With India bulls everywhere, a rare look at what could go wrong

There are times in financial market rallies where the gains become so spectacular and the euphoria reaches such a pitch that it becomes easy to forget about the risks. India, it could be argued, is going through such a moment.

The benchmark stock index is at a record high, having gained 43 per cent in the past 12 months; the rupee is Asia's best performer this year; and the nation is poised to become the world's fastest-growing major economy in 2016.

But there are risks, of course. There always are. Here's a look at five of the biggest of them -- events ranging from a faster-than-anticipated surge in US interest rates to renewed religious tension in India. All of these are capable of halting, or at least slowing, the market rally.

Oil rebounds
Just as the 55 per cent plunge in Brent crude over the past seven months has given a boost to India, which imports 80 per cent of its oil, a swift reversal could undo those gains. The economy is only just recovering from a slump in growth over the past two years when its inflation was Asia's fastest and the budget deficit was among the widest in the developing world.

Oil prices have fallen by $66 since mid-June to $49 a barrel. Every $10 drop shrinks India's current-account and budget deficits by 0.5 per cent of gross domestic product, lowers inflation on manufactured goods by 0.1 percentage point and boosts growth by O.2 percentage point, according to JPMorgan Asset Management Co.

"If oil starts reversing due to geopolitical tensions, that's definitely not good for the markets," said Jonathan Cavenagh, a strategist at Westpac Banking Corp in Singapore. "A rebound to the high $50-level will have people questioning the flowthrough into India's trade balance."

US interest rates jump
The "primacy" of US-based investors in India means the country is vulnerable to unexpected shifts in American monetary policy, the central bank said last month.

A bigger than expected increase in the Federal Reserve's benchmark rate risks significantly narrowing the 591 basis point spread offered to purchasers of Indian 10-year sovereign bonds over similar-maturity US debt. It also damps the 3.4 per cent carry return to those who borrow in dollars and invest in rupees, the highest this year among Asian currencies.

"When the Fed starts tightening there will be outflows from emerging markets," said Dariusz Kowalczyk, a strategist at Credit Agricole CIB in Hong Kong. Investors would be persuaded to stay in India if the government continues cutting the budget deficit and takes steps to attract more investment, he said.

FX reserves prove insufficient
Since the rupee fell to a record low in 2013 when the Fed signaled it would cut bond purchases, policy makers have raced to boost foreign-exchange reserves. The holdings have risen 17 per cent since then to a record $322 billion and cover about nine months of imports, higher than the three months the International Monetary Fund considers to be the amount needed.