With the biggest driver of global growth for the past few years looking increasingly shaky—at 47.1, China’s August PMI was the lowest in six-and-a-half years—and analysts increasingly unsure of the quality of the real economy, it is not surprising global markets have sold off in the manner they have. While oil is at a six-and-a-half year low as a result of collapsing Chinese demand, European markets fell by around 5% on average on Monday—Germany’s DAX has lost 20% since its April peak and the UK FTSE is at its weakest since January 2013—and US markets opened 4% down; not surprisingly, VIX futures are at 3-year highs. While China is expected to add to liquidity by cutting reserve requirements, it is no longer certain that will boost the economy, given how most other measures over the past few months have failed to work—the Chinese stock market fell 8% yesterday, down 38% from its June peak.
Though India’s Sensex fell 1,625 points in response, and the rupee tumbled to 66.64 in response to the global rout and what could just become a currency war, it is important to keep in mind India is among the best performing economies in the world, and well positioned to take advantage of the current turmoil. While poor global demand has obvious implications in terms of growth, especially those of exports, the collapse in global commodities—particularly oil—means India is a net gainer. Oil prices have made India’s current account deficit look much better, helped ensure the fiscal deficit—and oil subsidies—remains under control and even allowed the government to go for a major reform like decontrolling diesel prices. Had global commodity prices not collapsed, it is unlikely India’s inflation would have come under control, even opening up the possibility of a rate cut in a month or two—more so, since while the Fed did look like it was going to hold off on a rate hike in September, this is now almost a given. If the rupee slips out of control, as it could well in the immediate short-run, there could be trouble for India’s corporates as well as banks, given how the bulk of forex exposure still remains unhedged. Which is why the central bank is intervening in the market—unlike the situation when Raghuram Rajan was taking over 2 years ago, this time around, RBI has considerably more fire power to defend the rupee, though there are obvious limits to this.
It is, therefore, important the government does its best to convince global investors—FIIs sold $792 million on Monday over and above $528 million last week—that it means business. Though the inability to introduce GST is a clear dampener, all indications are the government will give MAT relief to FIIs—an official statement to this effect, at the earliest, will be a good idea. There are a host of other moves—a decision on going ahead and settling the Cairn tax case through arbitration, reviewing spectrum caps for telecom, and raising prices for natural gas come to mind immediately—that can bolster the view that India is not hobbled by its politics or by needless irritants like filing a class action suit against a global noodle manufacturer based on tests that the court has said lacked due procedure. The question is whether this is the crisis that will galvanise the government into action.