India Ratings and Research (Fitch Group) expects headwinds to foreign portfolio investment (FPI) flows into India to continue over the near-to-medium term despite the accommodative global monetary policy stance and the central government’s efforts to alleviate uncertainty regarding the higher surcharge. A gamut of factors, such as slower-than-expected demand growth in major economies, geopolitical and trade tensions and a gradual weakening of the economic growth prospects in India, have contributed to a build-up of risk aversion, which has impeded the demand for emerging market (EM) debt instruments.
China Continues to Crowd-Out Capital Flows to EMs:
The impact of the above-mentioned factors has been exacerbated by the weakening current account surpluses of major economies, including China and Germany, which has impaired their ability to export capital. In fact, countries such as China and Saudi Arabia have actually been borrowing large quantum of funds from the global markets. Fitch Ratings envisaged a shrinkage in China’s current account surplus to around 0.2% of the GDP from 2.93% in March 2015. Although the current account surplus is still above 0.2%, the shrinkage has been accompanied by a large quantum of debt flows into China, driven by continued Chinese policy action towards stimulating domestic consumption. The agency believes this phenomenon is likely to continue over the medium term, with China crowding out capital flows to EMs like India; consequently, FPI inflows would remain under pressure.
Limited relief from US Fed rate cut, ECB TLTROs:
Ind-Ra believes that the shift in global monetary policy conditions to a relatively accommodative stance is unlikely to revive capital flows into EMs like India. Despite the US Fed’s decision to restrict the contraction of its balance sheet and the European Central Bank’s (ECB) decision to conduct a fresh round of targeted long term refinancing operations (TLTROs), Ind-Ra expects the cumulative liquidity infusion by the four major central banks (US Fed, ECB, Bank of England and Bank of Japan) in 2019 to be significantly low at around USD186 billion compared with the infusions of USD353 billion and USD1.45 trillion in 2018 and 2017, respectively.
Financial risks, funds cost likely to remain elevated:
While India might occasionally experience pockets of inflows, as discussed previously, global capital inflows are unlikely to pick up sustainably. Moreover, domestic institutional risk appetite remains subdued. Consequently, corporate bond spreads are likely to remain under pressure.
Notwithstanding a series of rate cuts by the Reserve Bank of India and the softening of government security yields to a five-year low, the corporate spread over the benchmark has only widened. As the banking system struggles to ensure transmission of the repo rate cuts amidst high deposit competition and low risk appetite, the demand for corporate debt instruments has remained lacklustre in FY20.
Furthermore, given the continued slowdown in economic activity, the agency expects combined market borrowings of nearly INR6.35 trillion by the central and state governments between September 2019 and March 2020. Therefore, in case demand for central government paper continues to be tepid through the second half of FY20, the benchmark G-Sec yield curve could come under pressure. This would lead to a further rise in financing costs for private sector borrowers.