Will a Fed Rate Hike be a Boon for Indian Markets?

Sep 15, 2015

In this issue:
»  Why you need to look at CEO pay...
» What will drive 8% GDP growth for India?
» ...and more!

Expectations of the US Fed raising rates have been doing the rounds for quite some time now. So far, the Fed has not obliged. Will it be any different this Thursday when the US central bank meets?

We don't know. But according to us, there are two ways of looking at the matter at hand. One is whether the Fed will raise rates in the first place. The other is that on the chance that it does, what will it mean for Indian investors?

But let us quickly address the first question. According to an article in MarketWatch, some Fed members are of the view that the labour market is strong enough, and that inflation is growing fast enough, to warrant a rate hike. Many other members believe that more data is necessary to prove conclusively that the US economy is improving. Of course, the turmoil in the global markets and China's devaluation of the yuan has further complicated the situation for the Fed.

One cannot deny that, since the 2008 global crisis, the Fed's loose monetary policies and near zero interest rates has propped up the US economy. Even if the Fed increases rates by just 0.25% (as is widely believed), many fear the adverse consequences this would have on global stock markets.

More importantly, what would be the impact on global debt? As money supply and credit has expanded across both the developed world and the emerging markets, including China, a rise in rates could further pile on the pressure. Indeed, according to a report by the Bank of International Settlements (BIS), much of the global financial system remains anchored to US borrowing rates.

So taking all this into account, there's a very strong possibility that the Federal Reserve will choose to do nothing, as it has in its previous policy meets.

But let's say that the Fed does raise rates for the first time since 2006. What would it mean for India?

Indian stock markets, as we know, are strongly influenced by foreign institutional investor (FII) flows. A rate cut in the US would see foreign funds flow out of India. Moreover, Indian inflation data has been relatively benign in the past few months, mounting the pressure on the RBI to cut rates. As the gap between US and Indian interest rates further narrows, more FIIs would pull money out of India and park it back home.

So as an Indian investor, you cannot rule out the possibility of another correction in the Indian stock markets. The meltdown in the Chinese markets caused stocks around the globe to correct sharply. The 24 August 2015 crash certainly didn't spare Indian markets. But even after that fall, many Indian stocks remain expensive in terms of valuations.

Another round of correction would actually be a good thing. A broad stock market meltdown would not necessarily impact the fundamentals of the businesses. Companies with strong businesses will continue to increase shareholder wealth, especially if the shares are bought at the right prices.

Do you think that the US Fed will raise interest rates? How will this impact Indian stock markets? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
While traders worry about the possible fallout of a Fed rate hike, we believe there are far more important things investors should be worried about. As long term bottom-up stock pickers we believe investors should focus more on company fundamentals than macro events. One such factor is the management integrity. A recent article in the Mint which caught our eye highlights the important issue of CEO pay.

As today's chart shows, the growth in the chief executive's pay has slowed down recently. Is this a good thing? Not really. During the bad years of poor profitability, these managers received huge salary hikes. Heightened investor awareness and new disclosure norms have made this a mainstream issue.

The names of the highest paid executives are now common knowledge. During FY10 to FY15, the chief of GMR Infrastructure, GM Rao received the biggest pay hike; an unbelievable 1,002%! During that time, the company's net profit fell by a whopping 94%.

Now it is important not to jump to hasty conclusions. Companies like TCS, Bajaj Auto and Lupin have also significantly increased the compensation paid to their respective CEOs. However, the financial performance of these firms over the last 5 years speak for themselves. We believe this is something investors should closely track in the annual reports.

Are CEOs being paid for performance?

Do you think India's economy can sustainably grow at 8% annually? Goldman Sachs thinks so. The investment bank in a recent report, widely reported in the media, believes that under the new GDP series, India can grow at an average of 8% from FY16 to FY20! How will this happen? Their answer: rising productivity.

Increasing use of technology by individuals and corporates, higher penetration of banking and other financial services, urbanization, improvements in education and e-governance have all been stated as important factors for this optimistic forecast.

Now first of all, we are not big fans of the new GDP series. It has been criticized by several leading economists, including the RBI governor. However, we do agree with the argument of rising productivity. We have seen this for ourselves in our travels around the country. The only problem with this model is the 13 million people entering the workforce every year. Productivity growth without the absorption of these people into the workforce could be disastrous in our view.

Indian stock markets began today's trading session on a weak note. In the subsequent hours, sustained selling activity has ensured that the key indices traded well below the dotted line. At the time of writing, the BSE-Sensex was trading down by around 126 points. Losses were led by mining and steel stocks.

 Today's investing mantra
"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst).

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