Rate hike may slow down fund flow from Japan

MUMBAI: The quarter-percentage point hike in interest rates by Bank of Japan on Friday could have some impact on foreign fund inflows into emerging equity markets like India in the near future, as the hike has reduced the incentive for leveraged funds to invest in shares of these markets, said investment advisors.

“We will not see robust fund inflow (from Japan), as seen in the past, from leveraged funds due to higher borrowing costs,” said VVLN Sastry, country head, Firstcall India Equity Advisors.

Taking advantage of the near-zero interest rate in Japan, hedge funds in the last couple of years borrowed in yen, converted them into dollars and invested in shares of emerging markets for higher returns. As this rate hike was more or less expected, these funds started booking profits in emerging market equities since May, resulting in their sharp fall. Since mid-May, share indices have fallen roughly 16%, but managed to erase part of the losses.

Market sources said Japanese funds over the last two months have reduced their exposure to Indian equities significantly, and have been among the active sellers. Going further, Mr Sastry said the inflow into Indian equities from leveraged funds would depend on to what extent the dollar weakens against the yen.

“If the dollar weakens further against the yen, then we may see some more fund inflows,” he said. A rise in the yen against the dollar is likely to offset the hike in interest rate in Japan. However, analysts believe Japan is unlikely to let the yen appreciate sharply on fears that its export-led growth could be derailed.

Lack of any new India-specific funds from Japan in recent times due to lower risk appetite for domestic equities has strengthened belief of a slowdown in investments into Indian equities, analysts said. A similar trend is being observed among domestic retail investors, who haven chosen to stay away from equities in recent times, especially after the recent meltdown.

“The risk appetite has reduced, which could result in investors revisiting their investment options. There could be some rebalancing within asset classes in India and some could shift to fixed income,” said A Balasubramanian, chief investment officer, Birla Sun Life Mutual Fund.

The dismantling of the zero interest rate regime in Japan further reinforces the tightening liquidity scenario across the globe. High interest rates also spell trouble for corporate earnings, and thereby stock valuations.

“Delays in capex on tighter capital availability could impact medium-term growth,” a CLSA strategy note stated. However, stronger interest rates are unlikely to have a major impact on earnings or growth plans of Indian companies, at least in the short-term, given the under-leveraged nature of their balance-sheets, analysts said. “Indian firms have enough space to accommodate debt in the short-term,” said Sandeep Dasgupta, CEO, Deutsche Asset Management.