Return of foreign capital likely going towards end of this year: Mitul Kotecha

Do you think the markets have moved on from this FOMC rate hike or what used to be the reaction is not the case now?
Markets reacted positively to the Fed. It was not necessarily the decision to hike rates that was well expected and well priced in. Markets were expecting a 75 basis point move. What was positive was the fact that in the press conference, Fed Chair Powell talked about moderating the pace of hikes going forward and then we did see a rally in the US equities, specifically tech stocks.

The dollar was undermined somewhat and we have seen today that most currencies are rallying against the dollar and interest rate markets have also rallied. We are seeing that follow through coming through from the Fed. Obviously the next focus would be on the Q2 GDP report but this has helped markets rally. The risk appetite is firmer and certainly markets have seen generally a positive reaction to the Fed outcome.

What is your take on what will happen next? Are you in the camp which is now expecting the rate up cycle to be tempered to 50 bp hikes? Could there be a potential cut in the middle of CY23 itself?
Mitul Kotecha: Yes I think so. We expect the next hike to be 50 basis points. We could see another 50 bps hike after that and we expect the hike towards the end of the year to be about 25 bps. That will give us a rate of about 3.75% for the Fed funds which would be seen as a terminal rate. So now the Fed is probably at a neutral rate, further hikes from here will mean tightening from a neutral position.

But as I said, 3.75% seems reasonable to us. Inflation should peak around this quarter and that will give the Fed a little bit more breathing space not to have to hike as aggressively going forward. Markets have already started to price in rate cuts in 2023. We would agree with that. We do think the Fed will start to cut maybe not as early as what the markets price in, but we do see rate cuts happening in 2023, probably sometime in the second quarter. That could be the timing for the beginning of rate cuts, if not a little bit later. Nonetheless, the Fed still has some way to go to hike rates in this cycle.

When we just talk about the markets and how markets have reacted, how would you look at emerging markets versus developed markets, considering that now a lot of rate hikes are also being priced in?
The emerging markets will benefit in the short term from the softer dollar tone, the rally in interest rate markets and, of course, the boost to equities. So, we see a little bit of relief for emerging markets but that said, the other concern for emerging markets is a slowdown in growth.

Today’s GDP is likely to be negative and we could see two quarters of negative growth in the US. European growth is slowing significantly as well. We will see a mild recession in the US and Europe. In our view, all of that means that growth in emerging markets could suffer as well, especially as China’s growth engine also is not picking up significantly. China stands to miss its growth target this year.

So while we will see some relief for emerging markets, we are still playing catch up with higher interest rates in a lot of emerging markets. Inflation is still moving higher in many countries and growth pressures are increasing. It may end up being temporary relief for emerging markets.

Where does India stack up in terms of preference when you talk to the FII investors? Is it still at the top of the list or the top three? How does it compare with the likes of China, Brazil etc?
India is obviously still up there in terms of being a favourite for investors. Clearly there had been some concern about the inflation outlook which had been worsening but it does appear that inflation in India is starting to peak. It is obviously focussed on what the RBI will be doing at its meeting next week and the expectations of a rate hike taking place.

But investors are still looking favourably towards India’s growth profile which still is going to be one of the strongest in emerging markets, especially at a time when Chinese growth is still quite weak relative to our country. So India may see some investor inflows but at this point in time, we are seeing capital outflows from most emerging markets including in Asia. So we really need to see capital coming back in to see more significant foreign interest and clearly that is not the case yet. So, perhaps with more rate hikes and inflation under control, some stabilisation in the developed market in assets could help India.

How would you look at the overall growth space? We have seen GDP cuts across the globe. India is not different, China is not different. Do you expect growth estimates to be quite high or do you expect more cuts to come in as the real impact of rate hikes would happen?
We will probably see more growth revisions downwards. The market attention is shifting from inflation concerns towards growth concerns. As I mentioned, recession risks are rising in several countries including in Europe and the US and it is hard for India and other Asian countries to escape from that. We probably will see some downward growth revisions but that said, we are coming out of Covid in a positive way.

It does seem as if we are not going to see renewed lockdowns in countries even as Covid numbers pickup. There is a pent up demand still there and we are seeing that in travel and tourism. Consumer balance sheets are pretty positive too, especially in the US. But we still expect to see decent growth momentum in India and we would expect not to see a significant cut in India’s growth forecast going forward. In fact, the growth outlook still seems pretty positive in India this year.

I am wondering where the flows are actually moving into because of course a lot of the asset classes have been coming under pressure from the start of the year itself, we are seeing a bit of a reversal in equities but not to the tune the kind of cuts that we have seen and for India itself we have seen quite a few outflows, is it just heading towards the dollar index and into the dollar which is actually on an acceleration path?
The strength of the dollar has had significant headwinds in terms of capital flows. The bottom line is when you have got higher rates in the US a very strong dollar that really does not bode well for inflows at a time when growth is slowing, inflation is rising, risk aversion has picked up but inflows and outflows from India and from a number of emerging markets have been significant in recent months from both equity and bond markets.

We may start to see some stabilisation in this as markets start to pay back expectations of timing and start to price in rate cuts as we start to see the dollar lose some of its upward momentum. It does bode well for eventual return of capital into India and into several emerging markets. So we may be off the worst. So much capital has flown out of emerging markets that we may start to see a bit of stabilisation in the next few months and even a return of capital as we move towards the end of this year.