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Could India be a hedge for U.S. recession?

August 9, 2024
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This report is from this week’s CNBC’s “Inside India” newsletter which brings you timely, insightful news and market commentary on the emerging powerhouse and the big businesses behind its meteoric rise. Like what you see? You can subscribe here.

The big story

A surprise interest rate hike from the Bank of Japan and the Federal Reserve’s willingness to put a September rate cut “on the table” put global stock markets on the brink.

Then came a disappointing U.S. employment report that ultimately pushed stocks off their cliff and spoilt the party for investors.

Global stock markets fell the most on Monday in over two years. Japan’s Nikkei cratered by more than 12% and the S&P 500 fell 3% — yet India’s Nifty 50 only lost 2.7%.

The Indian benchmark (of emerging market stocks) has also started to outperform the S&P 500 year-to-date.

Could these market moves foretell how Indian equities might perform in the future if the U.S. does indeed fall into a recession?

Could India be a hedge for U.S. recession?

Taking stock of current economic conditions worldwide could partly address that question. While Europe is struggling and China is slowing down, India is booming.

Such a disconnected global economic picture means “it is unlikely that a macroeconomic distress in the U.S. becomes a global event in 2025,” Venugopal Garre, head of India research at Bernstein, told clients this week. Bank failures in the U.S. and Europe in 2023 and China’s multi-year housing slump provide evidence of the impact of significant shocks being localized rather than allowed to spread worldwide.

Historically, a U.S.-led recession typically leads to fund flows into safe-haven assets, such as U.S. dollars, Treasurys and gold. In contrast, risk assets like stocks and emerging market currencies fall. A depreciating Indian rupee, which hit an all-time low this week against the greenback, would dent total returns in U.S. dollars, euros or sterling, as the case may be for foreign investors.

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Japan trade on deck, Wall Street rally pauses

However, the interest rate differential created by the Reserve Bank of India’s decision this week to hold interest rates at 6.5% while inflation continues to edge lower amid strong GDP growth might help temper the severity of a rupee sell-off, according to Garre.

The rupee might also benefit partly from a U.S. recession if commodity prices tumble. As a net energy importer, India is highly sensitive to crude oil prices. A U.S. recession that lowers Brent crude oil prices might help prop up the Indian currency.

More broadly, the Indian economy is also consumer driven, unlike China’s and Japan’s reliance on exports. Data shows that the U.S. is not a major destination for Indian manufactured exports. Services such as those in IT and business process outsourcing, which accounts for 75% of exports, are unlikely to become uncompetitive suddenly.

“The fundamentals of the economy don’t change — even when the U.S. enters a recession,” Bernstein’s Garre said. “Hence, a short term correction … does not necessarily create the case of a longer fallout and we see limited risks from a U.S. recession — if it plays out that is.”

Elsewhere, the Indian government — after Prime Minister Narendra Modi took a significant hit in the general election — has also taken steps to mature the economy. Investors have welcomed the lower budget deficit forecast and self-imposed constraints in the latest spending pledges, which could help push stock prices higher.

“Eventually, India is likely to head into primary balance which supports a new high for corporate leverage, private investments and share of profits in GDP,” said Morgan Stanley’s equity strategist Ridham Desai in a note to clients this month.

“The consequent rise in share prices will also be supplemented by a further increase in the equity allocation on household balance sheets, significant global allocations to Indian stocks (reflecting India’s rising index weight) a rise in corporate issuances and a new peak in equity valuations.”

However, not everyone subscribes to the view that India could be used as a hedge if the U.S. falls into a recession.

“I wouldn’t say that India is going to be completely detached, but I think that India is in a much better position to ride through the volatility noise,” John Ewart, a portfolio manager behind Aubrey Capital’s $600 million Global Emerging Markets fund, told CNBC’s Inside India. More than half of Ewart’s fund is invested in India.

“Companies that we’re looking at are insulated from the short-term noise that we see and read, which emanates from speculation as to what the next U.S. Fed rate cut may be, and when, or what’s happening to the Japanese yen,” Ewart added. His fund’s top holdings are Varun Beverages — a distributor of Pepsi, food delivery company Zomato, and real-estate developer Macrotech.

In fact, “the enemy lies within” for Indian equities, according to Bernstein’s Garre. A key risk for investors is the lofty valuations for stocks in the current climate. Indian equities continue to create all-time highs even after analysts downgraded earnings expectations by 1% for nearly half the 200 largest Indian companies.

The strategist pointed out that despite a two-day intense sell-off, Indian equities continue to have “rich valuations and lack of earnings support.”

— CNBC’s Michael Bloom contributed to this report.

Need to know

India’s Nifty 50 is now outperforming the S&P 500. As mentioned above, the benchmark has surged 11.8% so far this year, outpacing the S&P 500′s 9% gain, and analysts have told CNBC that the index could go even higher. Traders increasingly expect the U.S. Federal Reserve to cut interest rates in September, and that environment could boost Indian stocks.

India’s central bank asks banks to stop betting against the rupee. The Reserve Bank of India asked some large banks to not add to their existing positions against the rupee in a bid to support the currency, the Reuters news agency reported. Officials from the RBI’s financial markets regulation and operations department spoke to the firms on Tuesday when the currency was at risk of breaching 84 against the dollar in the spot market, Reuters said.

Travelers react to new IndiGo airlines booking feature. India’s biggest budget airline has been trialing a booking feature that will allow women to avoid booking a seat next to men on flights. Many users on social media platforms X and Reddit commended IndiGo’s new initiative, with some commenting that it is “such good news” after having bad experiences when traveling alone.

India is expected to see the fastest growth in the ultra-wealthy. The number of ultra high net worth individuals is expected to rise by 50% in India over the next few years, according to consultancy Knight Frank. Earlier this year, India’s financial center, Mumbai, overtook Beijing to become Asia’s leading billionaire hub. Globally, the city ranks third on billionaire count, after New York and London.

What happened in the markets?

Indian stocks have fallen 2.4% this week alongside global peers. The Nifty 50 index has stayed above 24,000 points after hitting 25,000 for the first time last week. The index has risen 11% this year.

The benchmark 10-year Indian government bond yield has fallen to 6.87%, alongside other global bond markets.

Stock Chart IconStock chart icon

Japan trade on deck, Wall Street rally pauses

On CNBC TV this week, Praveer Sinha, CEO of Tata Power, said the company is on track to meet its 2045 target of net-zero energy production. More than 40% of the company’s energy generation currently comes from renewable sources, and this is expected to rise to 70% by 2030. “We are very much on track, and you will only see that the speed gets enhanced with some of the new hydro projects we have identified for ourselves,” Sinha said.

Meanwhile, Abhay Soi, chairman and managing director of Max Healthcare, said he doesn’t see any reason for growth to abate. “We’ve had growth of 18%, including the two new hospital acquisitions we’ve done in the last three months, as well as the new hospital we’ve commissioned in the last week,” he added.

What’s happening next week?

Shares of baby products retailer Brainbees Solutions and e-commerce supply chain software provider Unicommerce eSolutions will debut next week on the stock market.

August 12: India industrial output

August 13: U.K. unemployment

August 14: U.K. inflation, India wholesale inflation, euro zone GDP, U.S. inflation

August 15: India Independence Day bank holiday, Japan GDP, U.K. GDP

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