Wednesday, August 26, 2015

This time is no different - EM shocks spares none

The contrast in economic fundamentals with the May 2013 US Fed taper-tantrum days and today's China contagion could not have been more stark. At that time India was one of the most vulnerable, even among the 'Fragile Five'. Now the country has become so much of a positive outlier that it does not even figure in assessments of emerging market (EM) risks.

The two graphics from FT conveys the relative strength of the Indian economy. The first conveys how insulated the country is from the two biggest risks - exposure to Chinese market and foreign currency bond borrowings.
The country is among the only two EM economies not overly exposed to the trifecta of unwinding Chinese leverage, US QE, and domestic debt. 
Clearly, India is as insulated as markets can be from any triggering exogenous shock, with its accompanying portfolio re-balancing by foreign institutional investors. Further, its macroeconomic balance, both domestic and external, as well as inflation, are stable. But the events of Monday shows that very little of this is material, atleast in the immediate aftermath of the triggering exogenous shock. The battering of the equity markets and the rupee this week, especially given the relative strength of the Indian economy and the depth of weakness among almost all of its emerging market peers (a position that it has never been in), is the strongest possible reminder that such global shocks are largely divorced from fundamentals and spares none. As the RBI Governor found out, no central banker (or anyone) has a magic wand to ward-off or talk up the markets. 

The trajectory of the current bout of market volatility in India will be contingent on the trends across other emerging markets. If the markets adjust to the potential adverse consequences of a Chinese slowdown or the Chinese government is able to postpone the denouement to its bubble valuations, the Indian market too would be calmed. However, if the EM weakness persists, the volatility will continue to haunt the Indian markets. In that case, stability will return only when the broader EM sentiments stabilize (and not with country-specific events), as happened in August 2013. 

This should also serve to put in perspective the despair that followed similar trends in the aftermath of the May 2013 taper-tantrum and the subsequent uptick that was popularly attributed to the entry of the new central bank governor. 

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