India remains vulnerable to FII outflows: UR Bhat

US markets tumbled on the weaker-than-expected factory activity with the Dow Jones losing over 300 points. Asian markets followed suit and ended the day with sharp cuts and Europe also traded in the red. Is this just a temporary correction or a trend reversal? In an interview to CNBC-TV18’s Menaka Doshi and Senthil Chengalvarayan, Arnab Das of Das Capital and UR Bhat, MD of Dalton Capital spoke about the global and Indian market and their outlook.   Below is a verbatim transcript of the interview on CNBC-TV18Menaka: I am a little confused to what to make of this. The US 10-year yield has gone from 3 percent in December to now below 2.6 percent—at 2.59 percent. If there was anything that would have caused the Fed to pause in its taper it was a strengthening or hardening of yields substantially. However, that does not seem to be happening. A lower yield may in fact just prompt the Fed to taper even further. What will that mean for emerging markets?Das: The yield by itself won't be the determinant factor. The determining factor will be the strength of the economy, growth, inflation and unemployment. I suppose the part of the reason that the markets are behaving in this way with a strong route in emerging markets kicking back into the developed world and then a stabilisation on evidence of the slowdown in the US recovery is kind of short squeeze may be generated by the hope that the Fed will pause or at least decelerate in its tapering.Menaka: The data that we have seen come in for January has been weak but the weather has been a big reason for why we have seen that weak data. Secondly, what I meant was that if there was anything that would probably prompt the Fed to pause, outside of weak fundamentals, it would have been a substantially higher yield. We haven’t seen that happen with the US 10-year. Thereby, one hindrance from any cut in the Fed taper has been taken away. So, if you combine both seasonal data and a lower 10-year yield this means the taper will continue, doesn’t it? And what does it mean for emerging markets?Das: The yield by itself is a double-edged sword because if the yield is falling it suggests that people are expecting weak growth and a disinflation and a deceleration in the pace of improvement in the labour market. So, it might not be a reason for the Fed to continue with taper. It might be a reason for the Fed to slowdown the pace of tapering. It could cut either way.You are absolutely right the lot of the noise in the data is about the weather. But there is nevertheless some chance that it is not just about the weather and that the momentum of the economy is not all that strong. So, a lot of these factors are coming into play. The market has to price in the risk that we have now had several string of data that part of which can be attributed to weather, part of which may be something not so great in the economy going on as well.Menaka: Are you saying then that you are now factoring in may be a pause in the taper process?Das: No. Where I was going with this is that the chances of a deceleration of taper have increased. Therefore, the knee-jerk reaction that says ‘sell all the risky assets and go short’— that reaction in the market place has to be itself somewhat tapered. In the end, I don’t think the Fed is really going to decelerate the pace of tapering. The Fed has turned a corner and where we are headed is: by the end of 2014, the process of easing will be completed; monetary policy will be on hold and in the next step, in 2015, people will be looking forward to is the first hike or not looking forward to as the case may be, the first hike in Fed funds. However, there is going to be some turbulence in expectations in the markets along the way as that process unfolds.

Senthil: How vulnerable is India today to global correction? We are certainly on the macro numbers front looking better than we were in September-October. We’ve got our current account deficit under control but the macro picture is possibly a little more worrying because, politically, we are looking more vulnerable. There are more populist schemes out there. The shape of the government to come after the elections is looking more and more uncertain. So, how vulnerable is India today?Bhat: India is extremely vulnerable to FII flows. Therefore, I think that is the most important single determinant for the direction of the market.If you really see in calendar 2013, FIIs pumped in very close to USD 20 billion and in dollar terms the Indian market is probably down about 5-6 percent. It means the Indian market has got accustomed to huge doses of FII inflows in order to even sustain itself at current levels. So, at current levels at least the domestic investors don’t seem to be terribly enthused about the economic prospects or the corporate profitability of India. Therefore, the whole sustenance of the market depends on FII flows and that is quite a question.Senthil: There are two ways of looking at FII flows. One is the macro FII flows, how FIIs are looking at emerging markets and two how are FIIs looking at India. So, is the quantum of FII flows to emerging markets is slowing down and is the attitude of FIIs to India also taking a bit of a dive?Bhat: The issue is: In 2013 emerging markets were darlings of international investors, but come 2014 I think it is taking a U-turn. What I am saying is it is not just some small USD 5-10 billion of FII flows that can really enthuse market. Something of the order of USD 15-20 billion is required as is evident by statistics of 2013 for the market to even sustain at current levels. Largely because domestic investors don’t think the market is at good levels for them to buy.In addition, even if you make the argument that emerging markets might still find favour with international investors, the domestic environment in India for economic corporate profitability-wise doesn’t seem to be the sort of market, which will enthuse either domestic or international investors. We have this big election agenda this year. So, therefore people would be probably bit reticent on their investments and they will wait for an outcome, which could probably be favourable for the economy and unless it is very favourable you can't really see a dramatic change happening even in the second half.