The following is a LiveMint op-ed written by Viral Acharya:
The rupee continues to weaken against currencies such as the dollar. Some might refer to it as a free fall. While regulators and the government are designing moves intended to defend the currency, the common man rues the lack of robust economic direction for India. Some complain about inflation and the price of onions, others refer to the sub-standard infrastructure of roads and lack of adequate public goods in the country, and yet others worry about another subsidy programme that gives a generous handout to the poor rather than empowering them to improve their own well-being.
None of these should come as a surprise to a keen observer of India. What should perhaps come as a surprise is that until recently, the investor view and pricing of India’s currency and markets hardly seemed to reflect the ground reality. The expansion of monetary base due to unconventional central bank policies in the Western economies, especially in the US, found its way readily into the Indian debt and equity markets. These flows, however, abruptly reversed themselves since the announcement in May of the potential tapering of the US Federal Reserve’s expansionary policies. The sentiment on India has since turned bearish, its asset and currency markets have suffered quick and massive depreciations, and its structural weaknesses for generating future growth have all of a sudden come to the fore.
Indeed, India has not been alone in facing the brunt of this reversal even if it is hurting the most. Many other countries and emerging markets are dealing with similar corrections. It begs the question as to why the negative sentiment was missing in the markets in the past few years. Where were the bears? While explanations abound, the one I find persuasive is that investors had gone bullish on emerging markets as they did not believe that any bearish bets will pay off in near future.
When an institutional investor such as a pension or hedge fund expresses a bearish view, it withdraws funds from a market or an asset class and it might even short it. These asset managers, however, face scrutiny of their financiers, who periodically assess their performance relative to benchmarks. An institutional investor expressing a bearish view thus needs to worry about whether the returns on the asset class they withdraw from would correct downwards sufficiently soon so that they look good relative to benchmarks, or whether the asset they short would depreciate in value quickly so that while covering the short position they make a gain and generate returns to their financiers. Such relative performance would generate future fund flows for these institutions.
Read the entire LiveMint article.