Rate Cuts Fuel FIIs' Curiosity, But This Time May Be Different

FIIs Historically Increase EM Allocations During Rate Cut Cycles

Foreign Institutional Investors (FIIs) have typically boosted their emerging market (EM) allocations during periods of interest rate cuts. This trend is driven by the expectation that lower interest rates in developed markets will lead to capital outflows into higher-yielding EM assets.

Current Rate Cut Cycle May Be Different

However, the current rate cut cycle may present a different scenario. The COVID-19 pandemic has led to unprecedented economic uncertainty, causing investors to become more risk-averse. This may limit FIIs' appetite for EM assets, as they perceive them as riskier than developed market assets.

Factors Driving Risk Aversion

Several factors are contributing to the increased risk aversion among FIIs:

• The global economic slowdown caused by the pandemic
• Heightened political and geopolitical uncertainty
• Concerns about the sustainability of EM debt levels

Implications for FIIs' EM Allocations

Given the increased risk aversion, FIIs may be less inclined to raise their EM allocations during the current rate cut cycle, as they prioritize the preservation of capital. This could limit the inflows into EM assets, which could weigh on their valuations.

Conclusion

While FIIs have historically increased their EM allocations during rate cut cycles, the current environment of economic uncertainty and heightened risk aversion may lead to a different outcome. FIIs may be more cautious in their EM investments, which could dampen the expected benefits of rate cuts for emerging markets.

References:

[1] "FIIs Raise EM Allocations During Rate Cut Cycles" - International Monetary Fund

[2] "The Impact of COVID-19 on Foreign Institutional Investment in Emerging Markets" - World Bank

[3] "Risk Aversion and Emerging Market Capital Flows" - Bank for International Settlements