Given how the Fed has been preparing markets for its eventual phasing out of QE after the global collapse when talk first began earlier this year, the end was remarkably event-free when it happened. Most Asian markets ended positive—India closed at an all-time high—following the taper announcement; the Dow opened positive while Nasdaq and FTSE opened on a negative note. On balance, there are many positives which suggest the longer impact may be a lot more benign than initially feared. For one, let’s keep in mind the Fed has already expanded its balance sheet by around $4 trillion since late 2008, and as long as that liquidity keeps sloshing around, there is no immediate danger of interest rates rising in the US. Two, as Sanjeev Prasad at Kotak Institutional Equities points out, there is a divergence in the approach of developed market central banks. While the Bank of England and the US Fed are moving towards policy normalisation, both the Bank of Japan and the European Central Bank are looking at deepening their unconventional monetary policies. Kotak estimates a $1.7 trillion increase in the size of the G-4 central bank balance sheets by the end of 2016 as a result.
There is also the fact that, among emerging markets, countries like India are in a sweet spot, which is why FII equity flows are likely to continue even if, at least temporarily, FII debt flows start going back—
Kotak estimates a 12-15% pre-tax return on 10-year GSecs over 12-18 months after penciling in lower interest rates (but without taking into account the impact of a faster fall in inflation) and a 20-25% return on equity over the next 18 months. The rapid collapse in oil prices also augurs well for India’s twin deficits and so also lowers pressure on the rupee, one of the triggers for FIIs wanting to pull out.
If, on top of the natural advantage that the oil and commodity price collapse confers upon India, if the government is able to carry on significant reforms, the outlook for inflows gets much brighter. The outlook on FDI in both petroleum and telecom looks a bit poor right now with the government not being pro-active enough, but the speed of clearing defence contracts—R1 lakh crore of orders have been cleared since August—has already resulted in Airbus announcing a tie-up to set up manufacturing in India to service this demand. Apart from working on improving the
Doing Business rankings, if the winter session next month is able to deliver on some substantive reforms—land acquisition, GST and opening up of coal and insurance—India is unlikely to feel the pain of the US Fed’s decision. But the tide, as Brutus said, needs to be taken at the flood.