For Indian markets, the real test will be when the dollars move out

Photo: iStock
Photo: iStock

Summary

Higher domestic institutional investments and growing retail interest have kept sentiments buoyant

While the MSCI India Equity Index has turned out to be the winner among emerging markets (EMs), 2022 could pose a challenge to its No. 1 status.

The index has outpaced many major EMs with a return of 20.7% so far in 2021. In fact, just a handful of major countries such as Mexico, Russia and Taiwan have delivered double-digit returns. By contrast, the MSCI Emerging Markets Index fell about 2% in 2021.

No doubt, the fall in EMs has been exacerbated due to large exits from China, which makes the India outperformance appear quite sharp. That said, the potential tapering of bond purchases by the US Federal Reserve is giving anxiety. Speaking at Jackson Hole, Fed chairman Jerome Powell indicated that the central bank could slow bond purchases this year. That would hit global liquidity, prompting foreign investors to exit EMs.

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Some of that switch is already visible. Since July, foreign portfolio investors have begun to offload Indian shares, selling 7,560 crore net. Of course, some of that selling has been absorbed by domestic institutional investors.

“Money will go from emerging markets to developed markets if there is a taper and US interest rates start going up. The arbitrage between dollar and emerging market currencies will reduce, and you could see more money going out," said Ajay Bagga, an independent market analyst.

The growing uncertainty around the Fed’s taper has also rubbed off on the listing of several recent domestic IPOs (initial public offerings). As the taper talk continues to accelerate, the risk appetite of foreign investors could further dip.

Already, the dollar index is showing a good rebound, which could pose further risks to EMs. True, the frontline Nifty Index has been hitting fresh highs recently due to the better performance of sectors such as IT, which stand to gain from a soft rupee. Defensives and metal firms have also contributed to the gains. But the broader market is weak as several mid- and small-cap stocks have reversed their gains.

What’s more, India is still one of the most expensive markets with a one-year forward valuation of 20 times earnings, compared to 10-13 times for other comparable countries.

The rise in domestic institutional investments, along with growing retail interest, has kept sentiments buoyant. But the real test for domestic resilience will be when the dollars move out

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