Posted by: Deepa Vasudevan on Wed, May 2nd, 2018
When Hot Money becomes Cool!
Emerging markets have always been wary of "hot money"- short-term global funds that rapidly flow into and out of markets in response to changing yields or risk profiles. Sudden outflows of hot money can destabilize an economy. In fact, a fragile economy heavily dependent on foreign capital inflows could be pushed to the brink of a balance of payments crisis - as India discovered in July 2013 after its taper tantrum experience. That is why regulators prefer the relatively more stable foreign direct investment (FDI) over "hot" foreign portfolio inflows (FPI).
Picture: FPI Flows into Bonds
But desperate times call for desperate measures. Between February and April 2018, FPIs sold nearly $3 billion worth of Indian bonds (See Picture). The 2013-rupee crisis also began with bond market sell-offs, which were set off by rising crude prices, fiscal slippages and a worsening trade deficit, and ended with a sharp fall in the rupee. This time we have all this and more: rising interest rates in the US, fears of a trade war, and the disappearance of banks from the bond markets. Not surprisingly, RBI decided that it could not afford to be fussy about the type of foreign money flowing into India. Last week, the minimum maturity norms for FPI investment in bonds were relaxed. FPIs can now invest in g-secs across maturities, including in treasury bills. They are allowed to invest in corporate bonds with residual maturity of one year or higher, down from three years earlier.
The announcement immediately pushed downbond yields as markets looked forward to having a higher demand for bonds. It appears that inviting hot money into bonds has been a success. But the question is, is this inflow sustainable? The answer depends on many diverse domestic and external variables such as the progress of US-China talks on settling trade disputes, GST collections and its impact on India’s fiscal position, resumption of oil supplies from Venezuela and its impact on crude price, inflationary trends in the US and the resultant outlook for rate hikes. One or more of these factors may evolve in a manner that could create a risk-off sentiment among foreign investors. RBI has tried to open the money tap wider, but it has no control over the various underlying reasons that could block future fund flows. For the time being, though, hot money is cool in the Indian bond markets!
For detailed knowledge check our course on Debt Indicators.