Although the plunge in benchmark crude oil prices is largely regarded as a positive event with its implications on India’s twin deficits and inflation trajectory, in the near term, a further decline from a five-and-a-half-year low could weigh on the Indian market.
Over the last 12 trading sessions, in which the benchmark global crude oil prices declined 16% after breaching the $70-per-barrel mark, the Sensex has lost 1,900 points, or 7%. On Tuesday, brent crude prices traded at $58.5 per barrel, down $2.6. During late trading hours, the Sensex lost as much as 583 points and closed at a seven-week low of 26,781.44, down 538 points, or 2%.
According to Andrew Holland, CEO, Ambit Investment Advisors, an extended decline in crude prices towards the $55-50 range could intensify a ‘risk-off’ trade among investors, leading to a sharp correction in global equity markets of the order of 10-12%.
“Even as this decline may bring in good news for India in terms of sharper rate cuts — as much as 100 bps — in the first half of 2015 bringing in a respite for equities, in the near term, the Indian market may not withstand the worldwide selling pressure,” said Holland.
Concerns around the currency and debt markets of oil exporting countries, including Russia and Venezuela, have so far rubbed on the emerging market pack even as oil importers like Indonesia and India are seen benefiting substantially from the recent meltdown in commodity prices, especially crude oil.
Since late November, as the brent fell below the $70 mark, the MSCI Emerging Market index has lost close to 9% of its value even as its developed market counterpart, MSCI World index, is down about 5.8%.
Experts also believe that a more than 45% plunge in crude prices could moderate the savings of oil producing Middle Eastern economies, in turn, impacting the investment flow from sovereign wealth funds of these countries.
Recently, in a media interaction, Neelkanth Mishra, managing director- equity research at Credit Suisse pointed out that on the back of a slowdown in sovereign wealth fund flows — responsible for $8-10-billion of equity investment in India in the last 2-3 years — the net foreign purchases of Indian equities may taper off in 2015.
According to the latest EPFR data, for the week ended December 10, 2014, EM dedicated funds saw an outflow of $1.7 billion, extending their outflow for a fourth consecutive week to $5.5 billion. In case of India, the momentum in FII buying has tapered in the last one week. The 14-day rolling average of FII buying has come down from $128 million on November 21 to $50 million as on last Friday, while in the last one week, they have sold Indian shares worth $530 million.
Historical data for the past 10 years do not establish a strong positive co-relation (11%) between Indian markets and benchmark crude oil prices. However, data compiled by FE suggest that whenever the quarterly average price of crude oil has decline by more than 2%, Sensex has reported negative to muted returns for nearly half of these instances.
The observation is true not just for the financial crisis of 2008 when the flight to safety had caused a broad-based correction in all asset classes, including commodities which had gained the status of “evolving avenue of investment” during 2003-2008, due to growth potential of emerging economies. Even during late 2006 and mid 2011 as well as 2012, a more than 9% plunge in average quarterly crude prices dragged down the Sensex return.
In the latest instance, as the average crude oil price fell from $97 in the quarter ended September to $76 in the latest three months, Sensex quarterly returns returns declined from 4.8% to 0.6%, in that order.