Financial Tips

undsIndiaAdvisor Views: Why 2016 will be difficult, but you should not panic Vidya Bala, Head – Mutual Fund Research It is less than a month since 2016 began, and the equity markets are already down by close to 6 per cent year to date. With this, the markets have corrected 13 per cent since the beginning of 2015 (13 months). That is good enough a correction to unnerve you a bit, or signal you to average. It is going to be a rough ride this year, or at least for a good part of this year. China, crude oil and currency are beginning to trouble the world. But then here’s why you should not panic and upset your portfolio. Why this is not 2008 There are many reasons why it may not be right to compare the current situation to the one in 2008. Given below are some: First, while commodity is a factor to worry about, the scenario was entirely different in 2008. Commodity cycle was at a peak then, and was only thought to go up. This time around, if anything, commodities have crashed, and are only forecast to go further down south. That means commodity per se cannot be a threat to the net import of developing economies such as India. Two, parts of Europe that were almost bankrupt, and the derivative trading collapse in the US were key reasons for the 2008 downfall. This time, the trigger has been China, and that too its primarily slowing economy (we will discuss the China conundrum later), although it may be too early to say whether it will lead to a credit risk globally at a later stage. While a slowing Chinese economy can slow global growth, that alone need not be cause for a crisis. Besides, global growth expectations are themselves moderate, with sufficient cuts in forecasts, as opposed to unrealistic growth expectations in 2007-08. India itself has been steadily seeing earning downgrades, and there seems little optimism in near-term earnings growth. In other words, there is complete absence of exuberance. This means less risk of a bubble. Three, various banks across the globe have been more actively using their monetary/fiscal tools to combat excess and low liquidity situations, as the case may be, since the debacle in 2008. That will also likely help curtail even a serious situation to snowball into one like 2008. For India itself, it is among the few emerging markets considered to have a revival, helped by the fallout in commodities, as well as fiscal/monetary adjustments. Why it will still be a tough year While the comparison with 2008 may be overdone, we do believe that this is not going to be an easy year; at least for the next one-two quarters. Why do we think so? What China can do: China is definitely reeling under a slowdown, following years of building over capacities. China now suffers from high savings rates, and the sinking of huge investments into capacities not balanced with productivity, therefore leading to the problem of mounting debt. There are no quick fixes for China’s woes. China’s lasting solution would come from a more open economy and market-driven currency valuation. However, allowing market forces to readjust means capital outflows (not just from China, but from other emerging markets as well), and a depreciation of the Chinese currency, renminbi, which could slowly result in global pain. This is because a depreciating renminbi could make some of the export-oriented nations less competitive. Besides, China is the second largest economy, and a slowdown there would hurt global numbers as well. What it means for India: Many of the Asian emerging markets are exporters to China, and a Chinese slowdown could hurt them. India is less vulnerable on this count. However, a depreciating Chinese currency could make us less export competitive in our own exports such as textiles or engineered goods. Besides, cheap dumping of Chinese inputs such as steel could send Indian commodity makers into a domestic supply glut and put down corporate profitability. Crude impact: Two, crude has bottomed to 11-year lows and is no longer driven by fundamentals. Multiple extraneous factors drive the price and removal of sanctions on Iran, and fresh supply of oil will likely not help provide any support to price. A number of oil producing nations that have taken sharp price falls on what is their main stream of revenue could also see a slowdown in their economy. Besides crude, a number of commodities have also crashed. That means many countries such as Brazil, Russia or South Africa are hit. As many of these oil nations are also high-importing nations, the countries that export to these regions would also be affected. There is, therefore, this ripple effect. Not that the US markets can be immune to all this as the S&P 500 gets over a third of its earnings from companies in emerging markets. What it means for India: As mentioned early on, net importers like India get to benefit from lower crude oil prices. However, the problem is that India’s own stock market fortunes are linked to institutional flows. The outflow of sovereign wealth (belonging to oil producing nations) from oil producing nations can mean outflow of money from stock markets, thereby impacting returns. This is what is being currently experienced. Credit risk More than China, currency or crude, what ultimately has potential to turn a slowdown or market fall into a crisis is credit risk. Whether it is the Asian Crisis in 1997, or the global meltdown in 2008, credit holds the potential to make or break. So what is the credit risk in the current scenario? The risk with Chinese credit is imminent as its debt to GDP ratio has been mounting at over 250 per cent. And China’s credit problems can impact the world, going by its borrowings as well as its parking of money across economies. But that is not the only credit risk. Oil producing nations could also see increasing risks in terms