Long-Term Story: Global blues cannot harm India

Here is a scenario study on the global developments on India:

Scenario 1: The US economy slows down

In the case of India, given that the economy is largely domestically-driven, the impact of a 1% drop in US growth would have the smallest impact on growth when compared with other countries in the region. This takes into account the rising share of trade (including software) from less than 14% of GDP to close to 20% currently.

Examining the sectors, a few that are likely to be impacted given their dependence on exports to the US include gems and jewelry, textiles, and software.

Scenario 2: The China Factor

The 9% drop in the A-Share Shanghai Index4 on February 27, which sent ripples throughout the global equity markets, is the first time that China's global influence extended from the real economy to the financial markets.

India's exports to China have risen over 12 times since FY00, but as a percentage of total exports the share remains low at 6.5%. What is important to note is that a significant chunk of these exports comprise commodities - iron ore and alumina, which have benefited from the on-going investment expansion in China.

Thus, in the event of a slowdown, one could see a pull-back in exports of these commodities.

Scenario 3: The Yen Appreciates Further

If we see a significant appreciation in the yen, besides the impact of leveraged investors offloading high yielding assets to repay yen loans, which would result in capital outflows (thus impacting stocks and the rupee), the Indian corporate sector has also been a party to the carry trade game - directly via taking ECB/trade credit in yen as well as via the derivative route (taking rupee loans and converting them synthetically in yen). However, two caveats: (1) to the extent that the rupee doesn't weaken more than the interest differential, the yen credit benefits the borrower; and (2) anecdotal evidence indicates that most of these deals were done at USD/Yen level of 110-115.

Conclusion

Unlike the May 2005 sell-off, the current correction happened across all markets and asset classes. India, too, was affected, but relatively less so (stock markets correcting 14% from the high of 14652 and the rupee falling to 44.64).

An important factor that could support optimism on India is that its growth story is domestic-oriented, which provides better insurance (than many other Asian neighbours have) at a time if/when global growth begins to moderate. This, combined with its relatively sound external position, should help sustain investor confidence.