Global investors currently have sufficient liquidity at very cheap rates at their disposal. However, it is no longer the return on investment that entices them. They are equally keen on the safety of the returns. The sovereign debt crisis in the developed world has made safety of returns an important criterion. Probably this would explain why emerging market debt has come to be the new object of desire.
Debt market in India is no match when it comes to depth as compared to equity. But a recent statement from the CEO of IDFC made it clear that for FIIs it is the place to be. "FIIs have been keener to buy Indian debt than Indians themselves" said Mr Rajiv Lal at a recent conference. His statement referred to high subscription by FIIs to several infrastructure bonds issued by IFCs like IDFC. For investors fleeing ultra-low interest rates in mature economies, fixed-income assets issued by emerging-market borrowers are irresistible. They not only offer higher coupons but are also more predictable than equities.
Emerging market equities have traditionally outperformed debt by a wide margin. As per the Wall Street Journal, in 2009, at a sterling 79%, the returns for emerging equities more than doubled the returns from emerging market sovereign bonds. However, in 2010 so far, equities have borne the brunt of market volatility. And at such time, it is debt issues in market like India that has gained investor favour. Again, data from WSJ suggests that FII investment in emerging market debt was on an average 4 times that in equity in the past 6 months. Against that the number was just 2 times in the second half of FY10.
However, the trend in the months ahead may not be the same. Debt issuances in emerging markets too may be seen with some contempt. Issues varying from corruption charges in India to tensions in the Korean peninsula to currency volatility may be to blame. At the same time with interest rates in developed markets remaining close to zero, investor money will seek favourable destinations. And we will not be surprised in emerging market equities once again regain their lost position.
For domestic investors, excessive FII interest in debt or equity warrants caution. The hot money may not be here for long. However, in the meanwhile it may certainly distort the demand and risk return scenario for emerging market instruments.