10/14/2014

The Economic Times

Title : COUNTERPoint - Why a Rise in US Yields may not Affect Quality of FII Flows into
India
Author : Sriram Ramakrishnan
Location :
Mumbai:
Article Date : 09/02/2014
Markets are a herd, a herd of elephants and they can have a long memory. Last June, taper-talk by the
US Federal Reserve devastated emerging markets, sending currencies into a tailspin and driving stock
indices to record lows. For many investors, a possible rise in US yields will bring back memories of
those days of mayhem in JuneAugust 2013 when currencies and stocks plumbed new lows every day
and investors pulled out $14.1 billion from emerging market equity funds.
Could the mayhem return, especially with the talk of rising US yields? Last Thursday , Morgan
Stanley issued a note saying that consumption in emerging economies has been funded by the US easy
money policies since 2008. According to a report in CNBC, the Morgan note also forecast rising bond
yields pushing up the cost of capital and hurting expansion in emerging economies.
The issue of what happens to US yields is relevant for India as the stock market indices have hit
alltime highs, largely due to continuing foreign fund flows.
On Monday , the Nifty touched an all-time high of 8,000 and the Sensex is just shy of 27,000.
Offshore funds have invested ` . 79,400 crore so far into stocks in India, much higher than what was
invested in the same period in 2012 and 2013. In the last three years offshore fund investment in
dollar terms is more than $50 billion and is only climbing. The worry for investors such as Morgan is
that higher US yields will force some leveraged investors to cut back on positions, affecting fund flow
into emerging economies. Stock markets in India are likely to turn volatile, bringing back memories
of 2013, since India is one of the biggest recipients of foreign money and the country's markets are
totally dependent on FII money .
How valid is this worry? To start with, there is little doubt that US interest rates are headed upwards.
The Fed's easing programme is nearing its end and if the US recovery continues, rates are going to
climb at least next year if not this year. For a speculator, trader, the low interest rate scenario was easy
.He could borrow in dollars and invest in Indian stocks, earning a much higher return than he would
have gotten elsewhere. There was no need to hedge if the rupee remained steady and so he was spared
of the hedging costs.
The US 10-year treasury yield is 2.6% and a rate higher than 3% is going to make this strategy
costlier. Not only would he have to pay more but he may also have to hedge, given currency weakness
or volatility expected in the wake of higher US rates.
There are two problems with this theory . One, easing may be winding down in the US but is still
going strong in Europe and Japan. The Bank of Japan and the Abe government are determined to lift
the Japanese economy out of a deflationary spiral and are throwing everything in the battle to grow
the economy . The eurozone is in a similar position. A speculator, shortterm trader can switch from
dollars to euros or yen and still do the same trade.
Secondly , the Indian economy is in a very different position this year compared with earlier
years.The current account problem has been fixed, at least for now.The slowdown has bottomed out
and there are definite signs of a pick-up this year. The rupee is far more stable. For a foreign investor,
these are powerful positive signals to consider even if borrowing cost is high.
In a report dated last year, Ambit Capital analysts Saurabh Mukherjea, Karan Khanna and Gaurav
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Mehta said that rising US yields have historically augured well for Indian economy as they
correspond to a stronger US economy which benefits countries like India. The cost of equity rises but
the risk premium reduces as the economy starts doing well, they argued. It has happened in the past
and it can happen again, especially considering that India is a stronger economy.

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