Europe’s string of setbacks could result in a knock-on effect on Indian equities

The French government was felled by a no-confidence vote on Wednesday, December 4. This setback was the latest in a string of misfortunes for Europe and may even prove to be the last straw on the camel’s back. In this article, we examine if Europe’s struggles could have an adverse impact on Indian markets.

Europe’s string of setbacks

The global pandemic followed by geopolitical tensions shook all economies around the world. But it can be argued that Europe was among the worst affected. The post-pandemic easy money era, followed by supply chain shocks from geopolitical tensions sent crude prices skyrocketing. Europe’s energy-dependency led to the European economy bearing the brunt of the upheavals.

Germany was among the worst affected countries in Europe right from the beginning. But it was only a matter of time before the crisis dragged down other economies as well. Of course, things did start looking up as inflation started retreating after monetary tightening. The Olympics in France and a general pickup in tourism helped the economy as well. But in following the US, Europe may have tightened policy strings a bit too tight, and the economy soon fell into a recessionary zone. Consumer demand suffered and so did industrial activity.

The latest tranche of setbacks on Europe’s plate include Germany’s disappointing Q3 GDP print, signs of dampened consumer sentiment in the UK, and an across-the-board dip in industry sentiment in November (as measured by PMI). While the European manufacturing sector has been struggling for more than two years now, the services sector too entered the contractionary zone (PMI lower than 50) last month, thereby dragging the composite PMI down to 48.3. Trump’s election as the US president is expected to affect exports, which are already struggling with rising shipping costs amidst the Red Sea crisis. To make matters worse, the European Union’s consumer inflation spiked to 2.3% in November, while the struggling economy and the ballooning fiscal deficit have caused political and fiscal uncertainty. Germany’s 3-party coalition has failed and the country is headed for a re-election in February, while the French government succumbed to a no-confidence vote this week. Under these circumstances, the Eurozone’s growth projection of 1.3% for 2025 stands at risk.

ECB meets next week

Against this gloomy backdrop, the European Central Bank (ECB) is meeting next week, faced with the unenviable task of delivering rate cuts even as core inflation remains persistent. In fact, in the light of recent developments, the Euro has depreciated to a 2-year low in anticipation of a possible double-sized 50-bps cut next week.

Experts argue that given the European economy’s persistent struggles, the ECB needs to promptly bring down the policy rate from 3.25% to the neutral level of 2%. However, that may not suffice in pulling the economy out of the contraction zone, and fiscal support will likely be needed. But given the political uncertainty around the already massive fiscal deficit, there are no right answers and the path ahead is going to be difficult.

What does this mean for Indian stock markets?

Indian exports clocked a meagre 2.8% growth in Q2 FY25, and managed to drag overall economic growth down to 5.4%. Considering that Europe accounts for almost 20% of India’s exports, any weakness in is the European economy is going to stress India’s exports even further.

Sectors such as IT, Pharma, and Auto Components are likely to be the worst affected, considering that Europe is a major export destination for these sectors. Accounting for 30-40% of their export share, Europe’s struggles have already started showing up in the deal pipelines of these sectors.

Having said that, it is important to note that Europe’s slowdown is just one of the trends playing out currently. For instance, a recovery in banking and financial services abroad was one of the other important trends mentioned in the Q2 management commentary of IT players. As a result, on one hand, TCS’ topline suffered due to more than 30% of its revenues coming from Europe. But on the other hand, due to the BFSI recovery, Infosys and Wipro saw more than 60% of their incremental Q2 revenue coming in from Europe. This is to say that while a top-down approach would help select sectors least affected by Europe’s slowdown, bottom-up stock selection should not be overlooked while managing investments in current market circumstances.

(Ananya Roy is the founder of Credibull Capital, a SEBI-registered investment adviser.)

Views are personal and do not represent the stand of this publication.