The RBI’s 50 basis points cut in repo rate is a bold move for more than one reason. Not only has the Governor signalled that the drop in inflation is comforting enough to shift focus to growth, he has also implied that India now has less to fear from flight of capital to other emerging markets.
One of the reasons why the central bank was reluctant to move rates lower was due to the uncertainty arising from the impending rate hike in the US. It was widely expected that this move could make foreign portfolio money flow out of emerging markets. However, the larger-than-expected cut implies that India is now on a sounder footing.
So, how does India compare with other members of the BRICS following this rate cut?
Inflation the key The key factor that foreign investors watch is inflation as that would affect the real value of the investments they make in the country. The sharp decline in CPI in India to 3.6 per cent places the country at an advantageous position compared with Russia and Brazil that are grappling with runaway inflation rate of 15.8 and 9.5 per cent respectively. Inflation in China and South Africa has however been moderate between 2 to 5 per cent.
The problems arising from a rising inflationary scenario is amply demonstrated from the manner in which interest rates are moving in Brazil and Russia. Brazil has raised rates to 14.25 per cent while Russia too has double-digit rate of interest at 11 per cent.
The other factor that determines foreign fund flow into the country’s debt is the real yield on sovereign bond. Foreign investors prefer sovereign bonds due to the higher liquidity and lesser risk associated with these instruments. India is among the strongest placed, if the real yield on sovereign bonds is compared. After the repo rate cut on Tuesday, yield on 10-year government bond moved to 7.6 per cent. This has resulted in a real yield of 3.94 per cent. Among the BRICS, South Africa too has a similar real yield on its sovereign bonds. But Russia and Brazil have negative real yields, with inflation eroding the attractiveness of their sovereign debt. China too has a lower real yield compared to India at 1.2 per cent.
It is perhaps the attractive real yield that has made foreign portfolio investors stay put in Indian debt market in this bout of correction. They have pulled out only $270 million from debt since August 11, while the pull-out from equity has been $3.63 billion.
Strong growth rates Foreign investors in the equity market pay greater attention to the economic growth. Comparison on these numbers too stands India in good stead. Since other BRICS nations such as Brazil, South Africa, Russia and China are commodity exporters, their growth has taken a turn for the worst with the crash in the prices of crude oil and other commodities. India is a net commodity importer and has benefited from the fall in commodity prices.
While foreign investors have been pulling money out of Indian equity markets too due to the redemption pressure on emerging market funds (that hold Indian equity too), this selling is not expected to be long-drawn or too severe.