By Kunal Valia
India’s Foreign Exchanges Reserves have come down from USD 630bn in Sep 2021 to around USD 580bn in July 2022. This is on the back of selling in Indian equity markets by FII. FII Sell-off is not just restricted to India but widespread across emerging markets as well as quite a few developed markets. The Sell-Off has been triggered due to an aggressive rate hike by the US federal reserve on the back of roaring inflation not seen in decades.
We have a classical standard playbook on display, where higher interest rates in the US leading to flows moving to the US resulting in a strengthening US Dollar at the cost of Emerging economies. While Indian Equities and Bonds have been resilient relative to most markets, the domestic economy faces the twin challenge of high fiscal deficit and sharply rising current account deficit. While the Fiscal deficit is funded domestically largely, CAD is a function of Import-Exports and flows. We are more focused on CAD numbers till FY 23 as we are witnessing a surge and as per trends is likely to shoot above 3% of GDP. This is a worrisome macro for FIIs.
July 22 saw a sharp decline in FII selling and closed with mild positive flow and there is a turnaround in August to date with positive inflow of Rs 8600 crore till August 4. This shift is based on a few assumptions which are yet to fortify – We are past the peak inflation in US and Fed is likely to turn dovish post-2022 i.e., Fed Pivot
We are yet not confident that inflation is likely to drop to Fed’s Comfort level this year and whether recessionary trends are broad-based in US Economy as the Unemployment level is not rising and Wage Growth has been upward sloping. So, the current turnaround instance of FII with regards to India is yet to be confirmed. However, we believe a large part of FII selling in India is past us and we will monitor the Growth-inflation Dynamics for few quarters so to be certain. Indian Equities is back above long-term PE and PB following strong comeback in July and August till date.
Going ahead the journey of central banks from reflationary policy to disinflationary policy through high cost of capital coupled with high commodity prices may lead to higher earnings downgrades than what is estimated currently by Equities. While Short term priority is to bring down inflation at any cost, in long term we doubt that central banks will be willing to risk a prolonged stagflation/ recession.
In such a data-dependent scenario, equities may continue to stay range bound as has been the case for several months till the hope of Fed Pivot turns real.
(Kunal Valia is the Chief Investment Officer – Listed Investments, Waterfield Advisors. The views expressed are the author’s own. Please consult your financial advisor before investing.)