutions and retail investors cannot absorb FPI sales in such high volumes, if this pattern continues.

In a purely technical perspective, the Nifty has trended up from lows of 7,511 in April 2020 to a record high of 18,604 in October 2021 – a return of 148 per cent in 18 months. In December 2021, the index dipped to 16,400 – a correction of a little over 10 per cent from the peak.

A correction of 15-20 per cent would not be abnormal after such a bull run. The levels to watch would be 16,300-16,400 on the downside. If that is broken, the Nifty could fall till 15,000. The hedges would be oil and gas producers, and maybe metals producers. Exporters may also do reasonably well if the rupee does drop due to Trade and Fiscal Deficits.