India most vulnerable to capital outflows: Moody’s

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India is among the countries that are most vulnerable to capital outflows as it relies heavily on external funding, global credit rating agency Moody’s cautioned Monday.

“India and Indonesia are the most vulnerable to capital outflows because of high reliance on external funding,” Moody’s Analytics said in its report — “How US Monetary Tightening Affects Asian Markets.”

It said the impact of recent Fed announcements on bond yields have exposed structural flaws in Asian economies, particularly in India and Indonesia.

Moody’s said the US Fed’s talk earlier of a likely tapering of monetary stimulus depreciated the rupee by 15 per cent, making it the worst performing currency in Asia.

The US Federal Reserve last week surprised the markets by saying it will continue with its monthly $85 billion bond buying programme and wait for more evidence of growth recovery before thinking of unwinding the stimulus.

Expectations that the stimulus programme would be tapered had led to fears of capital outflows, causing the rupee to depreciate against the dollar and stocks to fall.

The rupee touched a low of 68.86 to the US dollar on August 28. It is currently trading around 62.83 to a dollar.

Reserve Bank governor Raghuram Rajan, while announcing the mid-quarter monetary policy review last week, said India needs to build a “bullet-proof national balance sheet” to deal with the fallout on the economy from US Fed’s tapering of stimulus that has been only been postponed not done away with.

The report meanwhile also noted that even the economies with current account surpluses have not been immune to the sell-off.

“Malaysian and Thai bond yields have also risen, albeit less than those in India and Indonesia, because these economies are growing at a decent clip, inflation is low, and they run current account surpluses, which mean they rely less on external funding to finance growth,” it said.

The report studies the performance of Asian markets during previous US tightening cycles in 1994, 1999 and 2004 and after the Fed’s earlier easing programmes in the wake of the 2008 global credit crisis and the resultant recession.

“Asia’s tight trade and financial links to the US make it susceptible to changes in US monetary conditions. Asian markets tend to react negatively during US monetary tightening cycles,” it said.

Asian equity indices declined 30 per cent peak-to-trough on average during the 1994 and 1999 US rate hike cycles.

Asian stocks shed around 15 per cent during the 2004 tightening campaign, and by a similar amount after the Fed’s first two rounds of quantitative easing after 2008.

“Recent stress in Asian equity markets indicates that the impact of the US policy remains significant,” the report said.

Domestic equities declined 27 per cent in 1994 and 24 per cent in 1999 during the rate hike cycle of the US.

After the end of first round of qualitative easing by the US, domestic equities declined three per cent while after the end of the second round quantitative easing, there was a significant fall of 18 per cent.

The recent talks of the Fed tapering the third round of quantitative easing has made domestic equities dip by six per cent, the report said.

The report said the Asian markets vary in their degree of sensitivity. For example, a one per cent fall in US stocks correlated with nearly a four per cent decline in Chinese stocks on average, during the six tightening periods since 1994.

Sensitivity appeared high for Thailand and Indonesia, and lowest for Hong Kong, Japan, Malaysia and Singapore, it added.

“The results reflect the greater susceptibility of emerging Asian markets to investors’ changing risk appetites than more mature markets with deeper capitalisation and better-functioning financial systems,” the report said.

The report, however, said the financial market effects from the coming US tightening cycle might not be as severe as in prior episodes.

“American policymakers are expected to tighten more gradually than in previous cycles, which should help Asian markets and central banks easily manage the shift to higher interest rates,” the report said.

Last week’s Fed’s decision to delay winding back asset purchases indicates that the US central bank is cognisant of unsettling financial markets and economies, the report concluded.