Analysing the interplay between geopolitics and India and its positive and negative ramifications on various sectors

This article is authored by Hemant Shah, Fund Manager, Seven Islands PMS

In the ever-evolving landscape of global geopolitics, India stands at a crossroads, where it can take advantage of the shifting dynamics while bracing for potential challenges.

The Downwards Spiralling USA-China Ties and its Indian Impact

A prominent observation centres around the widening chasm between the United States and China, driven by multifaceted factors ranging from political tensions to economic rivalries.

This rift has spurred a global trend towards diversification of the supply chain away from over-dependence on China, exemplified by the emerging "China + 1" model that originated during the coronavirus pandemic. India has stood out as the most agreeable alternative in this transformation.

The United States' reluctance to rely solely on Chinese imports has opened avenues for Indian exporters. For instance, in the solar energy sector, India has witnessed a surge in demand as an alternative supplier to China. Similarly, concerns over human rights violations in China have prompted Western textile firms to seek alternative supply channels, expanding India's textile market share.

Oil Dynamics and the Middle East: Implications for India

The Middle East, traditionally a hotbed of geopolitical instability, impacts global oil prices. The oil prices today are lower than they have been in the last 2-3 months, with Brent and WTI shedding more than 5 per cent from the recent high, an indicator that the events in the Middle East are unlikely to impact the D-street.  Similarly, the Red Sea crisis may have a passing effect like a spike in the freight rates but is unlikely to have any long-term repercussions.

India's primary concern lies in oil imports, with Western sanctions limiting Russia's export options, India emerges as a beneficiary, securing oil and gas at discounted rates.

Since the onset of the sanctions India has witnessed a significant shift in its crude oil sourcing dynamics. Previously reliant on Russia as its primary crude oil supplier, India has now been offered substantial discounts amidst geopolitical tensions.

Concurrently, data from the Ministry of Commerce and Industry highlights a notable surge in oil supplies from Saudi Arabia, indicating a 67.5 per cent increase to USD 2.6 billion in January. This has taken Saudi Arabia to the second position in India's list of oil suppliers.

Navigating Global Interest Rates

On the global stage, interest rates wield significant influence. Recent shifts in the global interest rate scenario have seen a departure from expectations of frequent cuts to a more cautious approach, with moderate cuts anticipated. This trend, driven by concerns over inflation control, particularly impacts the US and European markets.

Debt in emerging markets grew to a record of more than USD 105 trillion in Q1 2024 - having more than doubled over the past decade according to IIF data. Government budget deficits are still higher than pre-pandemic levels and are projected to contribute around USD 5.3 trillion to global debt accumulation this year. Rising trade friction and geopolitical tensions also present significant potential headwinds for debt markets.

However, India stands in a unique position, with the Reserve Bank of India (RBI) effectively managing inflation and interest rates through proactive measures. India's stable inflation environment positions it favourably for potential global interest rate reductions where the cost of funds will effectively reduce and hence, higher growth could be anticipated.

Tapping into the Domestic Market for Global Trade Competitiveness

While competition from Southeast Asian nations like Indonesia and Vietnam cannot be ignored, India's sheer market size offers an advantage. Unlike its neighbours, India can cultivate large-scale national industries that are less susceptible to global price fluctuations.

Take solar, for example. By encouraging domestic production, India creates a massive captive market, shielding manufacturers from the price wars that plague exporters. Chinese producers, known for aggressive pricing tactics, would be less likely to undercut Indian rivals if the primary market lies within India itself. This local market buffer allows Indian companies to scale up and become competitive players in the international arena as well.

This logic extends beyond solar to chemicals, pharmaceuticals, and even automobiles where India has emerged as a leading player. The success of Apple and other phone manufacturers in India is a classic example of this dynamic where access to the vast Indian market is a game-changer. Companies are willing to participate in the Indian market incentivized by the domestic presence and the engineering capabilities, even if it means starting with lower-value assembly operations. This creates a natural progression towards higher value-added activities over time, ushering in a manufacturing evolution.

Government initiatives such as "Make In India '' incentivize local production, and while challenges do persist, particularly in infrastructure development, concerted efforts are underway to address these bottlenecks which will play a huge role in improving India's competitiveness vis-a-vis regional counterparts like Indonesia and Vietnam.

 Going forward, domestically driven sectors will offer better premiums. India has a consistent history of growing at 10-12 per cent in USD terms over the last few years.  This translates to a strong top-line growth potential for domestically focused companies.

Global jitters cloud export growth (lower valuations), while domestic strength shines (predictable cash flow, higher P/E). This is one of the prime reasons why domestic money is driving the Indian market right now, DII holdings have been on the rise, while foreign ownership has dropped in the past few years

Looking ahead, sectors like defence and railways, backed by massive government spending plans, offer exciting investment opportunities. These sectors boast long-term demand visibility, translating into potential 15-20 per cent growth over the next 5 years.

For the next five years, the Indian stock market's sweet spot lies in domestically focused sectors. With potential recessions in the US and ongoing stagnation in Europe casting a shadow over exports. This prompts an important question: Is India on the verge of a ratings upgrade from global agencies, driven by its economic momentum?

Amidst geopolitical uncertainties, India remains a bright spot anchored by domestic demand and money in the equity market.

Disclaimer: The opinions expressed above are personal and may not reflect the views of DSIJ.