Mumbai: Global investors are staying invested in emerging market (EM) debt despite a possible increase in the interest rates by the US Federal Reserve (Fed) later this week. This is contrary to what was seen during the so-called taper tantrum of 2013 when investors sold large amounts from emerging market debt, which in turn put pressure on emerging market currencies. The fear was that similar outflows could be seen when the Fed starts to hike interest rates.
So far, these concerns have proved to be unfounded.
According to data from Bloomberg, most Asian markets have seen only limited foreign outflows from debt. The steepest outflows are from Japan, where foreigners have sold $2.8 billion so far this month, followed by Malaysia, where outflows this month are at just under $2 billion. Thailand has seen outflows of $610 million, while India has seen outflows of just $164 million, shows the Bloomberg data.
This is in sharp contrast to what was seen during the summer of 2013, when the prospect of the Fed ending its quantitative easing programme led to selling in debt markets across emerging economies. India was among the worst-hit during that time and saw outflows of nearly $9 billion in the three months between June and August 2013.
Eemerging market debt probably won’t see a repeat of the May-August 2013 sell-off when the Fed tightens, even though there could be volatility around the event, said a report by Morgan Stanley Investment Management issued on Monday.
The Fed is set to meet this week with the market split between whether a rate hike, the first in nine years, is on the table.
While $70 billion left emerging market fixed income during the 2013 correction, foreign funds in local government bonds are likely to be “stickier" this time around, said Morgan Stanley.
On a year-to-date basis, most markets in Asia still show net inflows from foreign investors in the debt market with Japan ($36.6 billion), South Korea ($24.2 billion) and Indonesia ($19.5 billion) leading the tally.
In the case of India, foreigners have invested a net of $6.14 billion in the debt markets so far. Most of the investments came in the early part of the year on expectation of a lowering of interest rates in India in response to cooling inflation. Lower policy rates lead to a drop in bond yields. Bond yields and bond prices move in opposite directions.
An expectation of a further drop in rates may give foreign investors enough incentive to stay invested in Indian government bonds.
A number of analysts and economists believe that the Reserve Bank of India (RBI) will cut rates when it meets next on 29 September and inflation remains below its target, while growth remains sluggish. Consumer price inflation eased to 3.66% in August from 3.69% in July.
RBI has so far cut rates by 75 basis points to 7.25% since the start of this year. A basis-point is one-hundredth of a percentage point.
Some also expect RBI to lift the ceiling for foreign investment in the debt markets. Given that inflows were strong at the start of the year and there has been no meaningful selling by foreign investors in recent months, investment limits for government securities have remained fully utilized.
“We too expect the RBI to raise the FPI (foreign portfolio investor) G-sec (government securities) limit by, say, US$5-6bn on September 29 if the September Fed hike is priced in by then or the Fed signals that it will hike from December," said Indranil Sengupta, India economist at DSP Merrill Lynch (India), in a 15 August report.
On 4 August, RBI governor Raghuram Rajan had said that the central bank was in talks with the government to raise the foreign investment limit in the debt markets, but added that this would happen at an appropriate time. RBI and the government are also in talks about denominating the limit in rupee rather than dollars, which will open up further room for foreign investments.
While indications of a disruption in the government securities market from a possible Fed rate hike are so far limited, there could be some negative consequences of higher rates in the US for companies that have been borrowing in the overseas markets.
“The gross external debt of Fitch-rated EMs rose by $2.9trn (trillion) between 2008 and 2014. Of this rise, $1.3trn came from the corporate sector," said rating agency Fitch Ratings in a 14 September report titled Fed Lift Off Matters For Emerging Markets.
Fitch noted that the recurring bouts of volatility in credit markets since the “taper tantrum" of 2013 suggest a strong connection between market expectations about the US monetary policy and investors’ risk appetite towards emerging markets.