IBSPECIAL

In early March this year, India’s benchmark indices – the Sensex and Nifty slipped to a seven-month low amid increased selling pressure following the Russian invasion of Ukraine.

The war in Ukraine and the unprecedented sanctions imposed by the US and European countries on Russia have kept investors worried about the near-term plight of the shares they have invested in. There is a rush among them to seek refuge in safe-haven assets such as gold.

The day Russian forces moved into Ukraine, the global stock markets and currencies witnessed a sharp fall while demand for safe-havens such as gold surged substantially. Treasury yields across the world fell while crude oil prices topped since September 2014. The Ukraine war roiled the global financial markets.

Like elsewhere, India’s bourses are reeling under the impact the ongoing conflict is having on the global economy as well as the financial markets. According to market experts, the stocks will be exposed to greater volatility in this uncertain climate.

Against this backdrop, most market experts warrant caution while venturing into high-risk assets. A few remain optimistic given India’s inherent economic strength as well as limited exposure to Russia, which has been at the receiving end of economic sanctions. Many experts are advising investors to diversify their investment portfolio away from equities into safe-haven assets or conserving cash, until the Ukrainian crisis gets resolved.

Most market experts are in agreement about the negative impact of the war on India’s economy, which heavily depends on oil imports to meet its energy requirement. The Indian equity market, which was performing well until recently with an 18% surge, has been rocked. In a knee-jerk reaction to the Russia-Ukraine conflict, the local bourses have been hammered.

“Equity markets continued with its weakness as various developments on the Russia-Ukraine front led to spiralling of crude and other commodity prices,” said Siddharth Khemka, Head – Retail Research, Motilal Oswal Financial Services.

A prolonged conflict would lead to a rise in energy prices and, hence, impact margins and earnings of Indian companies, Khemka added.

The economic consequence of the war on Indian economy could turn out to be profound and detrimental given the country’s energy dependence. In fact, the surge in oil prices touching multi-year highs has forced Credit Suisse to downgrade India’s rating from ‘Overweight’ to ‘Underweight’ for now, mostly due to the country’s vulnerable position on oil. According to the investment bank, India is among the most vulnerable countries to oil shocks.

In their assessment of a possible economic impact of the Russia-Ukraine crisis and India’s economy, several economists have aired similar concerns. Aditi Gupta, economist at Bank of Baroda, expects higher oil prices to worsen India’s trade balance. “Since India is a large consumer of oil much of which is imported, the impact of higher oil prices is likely to be visible not only on trade deficit and currency but will also impact inflation and fiscal situation,” she wrote in a note.

India imports more than 80% of its total oil requirement and is the world’s third-largest importer of crude oil. In FY21, India’s oil imports stood at $82.7 billion. In FYTD22 (Apr’21-Jan’22), oil imports have risen to $125.5 billion, driven in part by economic recovery as well as higher oil prices. However, with oil prices now hovering at an 8-year high, oil imports are likely to be higher. In FYTD22, oil imports could touch $155.5 billion.

“Sustained high oil prices are a risk for the broader macro health of the economy, as every $10 increase in oil prices lifts consumer price index (CPI) inflation by 20-25bps, widens the current account gap by 0.3% of GDP and poses a 15bps downside risk to growth. In addition, given the pass-through of higher oil and sunflower oil (refined oils have 1.3% weight in the inflation basket; and spillover to larger universe of edible oils), FY23 inflation faces upside risks,” said Radhika Rao, senior economist at DBS.

The ongoing conflict is threatening to disrupt global supply-chain dynamics and, hence, pushing the world economy into the perils of a hyper-inflationary pressure. Such fears are getting reflected in the various asset classes, especially commodities. Brent crude prices topped $138 a barrel mark on Monday, while gold prices soared above $2,000 troy ounce. Industrial metals and natural gas prices remain highly elevated to levels seen almost a decade ago.

The rally in global oil prices has taken the Indian crude oil basket up 32% compared to late-2021 levels, back to 2014 levels. However, the domestic retail fuel prices, by contrast, remain unchanged since early-December (usually revised daily), marking the longest freeze since the daily revisions were introduced in mid-2017.

Prices of industrial commodities as well as agriculture produce are also on the up move. Prices of nickel, aluminium and other metals have surged to record levels as a result of sanctions on Russia.  Besides being major energy exporters, Russia and Ukraine are also major exporters of agriculture (wheat, corn, barley), and metals (nickel, copper, platinum), crucial gases (neon etc) for chip-making, disruptions in which are likely to impact supply chains for auto, chip-manufacturing, etc. on the margin front. Most global semiconductor manufacturers have, however, assuaged concerns saying their direct exposure to these two countries is limited.

Interestingly, for India, the non-defence trade exposure to Russia and Ukraine is a modest 1% of total exports while imports make 2% of total purchases. Supply disruptions may provide an opportunity for India’s wheat and manufactured goods shipments. Nonetheless, sector-specific pain points remain for items like sunflower oil supplies. Of the 2.2mt consumed, Ukraine accounted for 1.7mt in FY21, followed by Russia and Argentina. Suspension in the air or port movement is likely to add to the buoyancy in prices. 

At the start of Russia’s invasion attempt, a broad shift to safe havens pushed the greenback higher, US yields lower, and triggered a correction in global equities. Indian markets corrected sharply, with the benchmark index Sensex marking the largest single-day fall since early-2020. Since then, the bourse has stabilised but foreign interests remain on jittery terrain, extending their selling streak since October 2021. Equities have witnessed $13.7 billion outflows in the past five months, besides $1.4 billion offloaded in debt.

Dollar strength and a sharp rise in oil prices have hurt the local currency, leading the rupee to be amongst the regional underperformers on a YTD basis. As a pre-emptive move to manage liquidity, the Reserve Bank of India (RBI) announced a sell/buy USD/INR swap worth $5 billion (Rs 37,500 crore) to be undertaken on March 8, i.e., sell dollars and mop-up Indian rupee liquidity through a forex swap, entering into a contract to buy the dollars back after two years. However, this move provided little support to the rupee, which has tumbled to 77 against the US dollar.

Such is the fear psychosis that the outbreak of the conflict has led to a global risk-off. Equity markets continue to witness intermittent correction amid elevated volatility, as the uncertainty over the duration and magnitude of the  conflict has added to market jitters. As such, the risk-premium is slowly building into stock prices, which resulted in price-to-earning (P/E) valuation multiple of Nifty50 falling to 18.52 times of its 12-month forward earnings, at an 18.8% discount to the record valuation seen in October 2021.

Khemka expects volatility to remain high in the near term given the elevated risks from the Russia-Ukraine conflict, upcoming state assembly election results as well as the US Fed meeting. Markets would watch out for developments on the Russia-Ukraine talks.

It must be noted that both the Union Budget and the RBI’s monetary policy announcement came much before this crisis and did not factor in the impact of the crude price shock. Both the budget and the RBI took a conservative estimate of crude prices at $75/bbl, which is likely to be a challenge going forward. Hence, the extent of distortion in value terms remains unclear.

As the Russia-Ukraine conflict rages on, Western nations have unveiled fresh sanctions to penalise Russia’s financial system and economy. As long as the conflict stands unresolved, the financial markets across the globe will suffer as they are caught in the crossfire.