Despite Correction in Equities, India Needs to Stay Focused and Get Ready for the Leap

The concern over the selling by foreign investors is overblown, and the RBI or the government should avoid any sort of knee-jerk reaction. India's position is far better than it has ever been during any previous global crises.

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There is legitimate worry about the weakness of the Indian rupee and what that means for oil prices and inflation.

Two recent articles in The Wire highlight the crisis and the short-term issues, however they suppress the positive outlook and potential for India which could be seen this calendar year itself.

The unwarranted Russian invasion of Ukraine and the subsequent 70% surge in oil prices, coupled with the increase in interest rates in the US, has added pressure to India’s economy which is still recovering from the economic impact of COVID-19. These are external challenges at a time when the government must find ways to create employment, add to India’s overall wealth and find ways to distribute this wealth. Constant attempts by neighbouring countries to redefine our borders forces us to maintain a higher budget for security needs – money that could otherwise help create wealth.

India’s performance in the past

Despite the turbulence of the recent months, is the Indian rupee really in a crisis mode? Is India about to go into a freefall? Over the past 30 years India has done spectacularly well. Between July 1991 and May 2014, the Indian stock markets gained 14.5% per annum while the world stock market index gained 12.7% in Indian rupees. The rupee lost 5.2% each year against the US dollar over that 8,342-day period.

From just days before Prime Minister Modi took office in May 2014 till July 1, 2022, the Indian stock markets have gained 12.6% per annum while the world stock market Index gained 10.8% – maintaining India’s outperformance when measuring stock market returns. The rupee has lost 3.7% each year against the dollar over this 2,984-day period.

During the past 31 years, the price of crude oil has surged seven times from $20 a barrel in 1991 to $140 in 2008; then it collapsed 65% to $50 in 2009 before rallying 100% to cross $100 by 2011. From 2014 oil prices trended downwards and collapsed to below $30 after the pandemic. The global economic recovery took oil to $60 per barrel and then, recently, the leap to $100 when the G7 and EU imposed sanctions on rogue Russia.

Over the past 31 years, India has seen its GDP (gross domestic product) grow by an average of 6.2% per annum (after adjusting for inflation) – a performance bettered only by China.

The headlines announcing the continued exit of foreign portfolio investors (FPI) shout out selective numbers. Yes, there is a tectonic shift occurring in the field of investments as the risk-free rate of the safest asset in the world – the US government 10-year bond – has surged from 0.5% during the early days of the pandemic to 1.5% by the end of 2021 to nearly 3% in May.

When a risk-free asset suddenly offers you two times what it did a few months ago, any other investment opportunity must adjust its expected rate of return sharply upward. And, in a world where there is uncertainty accentuated by Russian President Putin’s invasion, such promises of higher rates of return are doubted for their ability to convert to a reality.

Hence, the FPIs who sold $19 billion worth of shares in the first four months of the pandemic – February to May 2020 – only to bring back $40 billion in the next 10 months when they could start seeing visibility on expected, future economic activity and profits are now recalibrating considering the existing uncertainty. That is natural and does not require any panic reaction.

Keep grinding, keep focused

The concern over the selling by foreign investors is overblown, and the Reserve Bank of India or the Ministry of Finance should avoid any sort of knee-jerk reaction – such as suggestions of any windfall taxes or limits on sales and withdrawal by FPIs. Share prices were high, they are now correcting, that is all.

Fundamentally, India is in a far better position than it has ever been during any previous international crises. The Lehman bankruptcy exposed India’s weak link and questionable policy of allowing P-Notes, or participatory notes which have since been dialed back. The Indian rupee crises in 2013 when the Fed indicated they would raise interest rates was brought under control within six months as the RBI took steps to calm nervous investors.

Yes, there will be periods of sales and exits because there will always be the ‘tactical-allocator’ in the FPI category consisting of hedge funds, university endowments or foundations who – driven by near-term analysis of risk and reward – will wade in and out of India. The explosive growth of exchange-traded funds (ETFs) has added another layer of foreign retail investors who can enter and exit India on a whim.

While there are many who will run at the first sign of smoke, the overall strength and ability of FPIs has been enhanced with the larger ownership of Indian stocks by Sovereign Wealth Funds and pension funds as compared to the era of the Lehman crisis. Furthermore, when the dust settles, FPIs will scan the horizon to see where they can deploy their trillions of dollars of savings and capital.

Even with a 4% rate of interest on the US 10-year risk-free government bonds, the FPIs – particularly the pension funds – need to earn over 7% per annum in dollars to meet their liabilities to their pensioners. For over 31 years, India has delivered superior returns for those who were smart enough to invest in the Indian stock markets. My optimism is driven by the reality that multinationals need to find new markets and diversify their supply bases away from China – which is eyeing Taiwan and might be seeing lessons in Russia’s Ukraine war. In such a situation, it might end up being further alienated from global commerce.

This would mean new investments of factories in India, which will aid the process of job creation and a spurt in economic growth. Economic growth translates into growing profits, and that translates into higher share prices of listed companies – which means a higher potential for returns for the FPIs and local investors in India’s vibrant stock markets.

Also read: The Sobering Disconnect Between a Soaring Sensex and Contractions in the Real Economy

The headlines that should worry us

This is not the first time that India has had to withstand global shocks: whether its oil prices or higher interest rates in the US. The decline in the rupee or higher oil prices need not, by itself, have any bearing on the outlook for India’s economy or India’s stock markets. In fact, the sensible, long-term foreign investors recognise that a country like India – which is deficient in capital and needs external flows to fund its long-term growth potential – will have a weak currency for decades.

Sure, the decline of the rupee against the US dollar over the past 31 years took away 4.8% from the spectacular 14% per annum returns in rupees that the Indian stock markets delivered – but the long-term returns from investing in India at 9.2% per annum is still very impressive.

The risk to India is not the sale of shares by FPI or high oil prices – those are manageable. The headlines that one should worry about us are:

  • India will issue a sovereign bond: this means that the Government of India has succumbed to the pressure of issuing a bond owned by foreign investors, priced on the exchanges of New York, London, and Singapore and over which the government and RBI have no control.

In a crisis such as 9/11 or Lehman – which have nothing to do with India – any energetic and young 22-year-old trader sitting on the desks of the large banks may hit buttons to sell Indian bonds, resulting in an increase in interest rates in India, and creating distortion and panic in the real economy of India.

The common factor between the Latin American countriesand even Sri Lanka – is not only poor economic policies but the fact that they all issued sovereign bonds and lost control over the most important variable in any economy, the interest rate. The countries that issue sovereign bonds surrender the ability to control the risk-free rate of their economies – the very foundation of any economic policy – to the 22-year-old bachha looking to maximise his return for that day!

Periodically, these news items of India issuing sovereign bonds pop up as fee-hungry investment banks moot this idea to the Ministry of Finance and RBI. So far, the ministry and RBI have resisted.

India, a vibrant democracy, has been in a state of strife on caste and religious grounds for many decades. However, the recent violence based on the desire to correct centuries of wrong comes with the risk of the wrong kind of headlines that may start attracting the attention of the western world. Though the West is preoccupied with Russia and China, India cannot risk actions that could result in being outlawed by the West: we still need the financial and technological capital to grow the Indian economy to its full potential.

China has gamed the system well and no longer needs the West while Putin’s game plan is a return to Soviet supremacy and economic bankruptcy. The recent controversy over statements about the Prophet are proof of India’s vulnerability. Try burning a few churches and see what happens at the next G-7. The reactions could put us back in the bullock cart age – we will not need to worry about the price of oil then!

Despite the worry and the flood of near-term negative news, the Ministry of Finance and the RBI are on the right track and should do nothing out of the ordinary. The leadership skills of those steering our economy have come a long way since the fiasco of demonetisation in November 2016 and – like the recent records being set by India’s Test cricket players – may they bat on fearlessly.

Ajit Dayal is a mutual fund veteran and  is the founder of investment firm Quantum Advisors/Quantum Mutual Fund. The views expressed are personal.