A combination of high yields, improving public finances and room for interest-rate cuts will lure back overseas investors trimming emerging-market debt in the face of global risks such as a potential U.S. rate increase, according to Franklin Templeton Investment Funds, Mirae Asset Global Investments Co. and GAM International Management Ltd. Foreign funds are selling Indian shares this month for the first time since February, while their bond holdings have fallen the most since June, as odds of a Federal Reserve hike rose.
“One of the most exciting things about India is Modi’s reforms,” Mark Mobius, the executive chairman of Templeton Emerging Markets Group, said at a Bloomberg event in Mumbai on Friday. “India is in a very sweet spot. It is our top emerging-market pick at the moment.”
Modi secured parliamentary approval for a national sales tax in August, a move seen bolstering government revenue and economic growth. He also ensured a smooth transition at the central bank’s helm, removing a key uncertainty for investors, and contributing to the rupee’s 1.4 percent gain last quarter. Indian sovereign bonds offer the highest 10-year yield among major Asian markets after Indonesia, making local debt attractive for global funds amid negative rates in several developed nations.
“In times of a low-yield environment globally, the yield-hunting behavior will continue to drive international investors to India,” said Kim Jinha, head of global fixed income at Mirae Asset in Seoul, which manages $83 billion. “Its currency has shown much resilience against some of the notable headwinds and has seen limited volatility compared to other emerging-market currencies.”
The currency’s 3.1 percent total return this half is second only to the Indonesian rupiah in Asia and only the yuan is viewed as more stable by options traders. At 5 percent, the rupee’s one-month implied volatility compares with 4.18 percent for the Chinese yuan and 5.63 percent for the Singapore dollar.
The rupee “retains its status in our minds of a low-beta ‘defensive’ long, likely to be eclipsed by other currencies in a generic emerging-market FX rally, but unlikely to sell-off as dramatically during a downturn in global risk appetite,” said Caroline Gorman, a London-based investment manager at GAM International. “I would expect minimal negative impact of a Federal Reserve hike this year.”
Odds that the Fed will raise rates this year have risen to 68 percent, from 59 percent at the end of the last month. Foreign investors have sold $56.4 million of Indian shares this month, while their holdings of local government and corporate bonds have fallen by about 66 billion rupees ($986 million). That’s after inflows into local stocks and notes last quarter were the biggest since March 2015.
Even so, the impact on Indian assets of events such as Fed raising borrowing costs will be cushioned by the growing pool of domestic capital, Mobius said. Local mutual funds have bought $2.8 billion of shares this year, after plowing a record $10.5 billion in 2015, data compiled by Bloomberg show.
“I don’t think it will happen,” he said, referring to the possibility of capital outflows if the U.S. raises rates. “The reason is domestic investors are becoming more important. Going forward, they will drive the market, not foreign investors.”
The 10-year yield has climbed nine basis points since plunging to a seven-year low of 6.67 percent on Oct. 5, the day after India’s monetary policy panel cut the benchmark interest rate to the lowest in more than five years. It still offers 503 basis points more than similar-maturity U.S. Treasuries.
“While there may be knee-jerk reactions to events which may lead to outflows over short term, fundamentally, India stands tall within the emerging-market basket,” said Singapore-based Anand Gupta, who manages about $1 billion in Indian assets at Eastspring Investments Ltd. “Sound macro underpinned by an attractive real-rate differential and low external debt will likely lend a cushion to India. Being the fastest-growing market, it may be difficult to ignore India for a sustained period.”
The recent rise in Brent crude prices has also impacted sentiment for some investors as India imports about three quarters of its oil. The S&P BSE Sensex, the nation’s benchmark stock gauge, has dropped 3.3 percent since surging to an 18-month high in early September.
“There is some nervousness with regards to U.S. rates, but this should be short-lived since India’s yield gap is still very high,” said Nikhil Bhatnagar, the New York-based senior vice president for Asian equities at Auerbach Grayson & Co. “Unless we see oil spike above $80 a barrel, interest in Indian bonds should remain active.”