Market turbulence is here to stay, may deepen

Why in the News

Indian equity markets closed lower with the Sensex down 1.08 per cent, and the weakness ran across small and midcap indices as well. The fall follows a run of external shocks rather than a domestic slowdown, since the economy is growing at a fairly healthy rate. The Sensex has lost roughly 12 per cent since the beginning of this year. Brent crude has touched $100 a barrel as the conflict in West Asia expands, and the rupee has slipped past the 95 mark against the dollar. The tension is that the drivers of the sell off sit outside the reach of domestic policy. The instruments available to answer them act on demand at home.

What has actually moved in Indian markets?

1. Index and breadth both weakened: The Sensex closed down 1.08 per cent and the fall extended to small and midcap indices rather than staying confined to large caps.
2. Volatility rose sharply: The India VIX (an index of the volatility the options market expects in the Nifty over the next 30 days) rose almost 7 per cent.
3. The decline is not a single session event: The Sensex has fallen by roughly 12 per cent since the beginning of this year.
4. Information technology led the weakness: Concerns have mounted over the sector’s long term growth prospects, given the rapid deployment of artificial intelligence.
5. Asian peers did not move together: The Nikkei was down 0.2 per cent. The Kospi was up 1.4 per cent.

Why has investor sentiment weakened despite a healthy growth rate?

1. The West Asian conflict has widened: Attacks by the Iran backed Houthis on energy facilities and infrastructure in Saudi Arabia mark an escalation and raise concerns over energy supplies.
2. Crude has returned to triple digits: Brent crude oil has touched $100 a barrel, levels last seen in July.
3. India’s own import cost has risen faster: The Indian crude oil basket surged to $108.91 per barrel as on 8 September, according to the Petroleum Planning and Analysis Cell.
4. The currency has broken a psychological level: The Indian rupee has slipped past the 95 mark against the dollar.
5. Foreign investors have turned sellers: Foreign investors have taken out $1.3 billion from the stock markets in September so far.
6. The transmission runs through three channels: Higher prices act on the external balance, on the currency and on inflation together rather than one at a time.

What does the global rate environment do to India’s policy room?

1. The US central bank has signalled a harder stance: Remarks by the US Federal Reserve chairman at the recent Jackson Hole meeting were read as hawkish, raising expectations of an aggressive policy stance.
2. A rate increase is now priced for the coming week: The odds of an interest rate hike at next week’s meeting have risen on those remarks.
3. Sovereign yields elsewhere have repriced: The US 10 year bond yield is around 4.8 per cent and Japanese yields are hovering near 2.9 per cent, which narrows the return advantage of holding Indian assets.
4. The domestic decision arrives into a softening economy: The Reserve Bank of India’s Monetary Policy Committee meets early next month with expectations of a move towards tightening. Growth momentum that surpassed expectations in the first quarter is expected to moderate in the second half of the year.

Challenges to macroeconomic stability from sustained market turbulence

1. Imported energy costs pass through to domestic prices: An expensive crude basket raises the import bill and feeds into freight and manufacturing costs within a quarter. Eg. India meets over 85 per cent of its crude oil requirement through imports.
   The Fix: Expand strategic petroleum reserve capacity and widen term supply contracts beyond West Asian sellers, so a regional escalation does not move the whole basket at once.
2. A weaker currency raises the cost of external borrowing: Depreciation increases the rupee cost of servicing dollar denominated debt taken on by Indian firms. Eg. External commercial borrowings are raised largely in dollars and repaid out of rupee earnings.
   The Fix: Tighten hedging requirements on unhedged foreign currency exposure of corporate borrowers, so depreciation does not convert into balance sheet stress.
3. Portfolio flows reverse faster than they arrive: Foreign portfolio investment tracks interest rate differentials rather than domestic earnings, so an outflow can begin before any local data changes. Eg. The taper tantrum of 2013 produced heavy outflows and a sharp rupee fall within weeks of a single central bank statement.
   The Fix: Deepen domestic institutional demand through retirement and insurance flows, so a foreign exit is absorbed rather than amplified.
4. Defending the currency raises the cost of credit at home: A policy rate increase aimed at the exchange rate also raises borrowing costs for firms already facing weak demand. Eg. Micro, small and medium enterprises borrow largely at floating rates, so pass through reaches them first.
   The Fix: Pair any tightening with a targeted refinance line for small borrowers, so the rate defence does not fall hardest on the segment least able to absorb it.

Conclusion

Market weakness is no longer traceable to domestic growth. Its drivers are a war premium on oil, a harder rate path abroad and portfolio flows that respond to both. Domestic instruments act on demand at home and cannot offset an imported price shock. What remains unresolved is whether policy defends the currency or supports output, since a single rate decision cannot do both.

Back2Basics

1. What it is: The Indian basket of crude oil is a weighted average of the prices of the grades India actually imports, not a traded contract in its own right.
2. What it averages: It combines sour grades of the Oman and Dubai type with the sweet Brent dated grade, weighted by the share of each in India’s import mix.
3. Who compiles it: The Petroleum Planning and Analysis Cell, an attached office of the Ministry of Petroleum and Natural Gas, publishes it.
4. Why it is used: It is the reference price for estimating the oil import bill and for tracking the cost of the crude that Indian refiners actually buy.

Matching Previous Year Question

“[2018, GS3, 15.0 marks] How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability of India?”