India will see a sell-off if Fed starts to taper, but not total disaster

New York: US companies added 215,000 jobs in November, the most in a year, in a positive sign for the US economic recovery, the ADP National Employment report said on Wednesday. The positive data increased expectations that the labor market could be strong enough for the Fed to pare its $85 billion-a-month bond-buying program in December or January.

All eyes are on this month’s Federal Open Market Committee meeting on 17-18December where the US central bank may consider reducing its bond-buying program.

Expectations that the Fed might start to taper its stimulus program have been a concern for the world since May. Earlier this year, terror over the unwinding of the Fed’s bond-buying program hit emerging markets hard, especially India and Indonesia, which have large account deficits. Indian stocks plummeted 13 percent from May to late August.

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[caption id=“attachment_1260665” align=“alignright” width=“380”]  All eyes are on this month’s Federal Open Market Committee meeting on 17-18 December where the US central bank may consider reducing its bond-buying program. Reuters[/caption]

India only got a reprieve when the Fed shocked investors in September by maintaining its cash injections of $85 billion a month in full.

India on firmer to tough it out

Will we again see a capital flight from emerging markets, or will it rank as a market correction, perhaps one that has largely played out already in anticipation of a taper, or will these capital outflows intensify into a crisis?

Stronger than expected data out of India this week suggests it may be better placed to weather a tapering of US monetary stimulus. The Indian economy grew more than economists predicted in the last quarter and manufacturing expanded in November for the first time in four months.

India also reported a dramatic reduction in its current account deficit to $5.2 billion for the July through to September period, or 1.2 percent of GDP, down from $21.8 billion - or 5 percent - in the same period last year.

“India and Indonesia handled the fallout quite well. Their central banks did a great job in the turmoil in the summer. These policies are bearing fruit,” Tim Condon, the head of research for Asia at ING Financial, told CNBC.

“Taper fears are still out there but they’re less acute than they were last summer because people are less worried about another 150-basis-point spike in the yield on US 10 year Treasury notes. So investors are more comfortable that countries with current account deficits will be able to finance them,” he said.

The Reserve Bank of India (RBI) has taken steps to curb non-essential imports like gold. India has also benefited from stabilization in its currency, which has helped encourage foreign investors to return to the market.

Overseas investors have purchased a net $17.45 billion of Indian equities this year, the most in Asia after Japan, data compiled by Bloomberg show. They bought a net $1.1 billion of stocks in November, the third monthly inflow, the data show.

Year-end stock selloff

“I think the tapering will have an impact on the Indian market. It has had a good run ever since the appointment of RBI governor Raghuram Rajan and it’s true that the current account deficit is reduced partly driven by oil prices, as well as a modest reduction in gold imports. However, one quarter of improvement doesn’t constitute a trend,” Seth Freeman, CEO and chief investment officer at San Francisco-based EM Capital Management LLC, told Firstpost.

“Long-term investors may increase their positions after the market corrects and provide some stability. That flow of funds will help support the rupee. A synchronous volatility, meaning the velocity of downturns seems much more severe compared to market gain. It also ties in with the fact that the year end is also almost here and some professional investors will want to harvest gain so there will be some natural stock selloff,” added Freeman, who advises foreign funds on implementing investments in India.

Freeman, who has managed a US listed India-dedicated mutual fund, says that recent sentiment has improved among foreign investors, but the Indian government should design policies specifically to encourage local investment in equities.

“This will leave the Indian market less dependent on FII inflows,” said Freeman. “In parallel the government has to induce a net increase in not only the allocation to India, but allocators.”

Overall, Barclays research says Indonesia is more vulnerable than India in an environment of Fed tapering. It believes Indonesia’s current account deficit is likely to remain stubbornly high this calendar year and next, at 3.8 percent of GDP and just over 3 percent respectively.

Meanwhile, Prakriti Sofat, regional economist at Barclays Capital, told CNBC she expects Indian central bankers to have made a much more aggressive correction to their current account deficit, bringing it down from 4.8 percent of GDP in the fiscal year ending in 2014, to 2.6 percent of GDP in the following fiscal year.

“India has made more sizable improvements in its current account deficit, helped by measures to contain gold imports and weak growth leading to import compression,” Sofat told CNBC.

India’s GDP grew 4.8 percent from a year ago, government data showed on November 29, faster than the 4.6 percent median estimate.