Yen carry trade: India sees redemptions worth $66 mn, mostly from midcaps

For the first time since beginning of the Yen carry trade in India, there has been small redemptions from Yen denominated funds over the past 2 weeks

The recent panic surrounding the Yen carry trade has led to outflow of funds from India.  This investment strategy involves borrowing money at low interest rates in Japan (yen) and investing it in higher-yielding assets elsewhere. Last week India witnessed the largest weekly redemption since June 2022, amounting to $437 million, with $320 million coming from Global Emerging Market (GEM) funds, according to a report by Elara Capital. 

The Bank of Japan (BOJ) made a significant policy shift on August 5, 2024, by adjusting its stance on interest rates. This move was aimed at addressing the growing concerns about the yen's weakness and the potential risks associated with the yen carry trade.

• BOJ Intervention: The central bank's decision to modify its interest rate policy led to a temporary strengthening of the Japanese yen.
• INR/JPY Low: Consequently, the INR/JPY currency pair reached a low of 1.69. This level represents a key support level for the yen and a potential inflection point for the yen carry trade.
• Accelerated Unwind Risk: If the INR/JPY rate breaks below 1.69, it could signal a more rapid unwinding of the yen carry trade.

While the situation caused a temporary setback, the tide seems to be turning this week with a net inflow of $170 million. However, a new trend has emerged: a decline in Yen-denominated funds. This marks the first such outflow since the inception of the Yen carry trade in India. Although the amount is currently small at $66 million, it signifies a potential shift in investor sentiment.

All the redemptions so far are from Midcap funds. 

"In the previous Yen carry cycle of 2016-2018 in India, we saw the flows slowing down by Jan’18 and turning negative by Feb’18," said Sunil Jain of Elara Capital.

Interestingly, despite the Yen carry-related outflows, overall inflows into India remain positive, with other regions stepping in to fill the gap. South Korea, in particular, has emerged as a key contributor, with inflows reaching a 10-week high of $66 million.

"India dedicated funds saw inflows of $279 million (momentum has slowed down v/s avg weekly inflow of $750 million post-election results). The correction was used as an opportunity by S. Korea and UK investors to increase allocation to India," said Jain. 

Domestic investors have also capitalized on the recent market correction, leading to sustained inflows into global equity funds.

"Global equity funds saw inflows of $11.5 billion this week led by $5.4 billion inflows in US funds. Yen denominated flows in US has not seen any negative reading yet," Jain added.

Despite the panic surrounding the yen carry trade, investors have maintained their appetite for riskier assets such as junk bonds and emerging market equities. This is reflected in the steady flow of funds into these asset classes.

There has been a growing interest in gold as a safe-haven asset, with investment flows accelerating over the past three months