Is Booming India Immune to a U.S. Downturn?

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Until last week, there was at least some evidence to back a belief that India's stock markets would continue to defy gravity even as fears of a U.S. recession sent indexes plummeting across Europe and Asia. As recently as January 8, India's benchmark Sensex crossed the 21,000 mark, up 1,000 points from a previous record of 20,000 in just 49 days. Investors elsewhere may have been bracing for a fall, but in India their optimism was at a dizzying peak. That much was evident when a much-anticipated initial public offering by Reliance Power — India's largest ever at $2.9 billion — was oversubscribed within 60 seconds of opening on January 15, and oversubscribed 73 times by January 18. It looked like there was only one way for the bourses to go, and equity trading had risen to the top of the list of lucrative career choices.

The market's fall, like its rise, was sudden and steep. The Sensex lost 13% in a week starting last Wednesday, which, as the daily Hindustan Times reported, amounted to $375 billion — or 2.2 times the country's budget. "Brokers were left gasping for breath," says Jyoti P. Sharma, a New Delhi-based day trader. "It gave us no time to recover, or even think of cutting our losses." As retail traders across the country got a severe fright, the Times of India reported on its front page that a stock broker had attempted suicide on Tuesday, and "doctors reported a sudden spurt of patients complaining about cardiac problems in Mumbai and elsewhere."

It wasn't as if traders and analysts could claim to have been caught unawares. Even though Indian markets had continued to perform well despite the global downturn, there was good reason to doubt that India could remain immune. "India is just 2 percent of the world's economy," says Ramdev Agrawal, Director, Motilal Oswal Financial Services. "If everyone else is experiencing a meltdown, you will too." Dhirendra Kumar, CEO of Value Research, a mutual-fund research company, adds, "In today's world of digital connectedness, we all talk the same language and watch CNBC. Not only are Indian and U.S. equity markets interconnected, the key drivers of our emotions and psychology are also the same."

Analysts also agree that India's market correction is driven more by domestic factors than by the U.S. credit crisis. India's equity markets were already short of cash with huge amounts locked into the giant Reliance Power IPO, and margin calls worsened the situation. Many also believe that a correction was overdue as the market's hasty rise was unsustainable. Finance Minister P. Chidambaram told traders on Monday: "There is no reason to allow the worries of the western world to overwhelm us. Our economy is very different from the economies of some developed countries which are facing some stress. Our economy is a strong economy, our corporate sector is very strong. If the economy will grow this year at 8.9% and is expected to grow at 8.5% next year, the market sentiment should be a very positive sentiment."

Nevertheless, it was only after the Federal Reserve cut interest rate by 75 basis points to 3.5 per cent on Tuesday that the Sensex recovered some of its losses, rising 864.13 points on Wednesday to end the day at 17,594.07. While a U.S. slowdown may not affect India's 8%-plus growth, Indian equity markets may not be able to curtail their exposure. "The [Indian] markets remain vulnerable to the extent that FIIs [Foreign Institutional Investors] with exposure in the U.S. as well could pull out to consolidate and compensate for their losses in the U.S.," says Sharma, adding, "Fed rate cuts won't help. Unless employment and demand picks up in the U.S., things will remain gloomy."

But not everyone is as pessimistic. "The Indian corporate sector is strong and buoyant," says Agrawal. "The Indian market alone can give a 20-22% return on equity. Things are bound to improve, the question is: How soon?"