During the recent global market sell-off, the Indian stock market demonstrated notable resilience. In a span of just 25 days, Japan’s Nikkei 225 index experienced a significant decline of over 25% from its July peak to its August low. This sharp drop had a cascading effect on neighboring markets, causing Taiwan and South Korea to see corrections of approximately 20%. In the US, the S&P 500 faced a 10% decline, while the tech-heavy Nasdaq dropped by 16%. In contrast, the Nifty50 index in India corrected by only 5%, showcasing its relative strength amidst the global downturn.
The downturn in Japan was primarily driven by a reversal in the “carry trade” strategy. This global financial tactic involves borrowing in yen and investing in higher-risk assets such as equities and bonds. The yen, known for its liquidity and stability due to Japan’s developed economy and low interest rates, saw a significant appreciation. Japan’s interbank interest rates rose from 0.07% in early 2024 to 0.45% by July, strengthening the yen and causing the USD/JPY exchange rate to drop from 162 to 142. This 12% appreciation in the yen created challenges for carry trades, increasing the cost of funding dollar-denominated loans.
Though data on carry trade positions is limited, it’s assumed that a substantial portion of these trades are linked to the Japanese stock market, which has recently suffered considerable losses. This impact extended to markets in Taiwan, South Korea, and the Nasdaq, reflecting a broader cross-border influence.
Additional factors exacerbating the market decline include disappointing economic data such as rising unemployment in the US and diminishing enthusiasm for Artificial Intelligence (AI). Concerns about a potential US economic slowdown in 2025 and a decline in AI excitement, coupled with historically high valuations, have made these markets more susceptible to short- to medium-term underperformance.
In contrast, India’s stock market remained relatively insulated from the global turmoil. The country’s economic decoupling and the stability of the Indian Rupee (INR) have provided protection. Domestic investor inflows, including contributions from mutual funds and retail investors, have countered the selling pressure from foreign institutional investors (FIIs), who have been net sellers in equities over the past month.
Looking ahead, India’s economy benefits from robust domestic demand and the China Plus policy, with a projected growth rate of 7% for 2025. This stands in contrast to other economies facing potential slowdowns due to high interest rates and inflation. Additionally, moderating crude oil prices and the influx of FII into domestic bonds are supporting the INR and foreign exchange positions, offering short-term advantages.
However, India is not entirely immune to global market fluctuations. The increasing correlation between the Indian economy and global markets means that while domestic investors’ contrarian buying is currently providing some buffer, global market trends will continue to influence domestic sentiment. The ongoing global relief rally, anticipating the end of the carry trade unwind, may impact India as the yen appreciates in the long term due to a hawkish Bank of Japan policy.
The weak Q1 earnings reports suggest a potential slowdown in earnings growth, challenging the sustainability of current high valuations. Domestic investors are becoming more cautious, shifting from growth stocks to value stocks. Over the past month, sectors such as Pharma, FMCG, and IT have performed well. Given the global uncertainty, geopolitical risks, and high valuations, there is an increased risk that India’s buy-on-dip strategy could be tested, potentially leading to a shift towards a sell-on-rally approach.
