Is this the beginning of the end as far as the market rally is concerned? Indian markets in particular have reacted very sharply to tapering comments in the US. While Japan closed higher and other Asian markets were marginally lower, Indian markets fell by nearly 2% on news from the US.
Federal Reserve (Fed) officials said they were going back to a calendar date to end asset purchases or setting a total size to its bond buys (quantitative easing). This suggests that the Federal Reserve is looking at ways to exit or squeeze the easing much ahead of what the market was expecting.
So, has Indian market overreacted in comparison to its global peers? The numbers definitely say so. Even European markets are down by less than 0.5% while US markets fell by only 0.27%.
Indian markets are at the upper end of the leverage pole. Even a small movement in the ground is enough to create a volatile situation in India. With the current account deficit still at the wrong end of the comfort zone, any outflows can have a severe impact. This is contrary to what the Finance Minister and RBI Governor have been telling us.
An inflow of over $22 billion in the country since the time Raghuram Rajan announced his currency swaps have to some extent managed to stabilise the currency. It was on the basis of this war chest along with improving trade numbers that the governor was basing his argument of little impact on India on account of tapering.
Rating agency Fitch counters this argument by saying that the fall in current account deficit numbers is not big enough to shelter the country from an eventual tapering. The rating agency says that resolve to implement tighter fiscal and monetary policies will be tested as the country goes in for elections.
If the Federal Reserve does taper, it will come at a very bad time for India as headwinds are building up. The country is heading into election mode, one of the toughest seen in recent times which means moving in an uncertain zone. It's an area where investors, both domestic and foreign would not like to tread.
FIIs, who have an option of investing anywhere in the world would prefer calmer shores. China has recently announced a new set of reforms to boost their economy. Reports say that a large amount of money allotted to emerging markets has moved to China, which to some extent explains that Shanghai has barely reacted to the taper news and closed 0.03% lower.
Impact of tapering on the rupee is well documented and so is the fall in currency on Indian markets. Combined with an uncertain political environment and other economies which are looking more stable, India is in a tight spot. A falling rupee will accelerate the fall in equity markets.
Keep your eyes fixed on the currency market and your finger on the sell button for equities.