Since peaking in early 2010, Indian industrial production rates have gradually lowered, with the past 12 months pointing to a stalling economy. Unlike China’s slowdown, which still features double-digit retail sales growth, Indian domestic demand has been lacklustre. The burst of optimism in India’s financial markets was sparked by last year’s announcements of ambitious structural reforms, aimed at opening up the economy and addressing infrastructural needs. Since then, the election calendar has inevitably slowed progress, causing international investors to lose interest.
But this is not a fair assessment. India’s challenges are mirrored across the emerging markets and looking at its financial performance alone (the fall in the rupee) will only tell part of the story. Governments always face challenges when implementing structural reform and India is no different. Another case in point is Japan, whose assets have rallied sharply (and the yen has fallen) amid aggressive monetary policy easing by the Bank of Japan and increases in government spending. The pressure is now on the government to deliver. In India, the general elections are to be held next summer and investors are unlikely to see policy action before then.
More broadly, India has been swept up in the rise in US Treasury yields since May, alongside other emerging markets. The rupee has fallen about 8 per cent against the dollar since May 22 (when quantitative easing set in) and the market consensus does not see a quick reversal any time soon. Billions of dollars have exited emerging market equities and fixed income investments in recent months as globally, the prospect of sustainable higher US yields causes a major rethink about emerging market holdings. India has not been immune to these developments.
More recently, the Reserve Bank of India has mounted a defence of the rupee by hiking selected interest rates. At the same time, however, actual tightening of liquidity conditions was not clearly observed in the markets, causing uncertainty regarding the efficacy of the move. On a positive note, core inflation has been falling in India since the beginning of the year.
The overall backdrop for emerging markets is currently a challenging one, characterised by a cyclical slowdown that is amplified by the prospect of more US yields. But in India’s case, post elections, a renewed push to attract external investment is likely to occur. This requires investors to be patient, which is easier said than done.
