Carry trade unwinding risk lowest since July

Declining trend in index measuring chance of reversal

Carry trade unwinding might not funnel liquidity to emerging markets, as the probability has fallen to its lowest level in nearly two months, according to the Barclays Capital Carry Unwind Risk index, a measure of the chances of reversal in such trades.

The index shows a declining trend, having fallen to its lowest level in seven weeks. The latest available reading for mid-September is at 27.21. This is the lowest since July 26, when it was at 26.66. It has fallen by almost half from a high of 50.3 on August 23.

A carry trade involves borrowing in a country where interest rates are lower and investing it in the assets of another country, which provides higher returns.

CARRYING TRADE ON DALAL STREET

What is a carry trade?

• A carry trade involves borrowing in a country with a low interest rate and investing in higher yielding assets elsewhere in the world

Carry trade and FII flows

• Carry trades resulted in money flowing to emerging markets such as India
• FII outflows tend to happen when such trades are reversed
• Barclays Capital Carry Unwind Risk index tracks the risk of such reversal
• The index indicates that the risk of such reversal has been on a declining trend in recent times

While the carry trade mostly involving borrowing in dollars helped fuel a large amount of capital flows to Indian equities last year, in the current year, it has had more impact in the Indian debt market, according to experts. They say the risk of carry trade unwinding remains low. G Chokkalingam, executive director and chief investment officer at Centrum Wealth Management, said the US central bank is likely to keep interest rates low to help buoy the economy, suggesting there is no immediate threat to the carry trade.

“The QE (quantitative easing) programme is not expected to taper off this year in light of the fact that the recent US shutdown is expected to have a negative impact of 50 basis points on the country’s GDP. In the short-to-medium term, the carry trade would continue,” he added.

Deven Choksey, managing director at KR Choksey Securities, said US President Barack Obama’s call to raise the debt ceiling is expected to succeed, which would keep the liquidity taps flowing. “Should Obama succeed in his agenda of increasing the debt ceiling, QE is expected to continue,” he said.

In addition to the US, the Japanese and the European central banks also maintain low interest rates. “Last year, the dollar was still the funding currency, which was reflected in the way the market reacted to fluctuations in the value of the dollar. The interest rate in the US is expected to remain low till 2015, which suggests that it would continue to be the funding currency of choice,” said the chief investment officer of an insurance company.

"Last year, the dollar was still the funding currency which was reflected in the way the market reacted to fluctuations in the value of the dollar.  The interest rate in the US is expected to remain low till 2015, which suggests that it would continue to be the funding currency of choice," said the person.

Foreign institutional investors were net sellers by Rs.23108.8 crore in equities, according to data from the Securities and Exchange Board of India in the current financial year. They were net buyers by a record Rs.1.4 lakh crore in the previous financial year.

They had been net seller by nearly Rs.50,000 crore, as of September month-end figures.