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Navigating India’s Markets Through The Russia-Ukraine Conflict

We are on a roller coaster ride but don’t leave it mid-way. In the end, you will be glad you took the ride, writes Nilesh Shah.

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(Image: pxhere)

History has taught us that markets do recover after the war. History hasn’t taught us how to predict the end of a war and its after-effects.

Russia’s invasion of Ukraine has rattled markets around the world. Russia and Ukraine constitute less than 2% of global trade, but in many commodities, they have a sizable share — 37% of global palladium supply, 17% of natural gas, 13% of wheat, 12% of oil, and 9% of nickel is from the region. The barrage of sanctions imposed on Russia along with the supply chain interlinkages is bound to impact global trade and finance.

Macro Pressures

From the standpoint of the Indian economy, the impact on commodities especially energy is the cause of primary concern. Rising crude prices invariably result in a depreciating rupee, increasing inflation and fiscal deficit, and a reduction in GDP growth. It is estimated that a 10% rise in crude prices reduces our GDP growth by around 20 basis points, increases inflation by around 40 bps, and widens the current account deficit by around 30 bps.

Fortunately, the Indian economy can withstand the pain of higher energy prices and disruption caused by the Russia-Ukraine situation.

In FY22, India’s IT exports are likely to exceed its gross oil imports.

With higher remittances and services exports we are in a better position to withstand the current account deficit and rupee volatility. Undoubtedly, there will be a dent in growth but it will be bearable pain.

Central banks around the world will again be extremely careful about the withdrawal of monetary stimulus. The likelihood of liquidity remaining extremely easy and interest rates remaining low has increased. Accommodative policies in the western world can provide a ‘central bank put’ amidst the present market volatility.

Marketwide And Sectoral Impact

The debt market will keep a watch on the inflation trajectory, foreign fund outflows, the U.S. Federal Reserve’s next actions, and the borrowing program of the Indian government. Aside from the geopolitical risks, equity investors are monitoring fund flows, along with state election results and the trendline in corporate profitability. The results for the quarter ended December 2021 have indicated that the top companies are on course to achieve 725-750 Nifty 50 EPS for FY22 and 825-875 EPS for FY23.

It is difficult to predict what will be the bottom of the market in the current phase of uncertainty. The combined effect of rising inflation, slowing growth, and weakening rupee will dent corporate profitability. However, there are some silver linings in the dark clouds. The long-term growth trajectory remains intact. Policy-making is pro-growth. The domestic investor base has expanded. This is becoming a buy-on-dip market with moderate return expectations, as valuations are coming down to historical averages. Pockets of the market where valuations remain high due to concentrated holdings and limited floating stocks may not deliver expected returns.

Capital goods, home improvements, pharma, large-cap IT, and select financials are likely to outperform the market albeit with their share of volatility.

Disruptions in the supply of commodities like palladium will impact the semiconductor chip supply, in turn impacting the automobile industry which is struggling to get back on growth. A ‘tail wagging the dog’ scenario could play out across various industries. Conversely, the Indian IT industry could benefit from the shift of business from Ukraine and Eastern Europe.

Indian agriculture exports can sustain growth momentum as supply from Ukraine and Russia gets disrupted. Our granaries are filled with three times more stock than mandatorily required. With some work done on the quality and reliability of India’s food grains, this is a timely opportunity. Grain prices rising elsewhere in the world will hopefully not impact inflation as Indian domestic prices are above global prices.

Private equity flows in 2021 were almost equal to the investments done by listed companies. They contributed as much to GDP growth, especially on consumption as well as investments. With a sharp correction in the valuation of expensive and loss-making stocks that burn capital to scale businesses, private equity likely flows in 2022 could slow down, adversely impacting GDP growth.

Using This Moment To Build For The Future

There is also a silver lining to the dark cloud if India can revive the Rupee-Ruble trade to become a preferred supplier to Russia. Russia will need the support of a large economy like India for filling the gaps in their economy heavily impacted by the sanctions. There will be enough spoils to share with China which will be the first preference for Russia due to size and proximity.

India should make a serious effort to attract Russian capital to GIFT City. Those investors would find their investments to be much safer and more rewarding compared to western markets. India’s travel and tourism sectors could benefit from the sanctions imposed on Russia, as India could emerge not only as a transit hub for Russian travelers but also as a preferred tourist destination. We should aim to create many more Goas for Russian tourists.

India sends many students to Ukraine and Russia for higher studies. This demand should be used to expand our education sector. Billions of dollars are currently put to use as foreign exchange, to pay for education abroad. Instead, we have an opportunity to free the education sector for scale and size.

The western world will seriously consider reducing supply chain concentrations, and the ‘China + 1’ strategy will be pursued with far more vigour. India could be a big beneficiary of this shift accelerating, in sectors where the government has rolled out performance-linked incentive schemes. This can help sustain our export momentum and facilitate deeper integration into global supply chains. There is some work to do on ease of doing business and rule of law to encourage our entrepreneurs to capture this opportunity.

Russia prepared for sanctions through the diversification of its foreign currency reserves in gold. China could well follow a similar strategy, keeping in mind its long-term plans for Taiwan. If gold prices get supported by the Chinese buying, Indians as the largest holders of the yellow metal will witness a wealth effect at a sizable mass level. Such a wealth effect will support consumption and provide capital for investment to accelerate growth.

In summary, we are on a roller coaster ride but don’t leave the roller coaster mid-way. In the end, you will be glad that you took the ride.

Nilesh Shah is Managing Director at Kotak Mahindra Asset Management.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.