The September 2008 shock of default by Lehman Brothers was felt across the world, including India. The Indian stock markets fell 65% from levels at that time in a matter of nine months. The Indian currency tumbled 30% over the same period. However, timely action by various agencies ensured that the pain was not prolonged.
Now, in the last week, suddenly, the Italian Bond Market – the third largest bond market in the world, moved decidedly from the soft core to the periphery of the Eurozone. If markets do not settle in the next few weeks, and shut Italy of private funding, the shockwaves of risk aversion will be as strong as that observed post the Lehman Black Swan.
Given the lurking danger of an event capable of creating a market contagion, it may be a worthwhile to evaluate the status of some of India’s key Macro fundamentals to check if they are as resilient now as they were in 2008. In order to do that, we have developed a Macro Resilience Index for India, computed as follows:
Macro Resilience Index = Unabsorbed Liquidity in Economy as % of GDP
+/- General Government Surplus (Deficit) as % of GDP
+/- External Balance as measured by change in Net IIP as % of GDP
- Structural CPI Inflation
The chart below shows the movement in Macro Resilience Index for India
The table below shows the components of Macro Resilience Index for India:
The above chart and table show that India was in a very strong position to handle the 2008 crisis, as government deficits were in control, inflation – though rising - was not very high, the external position was very comfortable with no change in Net International Investment Position and finally, there was a record amount of Unabsorbed Liquidity in the economy.
However, currently, the fiscal position does not have any room for providing stimulus to the economy; inflation is high – so although our expectation is that RBI may not increase rates substantially, as explained in our note two weeks ago – RBI cannot cut rates dramatically; the external position is one of the worst in last many years and finally, the spare cash in the economy is lower compared to the last decade.
This leads us to believe that if the Italian situation worsens over the next few weeks, Indian markets may become a victim of the contagion, and more importantly, may not recover as quickly as they did in 2009-2010.