Fed Rates May Have a Minimal Impact on Indian Markets

Fri, 16 Jun Pre-Open

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The Federal Reserve raised its benchmark interest rate by a quarter-point on Wednesday, the third such increase in six months and a message of confidence in the strengthening of the US economy.

The Fed also outlined a clear path to reduce its US$4.5 trillion portfolio of treasury bonds and mortgage-backed securities, which it had purchased in the wake of the 2007-2009 financial crisis and recession.

Policymakers also issued forecasts showing another three quarter-point rate hike in 2018, similar to the previous projections in March.

So, how does Fed's interest rate hike influence India?

Such hikes generally have a negative impact on emerging economies like India. The usual scenario after a Fed rate hike has been that of sharp fall in equity indices, a weaker rupee and sustained foreign fund outflows.

Now, let us explore how the Indian markets and economy are likely to be impacted at this juncture.

Data from the past one year shows that BSE Sensex did not move more than 1% on either side after Fed announced its interest rate policy. When the US central bank hiked rates in December 2016, Sensex tripped only 0.3%, while after the rate hike in March it actually rose by 0.7%.

As per an article in The Economic Times, India is currently seen as being better equipped than other emerging markets to ride the impact of higher US interest rates because of its stronger economic growth and impressive foreign exchange reserves of more than US$300 billion.

Foreign portfolio investors may not drain away funds from India in a knee-jerk reaction to the Fed rate hike, as that would mean missing out on the enormous growth opportunities Indian markets offer.

HYPERLINK "https://www.equitymaster.com/stockquotes/indices" Share markets in India have recently touched new highs, boosted by domestic capital inflows and local factors, reinforcing the impression that foreign fund flows' impact on the markets would be limited.

As Rahul Shah, Co-Head of Research writes in Equitymaster Research Digest:

• "If such a small move sounds unworthy of your attention, you would be right. The hype and hoopla surrounding Fed meetings is irritating at best and dangerous at worst. Long-term investors would do well to avoid getting swayed by such events."

However, the US Fed rate hike could have some short-term impacts on the Indian economy and markets.

Hence, there could be some outflow from the Indian stock market as part of general reallocation of funds by foreign investors. However, any short period of downslope that follows a fed hike could always be corrected by domestic investors. Also, low crude prices in the past few years helped India reduce its current deficit account strengthening external balances.

While our ability to withstand gradual US rate shocks as the Fed looks to normalize rates further in coming quarters may have gone up, any short term volatility does not take away from the long term potential of the Indian share markets.

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