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Explained: Economy in time of war

Inflation is expected to increase, and markets will likely remain volatile in the near term. But India’s medium- to long-term economic prospects are not altered, and investors should not sell in panic, say experts.

Written by Sandeep Singh | New Delhi |
Updated: February 25, 2022 2:02:47 pm
russia ukraineA Ukrainian serviceman carries an NLAW anti-tank weapon during an exercise in the Joint Forces Operation, in the Donetsk region, eastern Ukraine. (AP/File)

News of Russia’s invasion of Ukraine on Thursday morning triggered panic among investors everywhere. The Sensex at the BSE fell 2,702 points or 4.7% to close at a six-month low of 54,529.

While markets will likely remain volatile in the near term in line with geopolitical developments, experts feel that since India is not party to this external event and is not impacted directly, its medium- to long-term economic prospects are not altered — and investors should not sell in panic.

However, there are some concerns.

Inflation risks

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Brent crude shot past the $100 per barrel mark for the first time in eight years on concerns over supply. Russia is the world’s second largest oil producer.

Rising oil prices could speed up already rising inflation. India imports more than 80% of its oil requirement, but the share of oil imports in its total imports is around 25%. Rising oil prices will also impact the current account deficit, which is the difference between the values of goods and services imported and exported.

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While increases in domestic fuel prices have been put on hold as five states vote in Assembly elections, the recent surge in global crude could intensify the pressure on the state-owned oil retailers. Calibrating price hikes is now more complex, given the cascading inflation impact that could follow the increase.

Also, sanctions on Russia by the West could impact its trade with the world — and result in a rise in the prices of other commodities and products, including wheat, edible oil, and metals. India imports most of its requirement of sunflower oil from Ukraine, and the two countries now at war are also two of the world’s biggest producers of wheat.

Economic recovery

The rise in crude prices poses inflationary, fiscal, and external sector risks. Oil-related products have a share of over 9% in the WPI basket — and according to Madan Sabnavis, chief economist at Bank of Baroda, a 10% increase in crude would lead to an increase of around 0.9% in WPI inflation. A larger oil import bill will impact India’s external position; it is also likely to increase subsidies on LPG and kerosene, pushing up the overall subsidy bill.

Some experts, however, argue that India’s economic fundamentals remain strong, and the war will not have a significant impact on the economy. There is a view that with the third wave of Covid close to its end and most restrictions having been withdrawn, there will be an uptick in consumption and domestic growth, quickening the pace of recovery.

Sensex closing; brent crude price

FPI sentiment, rupee

Foreign portfolio investors have been selling their holdings in Indian equities over the last four months after the US Federal Reserve announced an increase in the pace of withdrawal of stimulus followed by a hike in interest rates beginning March 2022. Investors started pulling out funds from emerging economies to park them in US treasuries and benefit from the expected rise in bond yields.

Geopolitical concerns have intensified the outflow of funds over the last two months. Out of the total FPI pullout of Rs 82,745 crore beginning November 2021, Rs 57,774 crore was withdrawn between January and February 2022. This outflow is likely to continue over the coming days. On Thursday, FPIs pulled out a net of Rs 6,448 crore from Indian equities, leading to the fall in the markets.

FPI monthly inflow/outflow

DII behaviour

As FPIs pulled out on Thursday, domestic institutions emerged as net investors. According to provisional data released by the stock exchanges, DIIs invested a net of Rs 7,667 crore on Thursday, which is more than what the FPIs pulled out. Over the last two months, DIIs have invested a net of Rs 55,551 crore in equities.

Experts say that the current geopolitical concerns will not impact long-term fundamentals and prospects of businesses, and investors should take the fall in markets as an opportunity to invest in mutual funds and high-quality blue chip companies.

Equity investors

While markets may remain volatile, retail investors should look at the DII investment pattern, investment advisors say. If DIIs are investing amid the sharp fall in markets, retail investors too should not panic — and should increase their investments if they are underweight in equities.

On Thursday, while the Sensex fell 4.7%, mid and small cap indices at the BSE fell 5.5% and 5.8% respectively. In times of volatility, investors should avoid venturing into small cap stocks, and should invest through flexi cap and multi cap funds, as they invest across market capitalisations and would generate superior returns when the market recovers.

Investors must also remember that while early in the pandemic, the Sensex fell 14,300 points or 35% in the one-month period between February 25 and March 23, 2020, it rose to new highs over the following one year.

With the fundamentals strong and concerns restricted mostly to external factors, experts say the markets will likely bounce back once the situation eases. However, investors should not take unnecessary risks.

Gold outlook

In times of uncertainty and inflation, gold emerges as the asset class of choice for investors. It is important to note that at a time when equities have been falling, gold has risen sharply. The price of 10 g of gold in Delhi has risen 8.7% from Rs 47,507 on January 31 to 51,627 on Thursday. Prices jumped 3.3 per cent on Thursday.

A report by Motilal Oswal Financial Services said gold prices are likely to rise further from current levels, as investors will move towards the safe haven following inflation-related concerns on higher crude prices and geopolitical tensions. “If the current situation further escalates, investors will cling on to safe haven asset or sit on cash, i.e. dollar. Along with geopolitical tensions, rising inflationary concerns has also been supporting precious metal prices on lower levels, hence supporting our view of buying on dips,” the report said.

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