The war in Ukraine, which is lingering longer than initially thought, is impacting the global economy. The impact on individual economies differs. Commodity exporters have benefitted from the sharp rise in commodity prices. For commodity importers, like India, the war has inflicted a blow. India is one of the emerging markets to be impacted by the spike in crude. The ‘crude shock’ came when the economy was recovering from the pandemic-triggered recession. As I write, we still don’t have any certainty on when and how this war will end and how severely it will impact the economy and markets.
Global growth will be lower and inflation higher due to the spike in commodity prices. For India, which imports 85 percent of its petroleum requirements, the impact of the war would be high. It is estimated that every $10 increase in crude prices would reduce India’s GDP growth by 0.2 percent, raise current account deficit by 0.3 percent and push up inflation by 0.49 percent. Of course, the real impact would depend on how long crude prices will remain elevated. The RBI while projecting GDP growth of 7.8 percent and inflation target of 4.5 percent for FY 23 had assumed average crude price to be around $75. The government too has assumed crude to average around $75 in the budget. Now that these assumptions have turned out to be way off the mark, the GDP growth and CPI inflation numbers need to be revised. Growth will be lower and inflation higher than the projections made before the war.
How will this impact the market? A lot will depend on the corporate earnings trajectory. Of course, lower GDP growth will impact corporate earnings too. But the impact will differ across sectors. For instance, IT and pharma will not be impacted at all by the war. In fact, both sectors stand to benefit from rupee depreciation. Metal manufacturers will gain from the high prices. Segments like paints which use petroleum inputs and FMCG with high commodity intensity will be negatively impacted. However, a lot will depend on the pricing power of companies and their ability to pass on the increased cost to customers.
Experience tells us that geopolitical events won’t last long. So, investors should not panic. History tells us that sharp market corrections are buying opportunities. Even after the recent corrections valuations are not attractive enough to warrant aggressive buying. But there is value emerging in some segments. During times of uncertainty like this, beaten down segments like financials offer value for discerning buyers now. India’s banking sector is well capitalized now. With rising credit demand and improving asset quality India’s leading banks, particularly the large private players, are emerging as good value-buys. IT is not a value- buy but it is a safe segment with good multi-year growth potential and earnings visibility. Even though interest rates are set to rise marginally, rates will remain low enough to be a tailwind for the construction-related segment.
Market direction in the short run will depend on how the war transpires. A quick end to the war will see crude prices declining sharply and markets rising. On the other hand, if the war lingers longer, crude prices will remain elevated with negative impact on the economy and markets. Let’s keep our fingers crossed and hope for the best!