India Story - Just A Pipe Dream?

Past couple of days have been bad for Indian markets, equities have crashed and the currency is making a new low on daily basis. 

A little bit of context - it all started with the talks of tapering in US, which resulted into US yields moving higher. More than that, it also meant less free money to float around the world buying the risk assets, and led to outflows on funds from emerging market funds (both equity and bonds). Countries which have been financing their deficits from capital flows were ill-prepared for this, and have nose-dived. India is one of them, with over USD 180 billion of trade deficit (part funded by IT exports, part by NRI remittances, and remaining from capital borrowing), it was always going to be hit hard once the flows stopped. 

So, the pullout made FIIs sell bonds (more than USD 12 billion worth, out of total investments of USD 40 billion), and equities (little less at USD 2 billion, out of more than USD 100 billion). As a result, there was no way to match our deficits, and INR got killed, dropping a whopping 13-14% in little over 2 months. Post this crash, now anyone investing in India gets a slightly fairer deal with 10-year bonds at 9%+ yields, as against yields below 7.5% before this crash. For too long, we have been underpricing yields, and as a result overpricing equities, bonds, as well as real estate. As a result, investors were not compensated enough on their investments as yields were much below the inflation rate. Little wonder it made domestic savings move to gold and real estate. 

With recent RBI measures making funding more dearer, and now almost in line with inflation rate, makes financial assets a little more attractive. With most fixed deposits now yielding over 9%, may be its the right time to switch over to the INR bonds. FIIs outflows may continue for some more time, and can take INR to 65, but in the long term I believe the lesson has been learnt. We should see financial savings increase from here, and see some softening of real estate prices as well. For too long, we have had stimulus in the market, and it has created a huge bubble in everything, and making households save less and less. 

I will wait on the equities a little bit longer, as they may have another 5-10% fall coming soon. Expecting Nifty to test 5000 levels if it doesn't bounce back quickly from here. However, on the debt front, we may be closer to the bottom. 

China: Finally Coming Of Age

Last few months have been very exciting for anyone who follows the Asian markets. China has announced a serious of reforms, and have been slowly expanding quotas for foreigners in its domestic A-share market. At the same time, its also moving ahead with internationalization of RMB (with the current plan of making it happen by 2017). I guess both the stock market and FX market reforms would go hand in hand, and one isn't possible without the another. 

There were apprehensions around the time of leadership transition, but now all those have gone away, and the new leadership is also dedicated towards financial reforms. We may be in for exciting times in coming months when more and more quota is released, and trading volume picks up. Already the futures trading volume in Shanghai has seen phenomenal growth over the past couple of years. Less than 3 years old as a product, they have already seen huge volumes being traded. 

The other giant, India has also embarked upon a series of reforms, opening up the country further for attracting FDI and FII inflows. India needs dollars, and hence it has no other option than opening up of economy further. However, the key difference here is INR on the ground very much reflects almost the true level of the currency - RBI hasn't been too aggressive or defensive with the currency movements, and has allowed the market to take it to its level. There have been interventions, but they mostly short term, and that too for preventing the volatility of the currency. 

I'm changing my stance of being underweight India for this year, and I think this may be another huge inflow year for all the emerging markets. We may see continued ETF flows in Asia, and have another 20% plus year for many indices.