Despite a supply shock in oil, rates, currency and stocks appear to be relatively calm, said Morgan Stanley‘s Ridham Desai in a note, in which the brokerage has analyzed likely reasons to see if this is a calm before a storm or a new market dynamic.
“Supply constrained oil price rises are bad for India. Indeed, the recent 25% jump in oil prices will expand the current account deficit by 75 bps and inflation by 100 bps on an annualized basis. Historically, India’s relative stock prices to emerging markets (EM) have reacted poorly to oil price increases caused by supply outages,” Desai said in the note.
India’s relative performance to EM appears to be breaking down in recent years. Therefore, the brokerage offered the following explanations:
Policy certainty: India’s policy environment is among the strongest in the world driving India’s idiosyncratic growth story and, more importantly, likely creating a new profit cycle. The rise in oil price is a threat but not strong enough in the context of the policy environment.
Declining oil intensity in GDP: Oil consumption relative to GDP is at all-time lows and is steadily declining especially since 2014.
High relative real policy rates: Monetary policy looks much better placed to handle the inflationary impact from an oil price rise especially when compared to history.
Rising share of FDI to FPI in external balances: India used to rely primarily on foreign portfolio (FPI) flows to fund its current account deficit. FPI flows tend to react more aggressively to the effect of oil prices on shares and their actions feed into the macro creating a vicious cycle. However, since 2014,external funding has shifted dramatically to FDI which is more stable and less sensitive to oil price fluctuations.
The above factors probably explain why the rate and currency markets have been relatively stable compared to previous oil shocks. Thus, stocks have also reacted less violently.
“Is this shift in the impact of oil on equities structural or are the markets assuming that oil prices will reverse quickly or does it takes another $10-20 rise in oil prices to cause the stock market to falter? We are not sure but the ensuing days could answer these questions,” Desai added.