Why India could feel the global financial aftershocks this time

India's huge domestic demand helped it weather the financial crisis of 2008. But since then, Indian companies have invested internationally, increasing India's vulnerability to economic downturns.

Rajanish Kakade/AP
Stock brokers watch the Bombay Stock Exchange (BSE) index on his trading terminal in Mumbai, India, Aug. 8. Asian stocks nose-dived Monday as the first-ever downgrade of the U.S. government's credit rating jolted the global financial system, reinforcing fears that the world economy is weakening.

When US President Barack Obama arrived in Mumbai last November, the country’s benchmark stock index had just hit a peak of 21,108. Today, the Sensex slipped as low as 16,759, making it official: The bears are roaring in India.

A traditional rule of thumb for a bear market is a 20 percent drop over more than two months. The final push today came as part of a wave of market losses in Asia in reaction to the downgrade of the US credit rating late Friday.

India fared better than most countries in the global financial crisis of 2008 partly due to its insular focus on its own domestic market. But India’s strong position fueled more Indian acquisitions abroad and greater foreign investment here. Now India stands more exposed to any second coming of global financial jitters.

“In IT, pharmaceuticals, manufacturing you clearly have industries that have all moved into directions of growing international exposure,” says Nick Paulson-Ellis, India country head for Espirito Santo. “We are not talking about a Northeast Asian country that is export-oriented, but I think it’s no longer the case that India is not exposed to international conditions abroad,” he adds.

India has a huge domestic population with rising living standards. And the ability to supply that domestic demand still gives India a resiliency unlike more export-driven economies.

But Mr. Paulson-Ellis notes that Indian corporate earnings are increasingly linked to global demand. Acquisitions of Jaguar and British Steel have helped make the Tata Group into Britain’s largest manufacturing employer. Manufacturer Bharat Forge Limited now gets a significant percent of its revenues from Europe, he says.

“One of India’s great attractions through the global crisis was its domestic-led demand. Whilst this hasn’t suddenly changed, there is no doubt Indian companies are less local than they used to be and therefore more exposed to headwinds currently faced by the global economy,” reads an August report from Espirito Santo.

Over the past few years, foreign investors have also come into the Indian market in a big way. Between December 2008 and December 2010, foreign institutional investment in equity and debt securities nearly doubled from $91.6 billion to $171.7 billion, according to the Economic Times.

Uncertain times

But such inflows have since fallen off as investors grow leery of India’s inflation and corruption challenges as well as global uncertainty.

To head off mounting concerns, Finance Minister Pranab Mukherjee told reporters Monday that India was well-positioned to weather the global economic headwinds.

“These developments could have some impact on India. But as India’s growth story is intact and its fundamentals strong, we are in a better position than many other nations to manage the challenge,” said Mr. Mukherjee.

One silver lining for India: Commodity prices like oil are trending downward, which will help India gain control of rising inflation.

Paulson-Ellis says if the government gets serious about expanding economic reforms, India will be in a strong position. “In the near-term there are reasons to be cautious, but if inflation comes under control, if the government starts to reform more seriously, India does not have the structural problems that you can see in the Eurozone,” he says.

Today's decline

Stock analysts say today’s decline was mostly due to uncertainty caused by the first-ever downgrade of the US credit rating. The Sensex shed more than 546 points at one point before it started to rebound. The index still lost 315 points, or 1.82 percent, on the day.

The main indices in Hong Kong and Japan dropped more than 2 percent, and the Shanghai Composite Index slid almost 4 percent.

The Sensex peaked last November around the Laxmi Pujan, a ceremony where traders open a new year’s set of account books and make offerings to the goddess of wealth. Stock brokers gathered in an exchange conference room decked out with Greco-roman pillars, marigold garlands, and a Bollywood movie poster for a comedy called “No Problem.”

Traders were giddy: The market had closed a smidgen away from an all-time high, and the next day the US president was coming to their city with the titans of American industry.

“The whole world is putting so much money in this growing country,” a retired colonel turned stock broker named R. Handa told this reporter. “The country has earned a name in the world.”

Today, Colonel Handa’s faith in India’s strength remains unshaken. He puts the blame for the 20 percent skid on the woes of the outside world.

“It’s the effect of the neighbors, the global market having done so badly,” says Handa, who is chairman of SIC Stocks & Services in Bangalore.

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