Poll verdict will decide fate of markets, rupee and FII inflow

The Indian markets are at a new high and the rupee is gaining ground, even as the US Federal reserve continues to reduce its bond buying programme.

Jyoti Vaswani (below left) chief investment officer & director, fund management, Aviva Life Insurance talks to Vishal Chhabria on why the markets are rising, domestic cyclicals are finding favour and some EMs including India could continue to do well even as developed market economic growth picks up. Excerpts:

Indian markets are up about seven per cent in a month, wherein information technology (IT), pharmaceuticals and fast moving consumer goods are out of favour and cyclicals have gained ground. What do you make of the rally?

The rally is mainly due to resumption of foreign institutional investor inflows.

The macros for India have also seen a major improvement in the recent past.

Inflation has been trending down, the currency has stabilised, the fiscal deficit is controlled and the current account deficit is well within two per cent of gross domestic product.

This, coupled with the expectation of a stable government coming to power, has led to this rally.

And, when the markets rise, defensives tend to underperform and cyclicals to outperform. This is evident in the current rally.

The rupee has also appreciated and, hence, there is a larger impact on the IT and p harma sectors. We expect the markets to remain volatile.

What impact will the Russia-Ukraine event have on India?

Such geopolitical events tend to impact everyone. If an amicable solution is not arrived at and the situation worsens, there will be an impact on both the developed countries and emerging markets.

Oil prices could rise, which will have a significant impact on India. All companies having exposure to this region will clearly be impacted.

Emerging market (EM) equities have been out of flavour recently. With the US and other developed economies looking up, the (US Fed’s) taper fear elevated, what is the outlook for EMs, including India?

Yes, there has been less focus on EMs of late. As a result of the Fed taper, we might continue to see outflows from EMs.

However, this might not be applicable to all. Some EMs have domestic issues, political and structural, which have resulted in net outflows. India and Indonesia have been resilient.

In fact, we have seen inflows resuming in equity in the past fortnight or so. Even on the debt side, we have seen good inflows in calendar year (CY) 2014.

So, individual countries will continue to attract FII inflows; India could be one. In India, the political outcome will be watched very closely, which will determine flows in the second half of CY2014.

The US is growing at two to three per cent (a year) and their interest rates are close to zero. But, if interest rates start moving up, won’t the risk-reward become unfavourable for EMs?

Not necessarily. If you look at history, rising US bond yields have augured well for Indian equity markets.

So, it is also to do with the fact that the developed world is doing well; there is an impact on the developing world. FII flows have been negative only twice since 1993, when FIIs were allowed to invest in India.

During this period, the Western world was growing and yet there was no major impact on FII inflows.

In the run-up to the elections, how do you see the markets behaving?

The markets will be volatile and a pre-election rally cannot be ruled out. However, the AAP (Aam Aadmi Party) and the third front could take away some seats, which might make it difficult for any party to get a clear majority.

As exit polls keep throwing up results and as the trends keep emerging, markets will react to that. The other factors, like FII flows, will add to volatility.

Should the worst come true and we don’t have a stable government, what is the downside you see for the markets, earnings and the rupee?

There is some amount of earnings recovery built into the second half. If you have an unstable government, there would be some earnings downgrades. The expected recovery is not based on the actions the government will take once it comes into power.

Any government that comes in June-July will initiate some action; by the time those show some result, the financial year will be over.

If we don’t get a stable government, the markets could correct by about 10 per cent. The rupee will also depend on flows, which in turn will depend on election results and global events.

Normally, it should range between 61 and 64 (to the dollar). However, significant outflows could cause increased volatility.