‘Foreign investors gain confidence with steady domestic equity flow’

Markets have bounced back after the sharp fall in crude oil and commodity prices. Goods and freight movement are more smooth than four months ago. This gave comfort that worry on inflation will fade away. The US Fed rate hike which was going on at 70 basis points per meeting got reduced. Following this, the unwinding of position by institutional investors stopped. Dollar strengthened against major currencies and this bought inflows into equity markets. The concern over Russian war on Ukraine and US Fed rate hike has mellowed down a bit. The money flow which was in the negative territory turned positive. The corporate financial results in the first quarter of this fiscal was much better than the expectations of most analysts and this buoyed the markets.

Interest rate hike in India was more measured. The RBI has done a fine balance between growth and managing inflation. Despite the hike, deposits have not gone up because credit offtake has not grown. This has given hope that the RBI will continue to keep cost of capital affordable to support domestic growth. India is in a better position compared to China, Russia and other emerging economies. The higher GST collections are only reflecting the uptick in economy. Higher toll collection also indicates an increase in the movement of goods. Rural economy will also do well because of good monsoon. When market fell 10-15 per cent, there was an outflow of $30 billion. The market bounced back 15 per cent because of $3.5-billion inflow. This shows a marginal inflow can push up the market so much and reflected the resilience of our market.

Flows into equity mutual fund schemes will remain steady because of the change in saving culture in the last few years with equity investment taking a centre stage. Within this, mutual funds have become a major vehicle to channel saving into equity investments. Mutual funds and domestic institutions have created a strong force against foreign investors’ flows. It will become larger in the overall scheme of thinking. Foreign investors are also gaining confidence with the domestic flow coming into equity markets.

FPIs’ allocation to emerging market especially towards India will always remain. When interest rate increases, the cost of capital goes up and leveraged trade becomes less attractive depending on return. Though the capital available for investment in emerging markets will slow down, but will not dry down completely. Asset allocation in emerging markets depends on the economic performance of the particular country. The return differential between the US and India is the lowest. On the contrary, on a nominal GDP the US rates are higher than India because of high inflation. India interest rate looks high because of base effect. On nominal interest rate basis, the US rates higher than India due to high inflation. This has happened for the first time. High inflation in the US will impact inflows into equity there. Even after hiking rates so much, the US has its own challenges. The unemployment and consumption in the US has not come as expected. The Jackson Hole meeting of central bankers have expressed concern on inflation and hence they will remain hawkish. However, they may moderate the current aggressive rate hike plan.

The RBI is increasing rates in a calibrated manner. I believe they will increase it by another 50 basis points. They may do another 25 bps hike this year taking the total incremental increase to 75 bps. When the repo rate reaches 5.90 per cent to 6.25 per cent, the 10-year bond yield would be near 7.60 per cent. Then the cost of borrowing for corporates would become 8 per cent to 8.50 per cent, which can easily be absorbed by India Inc. If the rates go beyond this, the growth may slowdown a bit.

India is not alone. Most of the economies around the world has become high on fiscal deficit. The major advantage is India is progressing well on PSU disinvestment, and revenue receipts in terms of direct tax and GST collection are showing improvement. Government is also not spending that much on infrastructure. Despite a high borrowing programme, interest rates on government bonds have not gone up.

The lack of pick-up in credit off-take has also helped in government borrowing programme. It is a blessing in disguise for the government. After giving two years of moratorium, the government has taken some tough decisions to bring even rice above certain price under GST to improve collections. The current deficit has resurfaced now. The country has accepted that high inflation will be sticky for sometime and the same thing can also be considered for current account deficit. Whether we are going to get worried over current account deficit crossing 3.5 per cent despite having high reserves is a matter of debate.

China has a different problem and they are cutting rates to kick-start their economy when the rest of the world is fighting inflation. The problem was created by themselves in the last few years. It will take sometime for them to come back on growth path. Some of the moving parts that will impact India include how soon the conflict in Ukraine gets resolved which will bring down crude oil prices and the possibility of US signing a nuclear deal with Iran. If this happens, Iran oil will start flowing in to cool down prices.