If markets correct sharply, seize opportunity

Indian markets have had to deal with the impact from two major pieces of negative and unexpected news in the past few days - exit of Dr Rajan from the Reserve Bank of India (RBI) and the Brexit news on Friday morning. So far, the markets' behaviour has been resilient. This is despite the fact that Indian market has done extremely well relative to other regional markets and in absolute terms, having risen 16 per cent from its bottom in February 2016.

India's macro parameters have improved significantly and provide reasonable protection against any global turmoil. First, India's balance of payment (BoP) situation is in very good shape given strong improvements in the current account deficit in the past few quarters. Secondly, given the early stage of economic recovery, shocks from any capital flight on account of portfolio flows would be comparatively limited as - 1) capital usage in the economy is relatively lower given slow investment cycle and 2) a strong reserves position gives India a strong defence against short-term capital flight. Finally, growth impulses are starting to grow as government spending in some key sectors is starting to have an impact and these growth impulses would likely be helped with a good monsoon and pay commission awards.

The impact of Brexit on India could potentially come from either the trade channels or via tightening of financial conditions which then have a knock on impact on the real economy. However, for an economy which runs a large trade deficit, negative impacts on account of any hit on exports could likely be countered by slower imports due to lower commodity prices. As noted earlier, a strong BoP and forex reserves position is an effective buffer against capital outflows. Thus, compared to other economies which are more connected by trade and are struggling with slower growth, Indian economy stands out in terms of its ability to weather a global turmoil.

There is a note of caution. The Indian markets, in the short term, cannot be said to be immune to a rising global risk aversion. There are likely to be many moving parts in the global equation in the short term, too. In case of a major risk off possible coordinated central bank action would likely be taken to calm the markets. All this couldmean volatility.

What does it all mean for the markets? It should also be noted that after a 16 per cent rally from the February-bottom, valuations are no longer a major defence against downside. While a recovery in earnings is likely to help lift equity prices in the medium term, the fact that valuations are not cheap means that investors can afford to wait and see the markets stabilise. If indeed, the markets were to go into a deeper correction, investors should be ready to take advantage of such an opportunity. India's improving economy would mean that markets would float back up over time.
The author is Head of Equities - India, Nomura

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