Emerging markets bore the brunt of the global monetary policy tightening cycle that led to steep fund outflows. Foreign investors turned their backs on EMs as elevated interest rates amid subdued global growth outlook made safe-haven assets such as the US dollar more lucrative.

A look at Bloomberg Emerging Markets Capital Flow Proxy Index mirrors this pain, with the reading remaining below the long-term average of 145 in calendar year 2023. But the tide may now turn in favour of emerging markets. The US Federal Reserve’s latest dovish stance signals three interest rate cuts in 2024. If that materialises, it would be manna from heaven for emerging markets.

In fact, as per the December Global Fund Manager survey by BoFA Securities, allocation to emerging market equities was up by 5 percentage points month-on-month to net 1% overweight, reversing the sharp 38 percentage point decline of the prior three months. While the current allocation is still below the long-term average, per the Bofa report, it nonetheless is a change of mood.

Inflationary pressures are expected to recede globally and would prompt central banks across the world to trim interest rates. The International Monetary Fund projects headline inflation decelerating from 9.2% in 2022 to 5.9% this year, and to 4.8% in 2024. Core inflation, which excludes food and energy prices, is also projected to decline, albeit more gradually, to 4.5% next year.

“EMs have far greater room to re-rate as the global policy easing cycle extends, and they are likely to benefit from a trough in global manufacturing and trade activity,” Oxford Economics analysts said in a recent report. They added that the markets would be surprised by the extent of rate cuts, with central banks in emerging markets leading the cycle.

Not without road bumps

While financial strains may ease as monetary policy gets supportive, risks remain. It is unlikely to be a smooth ride, especially given that global economic growth is expected to limp in 2024. Global economic growth is seen at 2.9% in 2024, well below the historical average, said IMF. This means that export-oriented emerging markets may be under pressure, and that could weigh on their earnings growth outlook.

According to UBS Securities India, EM consensus earnings have continued to see downgrades, largely driven by the weaker-than-expected recovery in China and the cyclical downturn. 

“While we expect a strong earnings recovery in 2024-25, our forecasts are still 3-5% lower than consensus. We think consensus has yet to account for weaker global growth, which could result in further downgrades,” UBS said in its report.

Steep valuations for India

In the case of India, foreign portfolio investors have been net buyers of Indian equities so far in 2023, to the tune of 1,65,845 crore. The pace of FPI inflows picked-up in December. According to NSDL data, FPIs bought Indian stocks worth 47,569 crore so far in December–the highest since July. 

To be sure, India is seen relatively better placed than its Asian peers on stable macros and resilience in a tough global macro environment, with benchmark indices Nifty50 and S&P BSE Sensex breaching key psychological levels. However, valuations are expensive. The MSCI India index is trading at a one-year forward price-to-earnings multiple of 21 times, show Bloomberg data. This is a steep premium to MSCI Asia Ex-Japan and MSCI EM Index.

While the outcome of the recently concluded state elections has been favourable, any negative surprise on the political front in the 2024 general election could be a sentiment dampener. 

Further, the recently released minutes of the Reserve Bank of India’s December policy meeting indicates that rate cuts may still be some time away. Note that India’s retail inflation in November stood at 5.5%, above RBI’s tolerance band. In that backdrop, movement in global crude oil prices will be a crucial monitorable given that India is a net oil importer.

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