Rally in CAD- challenged India to be short-lived: Nomura

US Federal Reserve’s move of continuing with the monetary stimulus triggered a huge rally across global markets. Majority of investors were expecting a modest reduction in monthly purchase of bonds, but zero taper decision has surpised emerging market investors, Michael Kurtz, Global Head Of Equity Strategy & Chief Strategist, Asia Ex-Japan, Nomura said.

But, for economies grappling with huge current account deficit (CAD) like India, this relief is temporary and this liquidity powered rally may be short-lived, he told CNBC-TV18 in an interview. The next key event for Indian market would be RBI governor Raghuram Rajan’s debut monetary policy, scheduled tomorrow.  Kurtz feels Fed decision’s gives the apex bank room to reverse some tightening and it may unwind some short-term liquidity measures. Below is the edited transcript of Michael Kurtz’s interview with CNBC-TV18 Q: Are you surprised by the way Fed said no tapering for now and what does this mean for emerging markets going forward? A: This was a bit of a surprise, but we had already been expecting that the probability of Fed move at this particular meeting was somewhat reduced compared to June-July when Bernanke first began to give a lot more signal that they were looking to move faster. The reasons for that have to do with some softening in the US data and a pick up in expectations that the budget negotiation process between the White House and Congress is likely to get messier. With both of those as kind of backdrop issues, it was perhaps not so much of a surprise that the Fed elected to defer the beginning of taper a little bit later. Having said that, this is still providing some surprise to emerging market investors. Particularly because of the fact that stronger dollar and pickup in treasury yields were putting a lot of pressure on markets like India, Indonesia and some of the other emerging Association of South East Asian Nations (ASEAN) markets that were now seeing a bit of a relief rally. Q: The debt ceiling debate seems to be the next trigger most of the investors are now referring to. Can you elaborate what would that consist of and whether or not there could be any sort of emerging market impact with that? A: In absence of any sort of an agreement on a new budget for the US then existing budgetary conditions persists. The problem is that it would then require Congress to approve an increase in the aggregate amount of US debt. So, related to the process of negotiating a new budget is the process of increasing the debt ceiling and if that were to not happen, then the US could technically face a default as indeed it did back in July and August of 2011. However, that was a particularly difficult time for the market. Our estimates are that the budget negotiation aspect of the volatility on the S&P 500, at that particular time was almost 10 percent. So we do believe that if we do not get a relatively smooth process this year and if we do not get a relatively transparent progress towards some sort of compromise between the White House and Congress, then we could be looking at volatility on the S&P 500 in excess of 5 percent. So, it does come down now to politics. Q: What about a market like India, which has now been given a bit of a breathing space up until December. Do you see a possibility of market going to all time high or do you think at some point the domestic concerns will come back and pause a bit of a headwind for the market? A: I am sorry to say, for India and for some of the other current account deficit challenged economies, for example, south East Asia, we still think that the relief that we are seeing in markets today may prove to be relatively short-term in nature. That is not to say that the relief isn’t real and indeed as we look towards the Reserve Bank of India (RBI) meeting this week, we are hopeful indeed that Governor Rajan will have some elbowroom now to at least unwind some of those very recent tightening measures that were put in place to provide some support for the rupee. That does give India a bit of a breathing room. The problem is that over medium to long-term, India still suffers some fairly substantial structural challenges of its own and it’s not just the current account deficit. There is also a deep fiscal overrun that need to be addressed over the medium to long-term. We have to keep in mind that while we are getting some relief on US treasury yields, therefore some return of portfolio capital into India and emerging ASEAN from foreign investors that the outlook for US treasury yields on a six month time horizon and beyond is still to the upside. Therefore some of this same risk that was visiting these markets over the past two-three months may very well come back again within the next three-six months.