Indian business and equity markets should remain largely untroubled by the Iraq war, provided oil prices don't play spoilsport
Are the markets priced for a "perfect war"? That is the interpretation of the bounce in world markets even before the US-led invasion of Iraq got underway.
The assumptions are that the war will be over soon, there won't be much damage to Iraq's oil wells, the country's reconstruction will soon get underway, and there won't be any terrorist backlash. Even if there is minor damage of Iraqi oil wells, the conjecture is that will be easily made up by extra production by other OPEC members.
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That rosy view has a historical precedence in the first Gulf war. During that war, although stocks fell in the run-up to the commencement of hostilities, after the first bombing campaign began stocks rose and regained their pre-Kuwait invasion levels by the time the war ended on February 27, 1991.
By the end of 1991, the S&P 500 was 14 per cent higher than before Iraq invaded Kuwait. Oil prices rose from $16 per barrel to a high of $40 during the war.
Although there was a substantial reduction in oil exported out of Iraq and Kuwait as a result of the war, other oil-exporting countries were more than willing to take up the slack. By the end of 1992, oil prices had fallen to US$13.50 per barrel.
This time, there's even more room for optimism. The Iraqi army is a shadow of its former self, weakened by a decade of sanctions. The US knows the country well, thanks to its continuous bombings in the no-fly zones and its intelligence-gathering.
And Iraq has the potential to be a much larger supplier of oil than Kuwait - once its production facilities are ramped up, it could drive down the price of oil dramatically, particularly because it would need oil revenues to fund its reconstruction.
Moreover, reconstruction contracts paid for by Iraqi oil could very well act as a tonic for the US economy, while lower oil prices would reduce costs and boost profitability for corporates across the world. If that happens, the Iraq war may very well be the bitter medicine a recession-struck world economy needs.
All these rosy projections seem to be getting priced into world markets - not only in the equity markets, but also the bond, oil and gold markets.
THE UNCERTAINTIES
The Indian markets, however, not only look to world markets, but also have their own story to tell. And this story at the moment seems to be a more stable one than the fairy-tale ending that the world markets are anticipating.
That's because, apart from the things that could go wrong with the war, it is by no means certain that a US victory would mean the end of uncertainty. The Bush doctrine of pre-emptive strikes, and its disregard for multilateral institutions, raise many disturbing questions.
Will other countries on Bush's list of evil nations be targeted? What will be the US attitude towards the WTO - will it insist that it too functions like a rubber stamp for its policies? Nobody knows what the effect of American occupation of Iraq will be on the Middle East.
Will it lead to more terrorism? These are the uncertainties that will haunt the post-war world. For the markets, the data coming out of the US economy has not been very rosy. Questions persist on whether the cost of the war will tip the US economy into a recession.
And the war has done nothing to change fundamental concerns about the American balance of payments deficit, the strength of the dollar, and the excessive leverage in the US economy.
Minutes from the two-day January 28-29 meeting of the Fed's Open Market Committee showed that while Fed officials were optimistic the economy's recovery would resume when uncertainties over Iraq faded, they acknowledged "substantial uncertainties."
And since the US continues to be the engine of growth for the world economy, concern for America means uncertainty for the global economy.
THE INDIAN STORY
Large parts of the Indian economy, fortunately, are relatively insulated from the global economy. And the economic numbers coming out of India, whether they are for industrial growth, or for infrastructural growth, or even exports, have been pretty good.
Non-food credit growth in the first two months of the current fiscal has been the highest in the last few years. The government's road building programme, the expansion of the domestic market through retail credit, the cost-cutting that has been going on in corporate India for the last few years, the export surge in many new goods, and the rise in commodity prices have effected a qualitative change in Indian industry.
The privatisation process continues. Further, while the technology sector may be dependent on the US economy, the outsourcing story continues to be attractive, and global investors are buying into the story.
The big uncertainty for Indian markets as a consequence of the Iraq war is not geopolitics, but the price of oil. Put differently, while international markets will be beset with uncertainties even after the Iraq war, all that the Indian markets need to be bothered about is the price of oil.
On March 21, the Nymex quotes for Brent crude oil were as follows: $31.20 per barrel for the April contract; $25.54 for May, and $22.71 for June, clearly showing that oil markets expect prices to drop dramatically by June.
To sum up, the Indian markets seem far more attractive than in the US in a post-Iraq world, provided oil prices behave. Will that result in more FII money coming into the country? That should happen, though the trouble with India is that it is still a pretty disastrous public relations story.
In spite of many companies giving good market returns and growing their bottomlines, the overall macro story is dominated by stories about dysfunctional government finances. But within the government too there has been change, albeit incremental.
In short, there's a structural shift in the Indian economy which has opened up new growth avenues for many companies. With low equity valuations, the investment argument continues to be compelling - far more so than for most international equity markets.