Slowing Asian growth & Fed rate hike key risks for India

Greece's exit from Euro zone might not lead to contagion but collateral damage from Fed rate hike likely

Indian equities have been on a correction mode since  April 13, with benchmarks dropping nine per cent. Had the markets not rebounded 5.5 per cent over the past eight trading sessions, the decline would have been higher. But this cheer is expected to be short-lived, as Indian markets are likely to face risks in the latter half of the year. India’s macro-economic situation may be better than what it was in 2013, but it is not insulated from global risks such as a rate hike by the US Federal Reserve, higher oil prices, or a possible contagion due to the possible exit of Greece from the Euro zone (Grexit).

Barclays, which polled 899 global investors, says investors are complacent about the risk of contagion spreading to other markets as buffers are in place to limit the risk. Less than 20 per cent investors polled believe Grexit will be a big negative for world markets. However, a prolonged uncertainty over Greece could give jitters to investors.

The possibility of a rate hike by the US Federal Reserve later this year continues to be a big risk for the Indian markets. Even as India’s macro-economic situation is better than what it was back in 2013, outflows from government bonds and equities could impact the currency. A large part of India’s macro improvement has to do with lower oil prices. DBS Vickers Securities has downgraded India to ‘underweight’ as it expects India to be among those that would be the most impacted by the rate hike.

Improvement in India’s macro-economic conditions might have been driven by lower oil prices. But lower oil prices have not fuelled growth in Asian economies such as India. With the Reserve Bank of India front-loading its rate cuts once inflation started coming off, any scope of further rate cuts in 2015 is limited. Nomura’s economists are of the opinion that the country has received substantial portfolio debt inflows in the past year. Hence, some caution is also warranted ahead of the reversal of US monetary policy. India’s high external debt makes the rupee one of the more vulnerable currencies. Also, volatility in the currency could further delay investment decisions of corporates.

Slower global growth will also have an impact on India’s economic recovery. Exports have contracted for five straight months, industrial output has remained weak and bad loans continue to rise. All these will crimp growth prospects further.