FIs to turn discriminatory in 2021 while investing in emerging mkts: Nomura

While overall FII sentiment has been positive, thanks to the low interest rate regime, analysts say India has managed to bag more than its fair share of overseas flows du to record capital raising

Foreign investors are likely to turn discriminatory in 2021 as they pick and choose their investment options across emerging markets (EMs), says Rob Subbaraman, managing director, chief economist and head of global markets research (Asia ex-Japan), Nomura in an October 28 co-authored note.

"Looking into next year, one possible scenario is robust capital inflows return across EM, but we believe the more likely outcome is foreign investors turn more discriminatory in EM, demanding a higher risk premium on EMs that are deemed to face dangerously high debt levels and/or balance of payments vulnerability. More discriminatory capital flows can compound the disparities between strong and weak performing EM economies," Subbaraman said.

The note categorises 20 EMs into four quadrants Strong balance of payment (BOP), weak fiscal; strong BOP, strong fiscal; weak BOP, weak fiscal and weak BOP, strong fiscal.

Brazil, India, China, Poland, Philippines and Thailand are slotted in the first quadrant that has strong BOP, but a weak fiscal. These economies, according to Nomura, there are fairly strong incentives for central banks to intervene in both the forex market and government bond market. In this backdrop, they expect liquidity to be loose, local currencies to be stable to stronger against the US dollar, and government bond yields to be stable to higher.

Thus far in financial year 2020-21 (FY21), foreign institutional investors have put in Rs 96,123 crore ($12,865 million) in the Indian equities, data show. Domestic institutions (DIIs), on the other hand, have sold equity worth Rs 25,793 crore during this period. While overall FII sentiment has been positive, thanks to the low interest rate regime, analysts say India has managed to bag more than its fair share of overseas flows because of record capital raising by listed firms.

Challenges ahead

While EM central banks and governments have thus far navigated the pandemic relatively well, avoiding full-blown financial crises, Nomura believes countries with deep recessions and weak economic fundamentals, the next phase could be the most challenging, as they have less policy space.

In many large EM economies – including India, Indonesia, Mexico, South Africa and Turkey – the absence of strong portfolio debt inflows has left governments more reliant on their central banks to help fill the void of diminished foreign funding of their ballooning fiscal deficits, Nomura said. Even though the foreign investor selling subsided since April, bond purchase programs have continued across EMs to help absorb government’s increased financing needs, as fiscal deficits ballooned.

"Even more remarkable – and novel for EM – is the marked and broad-based increase in central bank domestic assets this year from buying government and private sector debt. From February to August 2020, central bank domestic assets increased in 19 of the 20 EMs (the exception being Russia), with an average increase of 2.8 per cent of GDP, more than double that of foreign assets," the Nomura report says.

Meanwhile, many EM countries, Nomura believes, may not want sharp currency appreciation and instead prefer to build forex reserves, given the unprecedented portfolio capital flight in March.

"Long INR/IDR should perform over the medium-term and look for over 5 per cent total return (limited negative carry) over the next six months. The return should be larger if global risk negativity and central bank domestic asset growth/independence fears pick up. We expect India rates to outperform (we are long 5Y IGB) on attractive real yields and the Reserve Bank of India's (RBI’s) focus on capping interest rates, despite the implications for liquidity," the report says.