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US Fed cut likely to further boost FII flow

The rate cut by the US Federal Reserve by 0.25 per cent is likely to help further inflows of foreign funds into emerging markets, reports BS Srinivasalu Reddy.

business Updated: Dec 12, 2007 20:52 IST
BS Srinivasalu Reddy

The rate cut by the US Federal Reserve by 0.25 per cent (on Tuesday night in India) is likely to help further inflows of foreign funds into emerging markets (EM), particularly India. This is expected to provide arbitrage opportunities for US dollar-based global investors and funds.

This is the second time after September 18, 2007 that the US Fed has cut the benchmark rate taking the total cut so far to 1 per cent. Experts rule out major fund outflows due to sub-prime crisis in US.

The Indian markets discounted the positive outlook by taking BSE Sensex up by about 85 points to a new high of 20,375 points. However, some Asian markets tanked.

“This decision is a positive for India as it creates arbitrage opportunities for global funds. India and China, along with other Asian markets, are expected to benefit, particularly in the wake of sub-prime crisis in the US and slowing growth in Europe,” said Dilip Thakkar, CMD of Angel Broking.

Andrew Holland, Managing Director and Head of Strategic Risk Group DSP Merrill Lynch, echoed the same sentiments, and also disapproved the arguments in some quarters that some funds will flow out of India to bolster resources of their parent companies or funds affected by sub-prime crisis.

Responding to a query, Holland said, “I do not see any reason in that argument. Why money should go back from India or EMs, when there (the US) is a tentative risk. I am not convinced that the Fed measure will ease liquidity problems and boost the US economy immediately.”

“Fed is expected to cut rates further leading to more funds flowing into EM and India will get its fair share of that,” Holland added.

Asia contributes 17 per cent to the global economy. However, the international funds have allocated only 9-11 per cent over the last couple of years only, rating them as underperformers. “But to beat the average global returns, these funds have to invariably rely on emerging Asian markets now,” Thakkar said.

The other important factor that will impact the country is the impact on rupee.

Though rupee is expected to continue its strengthening bias, it is not likely to witness rapid gains. However, the domestic currency lost one paise in Wednesday’s trade anticipating some fund outflows taking cue from falling Asian markets.

“If it had been a surprise cut by the US Fed then there would have been a knee-jerk reaction in rupee upward movement. The rupee rise is expected to be gradual now,” said Sudhir Joshi, Treasury Head, HDFC Bank.

A foreign exchange treasury head of a foreign bank, who wished not to be quoted, said that they expect the rupee to be around 38.20 to dollar by mid-2008.