A sharp decline in India's currency and stock markets, while half a world away, may resonate in Canada as the weakness undercuts demand for commodities.
India's rupee continued its steep fall Wednesday, hitting a record low against the U.S. dollar. At the same time, India's main stock market index hit its lowest point in almost a year. On Thursday, the currency fell past 65 to the dollar to hit a fresh low.
Most analysts blame the declines on signals from the United States' Federal Reserve Board that it will soon begin trimming stimulus spending. Cutting back on that stimulus will shift funds back into the U.S. from emerging markets – including India – which had gained over the past years from strong inward capital flows, as the availability of cheap credit prompted investment in emerging markets.
"Countries that are net importers of capital are the ones seeing the most serious weakness in their currency" as a result of the Fed hints, said Doug Porter, chief economist at BMO Nesbitt Burns.
He noted that "the markets are running well ahead of any actual action" even though the Fed has not even set out a firm timetable for winding down its stimulus program, which is also known as "quantitative easing."
Other weaknesses in the Indian economy have compounded its problems, Mr. Porter said. India has a significant current account deficit – amounting to 4.8 per cent of GDP – and a large budget deficit, along with high inflation.
Indeed, the problems in India are so acute that a former deputy governor of the Indian central bank, Subir Gokarn, told the French newspaper Le Monde this week that getting a loan from the International Monetary Fund is "an option" for the country.
The Indian government has tried to stem the outflow of capital by placing limits on investments that companies and individuals can make outside of the country.
For Canadians, this may all seem very removed, but "Canada is very sensitive to what is happening in India," says Benjamin Tal, deputy chief economist at CIBC World Markets.
The weak rupee means it is more expensive for India, the world's second most-populous country, to import commodities which tend to be priced in U.S. dollars. And because Canada is so dependent on commodity exports, that weakened ability of India to buy our goods could dampen our economy. "Anything that is negative related to emerging markets, will have a negative impact on Canada," Mr. Tal said.
In addition, he said, many Canadians have a direct exposure to emerging markets through their holdings in mutual funds. Those funds will undoubtedly take a hit from problems in India and elsewhere in the developing world.
Even the Canada Pension Plan has significant exposure to these markets. As of March 31, it had 6.7 per cent of its assets in emerging market equities.
Overall, "Canada will be impacted by what is happening in India, more than the average country in the OECD," Mr. Tal said.
Patricia Mohr, commodity market specialist at Bank of Nova Scotia, said one of Canada's big exports to India is fertilizer, including potash. Higher domestic prices there, because of the declining currency, could cut into our sales. Canadian gold bullion also makes its way to India, she said, and that too could be affected.
India, where gold is seen as a means to store wealth, is the world's largest consumer of gold. The government has tried to temper that demand – which has pushed up its current account deficit – by raising import duties.
According to Statistics Canada, Canada exported about $2.4-billion worth of goods to India in 2012, and the vast majority of that consisted of commodities including minerals, metals, chemicals, paper and food products such as grain.
"Certainly it poses a challenge because their currency has fallen so much against the U.S. dollar," Ms. Mohr said.
Jayson Myers, president of Canadian Manufacturers & Exporters, said he is less concerned about the short-term impacts of the weak Indian market than the long-term picture. Canadian companies should focus on infrastructure and energy opportunities in India, he said. Those will remain attractive unless current problems "lead to more obstacles getting [in the way of entry] into the Indian market, or a more constrained business environment," he said.
Mr. Porter notes that the currency problems plaguing India are not confined to that country. "What we are seeing is a pronounced weakness almost across the board in emerging market currencies, stock markets and bond markets."
Brazil's currency has weakened significantly, the Turkish Lira hit an all-time low Wednesday, and Indonesia has been under pressure, for example.
If the currency slide in emerging markets takes on more steam, Mr. Porter said, "we could see some of these countries forced into defending their currency aggressively, either through interest rate hikes or other measures." That could lead to slower overall growth in these countries, and that, in turn, could put a damper on the global economy.