• Rising rates due to high inflation
• Slowdown in global and domestic growth
• Emerging Countries Run Down in the Forex Buffer

Indian market

India’s foreign exchange reserves have declined from US$ 630 billion in September 2021 to around US$ 580 billion in July 2022. This is on the back of continued selling by FIIs in the Indian equity markets. FII sell-offs are not limited to India but are spread across emerging markets as well as some developed markets. The sell-off has been triggered by aggressive rate hikes by the US Federal Reserve on the back of roaring inflation not seen in decades.

Higher interest rates in the US strengthen the US dollar at the expense of emerging economies. While Indian equities and bonds have been resilient”, relative to most markets, the domestic economy faces the twin challenges of a high fiscal deficit and a rapidly expanding current account deficit. While the fiscal deficit is largely funded domestically. Lets go, CAD is a function of import-export and inflows. We are focusing more on CAD numbers till FY23 as we are witnessing a surge and as per trends it is likely to go above 3% of GDP This is a worrying macro for FIIs.

FII sales witnessed a sharp decline on 22nd July and closed with mild positive inflows and have turned positive till 4th August with a positive inflow of 8600 crores so far in August. This change is based on some assumptions that have not yet strengthened – we are past peak inflation in the US and the Fed is likely to worsen after 2022, ie after the Fed pivots

We are not yet sure whether inflation is likely to fall to the Fed’s comfort level this year and whether recessionary trends are broad in the US economy as unemployment levels are not rising and wage growth is sloping upward. Therefore, the current change in the position of FIIs with respect to India is yet to be confirmed. However, we believe that we hold a substantial portion of FII sales in India and will be monitoring the growth-inflation dynamics for a few quarters to be sure. Indian equities are above long-term PE and PB after a strong return so far in July and August.

The journey from a deflationary policy of central banks to a deflationary policy through higher commodity prices coupled with higher cost of capital could lead to a higher earnings decline by equities than is currently projected. While the short term priority is to contain inflation at any cost, in the long term we suspect central banks will be willing to take the risk of inflation/recession in the long run.

In such a data-dependent scenario, equities could remain range bound as has been the case for several months until Fed pivot expectations become realistic.

Primary market sentiment remains cautious and may be followed if the positive inflows from FIIs continue in the secondary market over the next few months. Given the decline in share price performance of some IPOs, retail and domestic institutional investors will be more cautious about valuations of the upcoming IPOs.

Between April 2020 and December 2021, the IT sector had a strong performance and valuations skyrocketed. After 2021, the Fed changed its stance and moved to normalize monetary policy by talking about rising rates and balance sheet reductions, with US markets witnessing a sharp decline with the Nasdaq. This had a mirror effect in India’s IT sector and the sector was at the bottom of the YTD table.

Views are personal: Author –
Kunal Walia is the CIO – Listed Investments in Waterfield Financial & Investment Advisors Pvt Ltd

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