The crisis is deepening in emerging markets. The crack is widening far beyond the obvious names like Pakistan and Nepal. When a celebrated economy in the not-too-distant past is at the door-steps of IMF, one can understand the extent of crisis in the emerging markets. What was once extolled as a miracle economy, Bangladesh could now be bordering on an IMF bail-out? Such is the scorching heat across emerging markets. In such a scary situation, one can’t help, but start digging deeper for any hidden macros risks in India. Could the consensus view of a relatively stable macro for India be clouded by few serious misgivings? Or, has India’s macro really come of age from those fragile days of 2013? Let us dive in and explore.
Emerging market crisis follows a very familiar pattern. In times of high liquidity cycle (while Fed is easing), money supply is abundant and it reaches far-away shores to seduce the usual EM suspects to go for an over-drive on consumption-driven growth with borrowed capital. In a playbook style, falling dollar index, rising local currency, cheaper imports, lower interest rates etc. all play together to fuel local consumption. In times of abundant liquidity, currency valuations get distorted to artificially high level so as to hide the underlying twin deficit problems (Current account and fiscal) that usually the case for most of the emerging markets which import much more than what they export. When the music stops, which usually does when Fed starts the tightening, the reverse dynamics of rising dollar index, falling local currency, surging interest rates etc. pushes up the hidden vulnerabilities to the surface. In these times, markets start looking closely at some of the metrics like dollar debt to GDP, current account deficit, level of forex reserves, upcoming dollar debt payments etc. with a microscope. If market smells a rat in any of those metrics, it beats down the currency in a vicious cycle to bring the country down to the brink of bankruptcy. This usually happens in a self-fulfilling feedback loop fashion with a falling currency triggering outflows which in turn fuels further fall in currency that in turn aggravates the already aggrieved twin deficits, inflation etc.
So, the key thing is the confidence of investors in the macro metrics. If it is broken, it triggers a vicious cycle as explained above. The confidence comes from various factors that include level of forex reserves, credibility of central bank in handling inflation, dollar debt to GDP, short-term debt payments, manageable current account etc.
Where does India stand on these?
Level of forex reserves are reasonably high at over eleven months of imports (even after its recent depletion in defending the Rupee). Similarly, India’s dollar debt is at a manageable level of around 19%+ of GDP, far lower than many Asian peers. India’s central bank enjoys high credibility in tackling inflation risks. These are positives for India. But there is one sticky spot for India. That is, India’s historical vulnerability from high current account deficit (CAD) that suddenly shoots up during such crisis times, esp. when crude goes beyond 100$ level amid weakening Rupee (as 80% of India’s energy requirements are imported). This has always been a potential landmine for India, esp. during Fed tightening cycle. Will this time be different?
To answer this, let us go back and look at the key difference between 2013 and now in terms of CAD vulnerability. Not to forget that India was clubbed as one of the countries in Fragile Five in 2013. The key macro difference between 2013 and now, comes from the differing trajectory of growth between crude and the software exports. Software exports in dollar terms have more than doubled in this period while crude imports in dollar terms have stagnated or marginally declined (even at this elevated level). Looking at the data points, software exports have surged from 70Bn dollars (appx) level in FY14 to 178Bn (as per Nasscom) dollars now (FY22) whereas energy imports (including LNG) have declined from 140Bn dollars level in FY14 to 130Bn dollars in FY22. This has brought in a huge comfort in easing our macro vulnerability from Oil risks. Today, software exports income covers more than the total oil bill by a factor of 1.3 times (even at this elevated oil price of 100$+) from a precarious situation in FY14 when oil bill was 2X of software exports income. This comfort is only going to increase multifold with the projection of over 300Bn dollar+ annual exports by 2025 as per Nasscom projections, given the huge super digitization cycle globally. Also, bear in mind how oil import as a share of total imports has come down from 30% level in FY14 to 21% level now (FY22). It doesn’t stop here. India’s focus under the current political leadership on renewables, ethanol blending, CNG infrastructure, potential leadership in green hydrogen, sourcing oil at discount from Russia etc. will further strengthen India’s macro architecture. Needless to say that India has come a long way in its macro stability esp. in its external financing and CAD management.
In our view, this development will single-handedly change the contours of India’s macro risk profile. This change is the most under-debated and least understood across investment community. Add to this the Indian companies’ and banks’ rising credit profile on the back of huge cleanup of corporate and bank balance sheets. With NPA cycle behind, risk of potential accidents in the financial sector receding (such as ILFS in the 2018 tightening cycle), India’s macro seems to be among the few shining spots for global investors. This is probably the reason why India witnessed investments of near 34Bn dollars in the PE-VC (28% growth YOY) space in the Ist half of calendar year when FIIs were busy pulling out over 25Bn dollars from the equity markets. This emerging comfort on macro stability, progressive policy environment, Rupee’s relative strength and positive long-term growth prospects etc. probably could be the reasons for the rising confidence from domestic investment community and for the huge resilience Indian markets have demonstrated during the current crisis. Next few months will tell us whether this prognosis is right or wrong. Interesting times to watch out for!
This article of mine was published in the online edition of Economic Times (07/08/2022). Glad to share the link: https://economictimes.indiatimes.com/markets/stocks/news/will-the-emerging-market-crisis-eventually-touch-dalal-street/articleshow/93408910.cms