The US Federal Reserve’s more-hawkish-than-expected statement that accompanied the expected 75-basis-point hike will keep Indian equity markets on tenterhooks in the short term. That said, fund managers are still bullish on allocations to India in the medium- to-long term category, Vivek Sharma, head of international clients group at Edelweiss Wealth Management, said in an interaction with Moneycontrol.
Global inflation and the response from central banks is a key factor that will determine the sentiment towards India, he added. Edited excerpts:What is in store for the market now after the US Fed move?
We think in the short term, this (Fed hawkishness) will keep markets volatile. Not so much as the quantum of the rate hike but the Fed’s outlook has given rise to uncertainty now. Clearly, it seems that although most people were thinking the Fed will control inflation through rate hikes, it is more uncertain now.
What is coming out is that inflation is going through the roof and perhaps the policy tightening is not helping bring it down. After the latest statement, it is reasonable to assume that fed funds rate would go to 4.50 percent. One of the impacts of a rate hike is on currencies. The dollar is at multi-year highs and rate hikes mean it will continue to surge. This also means pressure on the Indian currency.
The question is how long the RBI (Reserve Bank of India) will continue to defend the rupee. The market will get tested on how the currency responds and how the RBI responds.
But there is a silver lining as far as India is concerned. India is in a far better position than it has ever been. That is why equity markets here are strong. Of course, how long this outperformance will continue is to be seen.
What factors tell you India is in a strong position?
Domestic markets are the strongest ever in performance. When FPIs (foreign portfolio investors) were net sellers, the market was supported by domestic investors. What this tells you is that India is not overly dependent on FPIs like before. Otherwise, this kind of outflow would have significantly weakened the market. There is a good domestic participation in the markets which is good from the long-term perspective.
The rethink over allocation to China will mean that Southeast Asia will be a beneficiary. India will also benefit. Further, Indian companies are stronger, balance sheets are stronger, leverage is low.
Do you see sentiments reversing after the Fed’s announcement?
In the short term we may see FPI outflows. But in our conversations with investors, everybody has a very structurally positive view from the medium- to long-term perspective which had not been the case before. It also depends on the kind of money or allocation. The Fed action could have a short-term impact on equity flows in India. However, long-term allocations such as private equity (PE), private debt or pension money will see reallocation to India over time. Inflows from the FDI (foreign direct investment) route will also remain bullish.
Europe is going through a crisis and will be under stress due to energy issues. Allocations to China are now being questioned. This is not a change that will start to reflect in the next month or so. Some of these would flow in, say, six or nine months. Fund managers also take fresh positions at the beginning of the calendar year.
There is a view that Indian markets are expensive even now. Do you agree?
India is expensive but it has always been expensive. It has never been a cheap market within emerging markets. But when you allocate to India, you get a growth premium. ROEs (returns on equity) in India are far higher. People get higher alpha. Some of this is relative. When everyone is suffering and you are doing well, there is reallocation. But there are more India-specific reasons too.
Do you see any headwinds that could affect the medium-to-long-term positive view?
Global inflation is a key factor that can swing sentiment. The pace of Fed hikes has been fast and we have not seen this kind of speed. This tends to make people pause and relook at allocations. We are coming from a very low interest rate regime to suddenly an environment where the US rate could be 4.5 percent. This will keep markets on tenterhooks as this uncertainty will weigh.
The second is currency. Definitely today, if I was an investor I would look at dollar-adjusted returns. If you allocate to emerging markets today, the expectation of returns has to be better. The cost of hedges has to be factored in. Dollar-adjusted return has to be higher.
Does India have an edge on a dollar-adjusted return basis?
India has an edge depending on how you look at it. On the equity side we are the best-performing market. You are getting 13-14 percent alpha. But this will get tested. In the PE space, clients today expect upwards of 20 percent to compensate for EM exposure.
Where do you see value, sector-wise?IT and commodities will remain under stress due to currency factors. Financials and consumption-driven themes will remain strong. These are dependent on domestic factors. So sectors that depend on global markets will be under pressure and those that depend on domestic demand will gain.