Passage of crucial bills like GST, land acquisition and improvement in ease of doing business would attract strong inflows towards India and support equity markets.
Emerging markets have been under pressure for most part of 2015. The oft quoted argument which appears to hold together a lot of market sentiment is that a “tightening interest rate environment” has hit emerging markets(EMs). The possibility of a rate hike from the Fed and risk aversion from investors has often been given the highest priority in 2015. However, historically emerging markets and especially Asia has seen strong up thrusts only in times when US rates were headed higher (meaning bond markets were discounting future growth led inflation). It is entirely likely that in 2015 the markets have suffered not because of ‘fear of the Fed’ but because growth has been anaemic. With more easing to hit the markets, it quite possible that world growth may see a revival and take equity markets higher.
We believe that the declining interest rates in 2015 are indicative of a slow and lethargic world economy with absence of animal spirits. With most central banks convinced that outright bond purchases aka quantitative easing leads to stronger growth a fresh onslaught of liquidity is not far into the future. The European Central Bank has already hinted at expanding its quantitative easing programme announced in Q1 CY15. People’s Bank of China has cut its benchmark lending rate 6 times in the last one year amid rising expectations of fiscal support to revive economic growth in China. Bank of Japan is also expected to add to its monetary stimulus of Yen 80 trn and increase it to Yen 100 trn.
Historically, the end of each year witnesses a fall in volatility as trading volumes dry up from international investors. However, with three major central banks indicating a change in their monetary policy in December, the markets may witness volatility. The US Federal Reserve has indicated that its December meeting is still live and its decision whether to raise rates or not is data dependent. At the same time ECB and Bank of Japan are expected to increase their quantitative easing programs as inflation continues to remain subdued.
These three event put together can cause markets to witness volatile moves in the month of December.
China has seen a considerable slowdown in the last one year and has seen its GDP growth decline below 7%. At the same time economic growth in Eurozone and Japan continues to remain tepid. The global GDP has seen a slowdown largely led by a slowdown in China, Eurozone, commodity producers like Brazil, Australia and Canada. There are few events which may define the course of economic growth in the world. One of the key event will be the policy response from China to shore up its economic growth. The Chinese Central banks PBoC has continued its loose monetary policy, but we believe a larger economic turnaround in China may happen once fiscal expansion drives economic growth. So any indications from China about structural reforms is in important data to watch out for as it will impact the whole commodity producer segment which remains a critical part of the world economy. The course of action for the US federal Reserve will be another important factor which will decide the fund flows across markets. We believe a rise in long term bond yields in US would indicate a return of growth and inflation. This would be a positive as the US economy will be able to growth without the need for a stimulus for the first time in nearly a decade. So any interest rate rise in US which is driven by strong growth will give important macroeconomic signals for the next one year. Domestically, the fiscal policy and the reforms process of the government is going to take precedence over other developments. Passage of crucial bills like GST, land acquisition and improvement in ease of doing business would attract strong inflows towards India and support equity markets.
Foreign investors have exited most of the emerging markets this year. According to the Institute of International Finance (IIF), the developing world will record net capital outflows this year for the first time since 1988. Slowing growth has pushed earnings-per-share 25 per cent off 2011 peaks, the longest recession ever for MSCI’s emerging index. Earnings recessions after 1998 and 2008 were more brutal but lasted only 18-24 months. Private companies have also racked up a mountain of debt, estimated by the IIF at $24 trillion. Of this $3.3 trillion is dollar borrowing, double 2008 levels.
India has seen strong purchases by domestic institutions and local retail investors through Mutual Funds SIP. The amount of new retail mutual fund folios rose by nearly 20 lakh to 4.24 crore in first half of 2015. A large number of investments are coming in through the SIP route in mutual funds which is much more sticky. Although foreign investors sold Rs 18000 cr in the September quarter, Mutual funds more than compensated by being net buyers of Rs 25300 cr. Therefore, India would continue to outperform its EM peers on back of relatively stronger economic growth and cushion from local flows.
The US Fed has not raised interest rate even once in the last 10 years. So an interest rate hike may be met with heightened volatility initially. However, if the US economy expands with the pace of job growth that it is currently witnessing the interest rate hike will be taken in stride. At the present pace of economic growth the US Fed may not have enough reason to adopt a extremely tight monetary policy. Therefore a “lift-off” by the Fed seems out of question and the markets will only be concerned with the pace of rate hikes in US and not with one or two isolated hikes.
Removal of MAT for FPI, Subsidy rationalization, Direct benefit transfers – savings of $30bn annually, Reduction of corporate tax rate to 25% in next 5 years as per initial target, focus on ease of doing business and Make In India are steps in the right direction. Passage of GST will be a major reform for the economy in the long term and the government should find solution to get this reform in place. The bull market which began in late 2013 to 2014 is undergoing a consolidation phase. The earlier triggers that the government will fast pace economic reforms and borrowing costs will fall rapidly as inflation cools have delivered in part. The delay in key reforms like GST and land acquisition has created some amount of skepticism in the minds of investors. However, we believe that the pace of reforms will continue and would remain positive for the markets. The turmoil in Emerging Markets have clearly segregated high quality markets like India and others like Brazil, Russia and commodity producers which are facing a lot of structural problems.
The author is chief economic strategist Edelweiss Financial Services.