India has seen the sharpest outflows in 2022 till date led by equity outflows:
India has witnessed $14.5 billion of total outflows in 2022 till date, of which a whopping $14 billion was equity outflows. Other EMs that have witnessed portfolio outflows include South Africa and Poland, but in both countries it was led by debt outflows.
South Korea has witnessed equity outflows worth $6.8bn but this was more than offset by debt inflows.
So, what is driving foreign portfolio investors out of India?
“Equity market valuations in India remain stretched and above all developed markets and emerging markets. This may have led to significant outflows
from Indian equities when compared to other EMs. Indian yield spreads with the US are comparable with Indonesia, and above most EMs, except Brazil, Mexico and Russia, suggesting that the debt market may be relatively fairly valued. However, the debt market is unlikely to attract flows in the near term given the headwinds ranging from elevated crude oil prices amid heightened geopolitical uncertainty, tightening by the US Federal Reserve and relatively low real rates in India,” said the brokerage.
Past episodes of liquidity tightening have seen higher debt outflows:
Past episodes of liquidity tightening by global central banks in FY14 (2013) and FY19 (2018) had led to higher outflows from the debt market vs. the equity market in India. In contrast, the current tapering has seen higher equity outflows akin to the 2008 global financial crisis. In fact, equity outflows by FPIs in FY22 at $18.4 billion have far surpassed equity outflows witnessed in FY09 (2008 GFC) at $10.3billion.
Unlike past episodes of liquidly tightening equity outflows have dominated
“Equity outflows generally tend to bounce back quickly, also pulling up the rupee, particularly going by the experience of the 2008 global financial crisis” noted the report.
How will the end of global liquidity injection affect the Indian rupee?
Data from Nirmal Bang shows that i past episodes of monetary tightening by global central banks, the rupee was prone to significant depreciation pressure. In the taper tantrum of 2013 the rupee depreciated by 20% between March and August. In 2018 global financial crisis, the rupee depreciated by 14% between March and October.
One of the primary reasons for the rupee coming under pressure at times of global liquidity tightening is the rise in rupee sensitivity to portfolio outflows over the past decade. Since the announcement of taper by the US Federal Reserve in November 2021, USD-INR’s correlation with portfolio flows has largely been in line with the correlation seen since 2013, albeit marginally lower.
According to the brokerage, there are several factors keeping the rupee volatile, which range from the end of quantitative easing (QE) by major global central banks, geopolitical tensions and spike in crude oil prices, rise in non-oil, non-gold imports and the return of the current account deficit (CAD), an
elevated fiscal deficit and inflationary pressures. Despite these headwinds, it doesn’t expect the rupee to go into a tailspin unlike past episodes of
‘tapering’ ‘oil shocks’ or ‘elevated twin deficits’ because of the following factors:
1 Relatively low FPI exposure in the Indian debt market: FPI outflows from the Indian debt market have been limited as FPIs’ exposure in the debt market was already at multi-year low and has fallen only at the margin in recent months. Limited outflows from the debt market have somewhat cushioned the depreciation pressure on the rupee.
2. Availability of alternative sources of crude oil: Elevated crude oil prices are unlikely to sustain for long due to enhanced production, including from US shale producers. Despite sanctions on Russia, India may resort to purchase of discounted Russian crude oil, putting in place alternate payment mechanisms.
3 Strong services exports, bolstered by pandemic-driven digitisation and reduction in fuel subsidies: The pandemic-driven acceleration in digitisation has boosted software exports from India, pushing up the invisibles surplus’(services exports + remittances) as a share of the trade deficit.Petroleum subsidies have declined with elimination of diesel and petrol subsidies since FY14.
4 Inflation targeting regime in India and low inflation differentials with developed markets
5 High level of forex reserves and willingness on the part of the RBI to sell USD to mitigate fx volatility: India’s FX reserves currently stand at
$622 billion, more than double the level when compared to the 2008 global financial crisis and the taper tantrum in 2013
It maintains its FY23 USD-INR forecast at 77/USD, down from an average of 75 in FY22.