OutflowsandPerilsofhotmoney

As the numbers of the virus infected cases continue to rise, the markets across the world are racing to the nearest safe harbour. The safe harbour in this case is US dollar and the liquidity it provides. Everything is getting sold and converted for getting the dollar safety.

If we take a look around. Equity markets across the world are down and the currencies are running for cover. Dow Jones futures are down in trading today. 10 year US yields are trading at 0.81 and US dollar index is at 102.3 which is close to its life time high. Euro trades at 1.07 and Pound at 1.1650. Offshore Chinese Yuan is now trading at 7.11.

Indian markets are no exception as equity markets hit the down circuit and Indian rupee crosses the 76 level against the dollar. However the issue is not limited to the Indian shores and EM markets and currencies across are experiencing the pain. A familiar playbook is getting played out as foreign investors pull their money out of the emerging markets, it gets hit by the eventual double whammy of fall in asset prices and depreciating currencies. Normally in such cases the war chest acquired by the countries in the good times will come to the rescue. But the decision to use the war chest is neither straight nor simple as the relative appreciation against the exporting peers is a problem in its own right and what if, if the tide is too strong too control.

To give the argument a historical context, lets see what happened during the East Asian crisis of 1997 at a conceptually same but more localised level. The problem of investor confidence started in one country and quickly engulfed all the neighbouring countries. As the asset prices tanked across, the use of the word “hot money” came into existence first time.

In Michael Lewis’s 2009 book Panic, which is a compendium of reports which were written by the financial reporters during the periods of crisis like 1987(Black Monday), 1997-98(East Asian crisis), 2000 (dot com burst) and GFC (2008) etc, author recounts that the east Asian crisis was perhaps the first one where the concept of globalization of finance made its entry in the lexicon of financial reporters. He identifies the common theme, which was that the foreign investors who had invested their hard dollars into these markets quickly reversed their calls at first sight of crisis. The lessons which were learnt by the affected countries was build a war chest ready and don’t try to peg the currency to a particular level. In the current crisis which has been triggered by a black swan kind of event may be some new lessons will be learnt.

To buttress our point we have witnessed close to 97000 Crore of FPI outflows in the month of March in India. Expectation is that this outflow can further accentuate impacting bond, equity and currency in equal measure.