With the recent news of US fed hikes, there are emerging markets where central banks have decided not to raise rates, like in India, Indonesia, China, etc. The common theme I read everywhere is this - "we expect capital to flow out of these EM countries and flow into the US". I read a lot of articles where they explain the recent equities sell off in India as FIIs rotating out of EM equities due to US rate hikes.
What I don't understand is this:
- The assertion that capital will flow from, say India to the US, seems true only for the subset of investments in the fixed income space. Although US rates might not be higher than Indian rates even after the hikes, but US treasuries might be comparatively safer investments.
- However, for risk assets like equities, US rate hikes are bearish for US equities since short term borrowing will become expensive for everyone alike, which will have a ripple effect on the buying power of customers and hence the demand, and also affect businesses' ability to grow due to expensive credit. Whereas the RBI (Indian Central Bank) has clearly voiced that they're going to support economic growth and not raise rates anytime soon, which is bullish for Indian equities. So in that sense, Indian equities might outperform US equities.
- Why would investors not prefer shifting capital from US equities to EM equities? Or at least not rotate out of existing EM equity investments? The only reason I can think of is the ripple effect of US equities on Indian equities. India is a net exporting country, and US might be one of the main customers for Indian listed firms, because of which weaker US economy might affect them as well. Also, if fixed income capital moves from India to the US, I can imagine how that can make the dollar go up relative to INR, which will impact the Indian equity returns in dollar terms for these investors. I'm not sure if these reasons are correct or substantial enough.
I had a slightly unrelated question as well, about inflation.
- Intuitively it makes sense that if inflation is above nominal interest rates, businesses/central banks can erode away their debt. If I take some examples,
(a) say I borrow at 3% for my business activity and inflation is 5%. Now unless my business activity revenue is able to use inflation to grow the debt by 5% this argument doesn't hold, right?
(b) similarly what mechanism would central bank use to utilize inflation to grow its borrowings at the inflation rate, so it has surplus on top after paying off its debt in the future, since inflation is above nominal rate?
(c) for an individual wage worker, this will work only if his nominal wages keep up with inflation, which might not always happen? So maybe for individuals, the argument is for the aggregate economy in which you can assume that statistically, cashflows are able to keep up with the inflation rate and hence able to outpace debt?