Economy

Will the US Federal’s Rate Rise Have Shocks for India? Not Really

Fund managers admit reforms are moving slowly, but think that India continues to be a good investment opportunity.

Janet Yellen - Chair of the Board of Governors of the Federal Reserve. Credit: Reuters

Janet Yellen, Chair of the Board of Governors of the Federal Reserve. Credit: Reuters

New York: Anxiety-prone markets from Mumbai to New York are starting to contemplate the idea that US Fed rate hikes this year are more likely, but not inherently bad in and of themselves as they signal hopeful prospects for the broader US economy.

In fact, US bourses were a bit giddy on May 24 as the Dow Jones Industrial Average rallied 213.12 points, or 1.2%, to close at 17,706.05, its largest one-day percentage gain since March 11. The rally of May 24 comes on the heels of hawkish minutes from the Federal Reserve’s latest policy meeting and comments from several officials that rate increases may come for the second time in six months at the Federal’s next meeting in June.

San Francisco Federal Reserve President John Williams said on May 24 that the US central bank will likely tighten policy a bit more quickly in 2017 than this year, by perhaps one or two more rate hikes.

Surprisingly, strong data on US home sales in April support the view the economy may be strong enough for the Federal to raise interest rates as early as next month. Investors will watch Federal Chair Janet Yellen speak at a panel at Harvard University on May 27, the same day as they take in a revised estimate of US first-quarter growth.

Fragile five

The prospect of US monetary policy tightening was so frightening that between May and August 2013, the rupee lost more than a quarter of its value, as bond and equity markets tanked. During the ensuing rout, a Morgan Stanley economist came up with the “Fragile Five” catchphrase to describe Turkey, Brazil, India, South Africa and Indonesia as economies that have become too dependent on skittish foreign investment to finance their growth ambitions. The phrase also raises concerns about the Fragile Five being able to withstand external shocks.

Today, India’s economy has managed to dig itself out of a hole and few think it still deserves to be included in the “Fragile Five” club. It accelerated from 4.5% in the fiscal year 2012-13 to 7.4% in 2015. It has overtaken China as the fastest growing major economy in the world, cementing its position as one of the sole bright spots in a flailing global economy.

Finance Minister Arun Jaitley talked up India’s growth prospects in a meeting of institutional investors in New York in April organised by Citigroup. He said India could tackle external pressure and growth could blow past estimates and tick up to as much as 8.5% this year. Part of this GDP boost is being attributed to predictions of a good monsoon after below normal rainfall in 2014 and 2015 left parts of India battling a severe drought.

Falling oil prices have put oil-producing emerging markets like Brazil and Russia on the ropes, but US fund managers say consumer emerging nations like India will find their stock markets intact — and even end higher in 2016.

“Emerging markets fall into two different groups — producers and consumers. Key producers continue to struggle, such as Brazil and Russia. These markets are going to remain challenged in the year ahead,” said Morgan Creek Capital Management’s Mark Yusko.

But consumer nations such as India “enjoy the tail winds of lower inflation and higher growth courtesy of lower commodity prices.” “India equities are cheap,” added Yusko. “India will be the greatest story on the planet 10 years from now. Start buying now.”

India’s inflation has fallen from double-digits to less than 6% over the past two years, as the slump in commodity prices fueled disinflationary pressures and allowed the Reserve Bank of India (RBI) to cut rates by 125 basis points to 6.75% in 2015.

Buying in the dips

Global fund managers are confident India’s underlying economic fundamentals are stable even though the global slowdown has hit Indian exports and might require policy to be more accommodative. Foreign investors have bought $201 million of Indian stocks so far this month, taking this year’s inflows to $2 billion.

“Volatility and market swings are possible if the Federal acts, but I don’t see the prospect of as much turbulence. India is not going to blow up,” said Seth Freeman, CEO and chief investment officer at San Francisco-based EM Capital Management LLC.

“Unfortunately, reforms move very, very slowly and not in a straight line. Foreign investors have to accept this as part of the fun. If you like the business story and fundamentals of an India large cap company, buy the dips,” said Freeman, whose earlier US listed India-dedicated mutual fund owned both large and mid-cap Indian companies.

US fund managers continue to look East for higher yields. “We have 20% of our portfolio in India and it could go much higher. We pick countries first, and then we pick companies. We pick countries that are reforming because we don’t want to miss out when a full country re-rates,” says Teresa Barger, chief executive officer of Washington-based Cartica Capital which invests in equity markets of emerging countries.

Risks to growth

It’s fair to say there’s been a lot of skepticism about India’s GDP data since the government revised the way it calculated those numbers in January last year. Some economists say they don’t see this rapid pace of growth reflected on the ground and the latest growth figures are at odds with other data for the economy, including weak exports, railway freight, and cement production.

One of the biggest areas of worry has been exports: declining month after month for over a year, due to a slowdown in global demand. India’s exports fell 15.9% to $261.1 billion in 2015-16 while imports contracted by 15.3% to $379.6 billion. The trade deficit for the year was $118.5 billion.

Investors anticipating the Federal’s rate decision have flocked back to the dollar and the rupee has weakened. This week, it crossed 67 rupees to the dollar, a 2013 trading level. A strong dollar, however, is likely to boost exports from emerging markets like India while potentially limiting the growth of imported goods.

New Delhi is hoping to raise India’s share of world trade to 3.5% by 2020 from 2% presently. Meeting its target of $900 billion in yearly exports by 2020 would require India to sell twice as much to the rest of the world as it does today.