Market blow: India FII flows to dry as Fed eyes end to easy money

by Jun 20, 2013

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New York: The Federal Reserve will keep its monetary ‘printing press’ running a while longer, though Chairman Ben Bernanke said the central bank could start winding down its $85 billion-a-month bond-buying program later this year and end it altogether by mid-2014. That sent a chill through the US markets.

The emerging markets, including India, which have also been invigorated by the fuel of the Fed’s easy-money policies, will not take the news happily when markets open on Thursday.

US markets sold off on the news with the Dow Jones industrial average plunging 206 points, or 1.35 percent on Wednesday to close at 15,112 points.

The Fed’s plan for unwinding its bond-buying program is based on optimistic new economic forecasts for next year, including a projection that the jobless rate, which was 7.6 percent in May, will fall to 6.5 percent by end-2014.


Representational Image. Reuters

Although this is not a formal announcement, Bernanke for the first time offered a timeline for winding down the bond purchases. But tapering the program will be dependent on positive economic data, Bernanke stressed during a press conference following the Fed’s two-day policy meeting.

“Policy is in no way predetermined,” Bernanke said.

He said the wind-down could begin “later this year” if growth picks up as the Fed projects, unemployment comes down, and inflation moves closer to the central bank’s 2 percent target.

Using a car as an analogy, Bernanke said the Fed’s tightening policies will be akin to “letting up on the gas pedal as the car picks up speed.”

“The fundamentals look a little better to us,” Bernanke said. “In particular, the housing sector, which has been a drag on growth since the crisis, is now obviously a support to growth.”

Stock markets have soared for three years under Bernanke’s program and analysts are expecting a sell-off and market volatility when the Fed announces a firm date for scaling back the purchases. The Fed chief was given the “Helicopter Ben” moniker during the financial crisis when he suggested dropping money from a helicopter to fight deflation.

The US central bank has added over $3 trillion of monetary stimulus to the economy and over $1 trillion of bailout loans to financial firms since the 2008 financial crisis. This was done to prevent a widespread banking crash and help the wider economy. Part of the stock market rebound from the March 2009 lows is based on market fundamentals, but a big chunk is courtesy Helicopter Ben.

Liquidity party over for India

The Fed’s $85 billion-a-month bond-buying program, known as quantitative easing, was aimed at spurring the US economy, but for years now it has also had the effect of sending waves of inflows into high-yielding emerging markets like India. Market watchers say that an end to US monetary stimulus could lead to portfolio outflows, pushing the rupee lower and, in turn, delaying any rate cuts from the Reserve Bank of India.

“Stocks that have been overbought might see sale. Investors that are using leverage, mainly hedge funds, may also want to reduce their holdings because of the carrying cost of debt combined with the expected decline of stock prices,” Seth Freeman, CEO and chief investment officer at San Francisco-based EM Capital Management LLC, told Firstpost.

“Indian small and mid-cap stocks are going to be the most affected by the Fed’s decision to the extent of foreign investment in those stocks. It’s not going to be risk-off but risk-reduced. US investors looking at India are likely to become more selective. They will look more closely at India’s larger companies,” said Freeman, who advises foreign investors and funds on implementing investments in India. He has managed an US listed India-dedicated mutual fund that owned both large and mid-cap companies.

Foreign institutional investors have been sellers of Indian shares for six consecutive sessions, totalling Rs 3,431 crore as per exchange and regulatory data.

Freeman said the money locked into exchange-traded funds may not trade out and that might be a backstop. A slew of exchange traded funds focused on India flourished after the 2008 financial crisis as US fund managers looked East for higher yields and Americans looked for exposure to the Indian markets.

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