The calm before the storm? What Morgan Stanley’s Ridham Desai says on market correction

“Supply constrained oil price rise is bad for India. Indeed, the recent 25% jump in oil prices would increase the current account deficit by 75 bps and inflation by 100 bps on a year-on-year basis. Historically, India’s relative stock prices for emerging markets (EMs) have responded poorly to rising oil prices due to supply constraints,” Desai said in the note.

India’s relative performance for EM appears to be breaking down in recent years. Therefore, the brokerage offered the following clarification:

Policy Certainty: India’s policy environment is one of the strongest in the world driving India’s distinctive growth story and more importantly, has the potential to create a new profit cycle. A rise in oil prices is a threat but not strong enough in terms of the policy environment.

Decline in the intensity of oil in GDP: Oil consumption relative to GDP is at an all-time low and has been declining steadily, notably since 2014.

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Higher Relative Real Policy Rates: Monetary policy in particular appears to be much better equipped to handle the effects of inflation from rising oil prices than in history.

Increasing share of FDI to FPIs in foreign balance: India mainly relied on foreign portfolio (FPI) inflows to meet its current account deficit. FPIs react more aggressively to the impact of oil prices on inflow stocks and their actions create a vicious circle. However, since 2014, foreign funding has shifted dramatically to FDI which is more stable and less sensitive to fluctuations in oil prices.

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The above factors probably explain why rate and money markets have remained relatively stable compared to the previous oil shock. Thus, stocks have also reacted less violently.

“Is this change in oil’s impact on equities structural or are markets assuming oil prices will reverse sharply, or whether a $10-20 increase in oil prices will cause the stock market to falter? We are not sure. But the coming days can answer these questions,” Desai said.